Come On, Seriously?

By: Michael Ashton | Sun, Jul 25, 2010
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I would like to say I am surprised, but how can anyone be surprised anymore by the shenanigans that go on at the highest levels of public policy?

The EU released their report on the results of the "stress tests" applied to 91 European banking institutions to see which of them need capital and which are doing fine, just fune. The over/under on the number of banks that would need capital, before the report, was 10. In the event, only 7 failed.

Honestly, the fact that 7 failed this test is amazing. It is like telling a room filled with 91 high school seniors that they can graduate if they can successfully spell "graduate"...and then and finding that 7 of them fail. Okay, can you spell "cat?" No? Is there any test you would pass?

All that you need to know about the test is this. Forget what economic trajectory is assumed. Forget everything else. All you have to know is that any sovereign bonds being held by banks - other than in their trading accounts, which are conveniently quite light on these securities - are assumed to be money-good. They pay off at par. The bonds in trading accounts are assumed to have mark-to-market losses; in the case of Greece this is 23% and the other countries are much less. Almost no one thinks that Greece survives without a restructuring of its debt...and folks, you don't restructure to save 23% of your debt.

This is an impossibly optimistic scenario. The capital required of the banks that failed the test totals 3.5bln Euros, a fraction of the lowest arm's-length estimates.

The only German bank to fail was the one that the government already owns. But get this: just one Greek bank failed. How dumb do they think we are? The answer, I guess is "dumb enough."

Just about every central banker came out immediately after the results were posted, trumpeting statements that "the results confirm the solidarity of banks" (as Costa from the Bank of Portugal said). What they confirm is the contempt in which the policymakers hold the rest of us.

Okay, fine. The marketing job from the regulators has been done. It's time to move on and forget that this exercise ever existed. Invest in one of the 84 passing banks at your own risk - if they go under, no one will give you credit for relying on this whitewash.

Not surprisingly, stocks were quiet in the morning; somewhat surprisingly, the market held its gains in the afternoon and the S&P index by some measures broke out of the top of the range again. I had thought equities would sag after the test results were posted, but maybe American investors don't have the highest regard for European investors and feared the latter might respond with unbridled ebullience to the news. We Americans don't understand Europeans, you know.

However, while stocks ended in pretty solid position, the VIX hasn't yet broken down and the 10-year yield is still south of 3% (albeit just barely south). I'd want to see some confirmation from those two indices before trying to ride one more buck of the bronco.

Because if we do rally, that is all I think it is. And there's never any question that the ride will end; the only question is whether you're on the horse's back, or the horse is on your'n.



Michael Ashton

Author: Michael Ashton

Michael Ashton, CFA

Michael Ashton

Michael Ashton is Managing Principal at Enduring Investments LLC, a specialty consulting and investment management boutique that offers focused inflation-market expertise. He may be contacted through that site. He is on Twitter at @inflation_guy

Prior to founding Enduring Investments, Mr. Ashton worked as a trader, strategist, and salesman during a 20-year Wall Street career that included tours of duty at Deutsche Bank, Bankers Trust, Barclays Capital, and J.P. Morgan.

Since 2003 he has played an integral role in developing the U.S. inflation derivatives markets and is widely viewed as a premier subject matter expert on inflation products and inflation trading. While at Barclays, he traded the first interbank U.S. CPI swaps. He was primarily responsible for the creation of the CPI Futures contract that the Chicago Mercantile Exchange listed in February 2004 and was the lead market maker for that contract. Mr. Ashton has written extensively about the use of inflation-indexed products for hedging real exposures, including papers and book chapters on "Inflation and Commodities," "The Real-Feel Inflation Rate," "Hedging Post-Retirement Medical Liabilities," and "Liability-Driven Investment For Individuals." He frequently speaks in front of professional and retail audiences, both large and small. He runs the Inflation-Indexed Investing Association.

For many years, Mr. Ashton has written frequent market commentary, sometimes for client distribution and more recently for wider public dissemination. Mr. Ashton received a Bachelor of Arts degree in Economics from Trinity University in 1990 and was awarded his CFA charter in 2001.

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