There Will Be No European Liquidity Crisis

The European Kigyo Shudan, Or The Return Of Zaibatsu

“Credit is a system whereby a person who cannot pay gets another person who cannot pay to guarantee that he can pay” – Charles Dickens.

Mr. Dickens ought to know. When he was 12, his father and family were imprisoned in the Victorian era Marshalsea debtor’s prison. This quote to me typifies the current woes of the European banking system, and their latest solution balloon which was floated Monday: the European Investment Bank, a.k.a. the EIB. Headlines have it that it is bound to be much more effective than the European Financial Stability Fund, a.k.a. the EFSF. That’s not difficult. Here is a quote of my August 11 article:

THEY INVENTED THE EFSF! Seventeen member countries would guarantee, on their own finances, billions of bonds that would be issued to the weakest of them. The problem is, seven of the guarantors were the recipients of the same money they could not repay in the first place, but that they would happily guarantee.

What the EIB does is kind of the same. It boasts total assets of 420 billion Euros and a very conservative 232 billion in subscribed capital. Wait, what’s this fine print “paid-in capital, 12 billion”? Oh, you mean that only 12 billion has been called and paid for, the rest is “guarantees”? Right. To be fair, reserves account for another 28 billion, so the bank’s “own funds” equal 40 billion Euros. I guess the leverage is not that conservative.

However, it is not that high either, at 10 times. And the contributors' base is larger than the 17 Eurozone members of the EFSF. It extends to all 27 EEU members to include the UK. So the ratio of dubious guarantors is lower – except in the top five, Spain and Italy account for 14% of the “subscribed” capital. Regardless, the EIB debt is rated AAA. It seems that the markets, having spent a few too many weeks navigating between the Charybdis and Scylla of headline news, are now throwing in the towel and are ready to believe in…leverage!

Hey, if the bad debt can be mutualized, why not? It is merely a transfer from the private to the public sector, and debt is like deferred taxes anyway – it does not impact short term cash flow, except for interest payments, currently at near zero percent and negative in real terms. This looks more and more like the Monte Commune of Florence in the 1300s.

So be it, and rest the case I have been making for a couple of weeks now: there will be no European Liquidity Crisis. It will guarantee, then monetize, and eventually nationalize – this is what Germany did to Hypo Real Estate in 2009. It first provided $109 billion in guarantees, then nationalized it.

One step at a time. Like the market. Last Friday, I suggested a first resistance at S&P 1150. It was tested at around noon Monday. Then on the EIB news, we closed at 1163, near my second step of 1170, with a Eurodollar December Futures in recovery mode, and strong moves by my two flagship European banks, Barclays (BCS) up 10%, and Deutsche Bank (DB) up 12%. Not all is well though – HSBC (HBC) is up a mere 1.9%, and it’s the world’s largest.

Now, why the title? I have long held the view that in Europe, there was an incestuous interlocking relationship between banks, industry and politics. If you think we are bad, check over there. Students don’t cross state lines to go to Universities – they go to their own, usually a couple of leading ones per country. And it’s not really meritocracy, but lineage that counts – “who is your father” is the main unspoken interview question, usually preceded by a friendly phone call. Remember, all these countries were kingdoms not long ago – and some still are. Not to mention corporatism. In any event, this EIB story was the missing link to the European version of such Japanese pre-WWII conglomerates called Zaibatsu, now Keiretsu. They all centered on a bank. Germany has Deutsche Bank; Europe now has the EIB.

While Monday’s move is a bit rapid, it is not out of the recent norm. I thus maintain my targets – 1194 with a first stop at 1172, then 1210 and eventually 1270, depending on Q3E (not QE3), and our own politics.

Click here for Part II

Disclosure: I am long PPG, WCC, URI, GTI, AGM, WWD, WSBC, MYE, TOL, SLM.