German debts set to blow ‘like a grenade’-Pritchard

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Completely agreed about the possibility of a bank blow up.

And it’s also possible the government plan blows up the government.

The eurozone is the region vulnerable to ratings downgrades- both banks and national governments.

Not the UK and US governments where spending is not revenue constrained.

The ECB can ‘save’ the eurozone but only by extending credit beyond that ‘permitted’ by the treaty which in some ways they have already done.

This warning comes from a financial regulator:

German debts set to blow ‘like a grenade’

by Ambrose Evans-Pritchard

May 25 (Telegraph) — German debts set to blow ‘like a grenade’
Germany’s financial regulator BaFin has warned that the toxic debts of the country’s banks will blow up “like a grenade” unless they take advantage of the government’s bad bank plans to prepare for the next phase of the crisis.

German Chancellor Angela Merkel’s bad bank plan has been heavily criticised Photo: EPA
Jochen Sanio, BaFin’s president, said the danger is a series of “brutal” downgrades of mortgage securities by the rating agencies, which would eat into the depleted capital reserves of the banks and cause broader stress across the credit system. “We must make the banks immune against the changes in ratings,” he said.

The markets will “kill” banks that try to go it alone without state protection, warning that banks have €200bn (£176bn) of bad debts on their books. “We are pretty sure that within a month or two our banks will feel the full force of the sharpest recession ever on their credit portfolios,” he said, speaking after the release of BaFin’s annual report last week.

The International Monetary Fund (IMF) has called for a stress test for Europe’s banks along the lines to the US Treasury’s health screen, saying the region “urgently needs to weatherproof its institutions”.

The IMF said European institutions have written down less than 20pc of projected losses of $900bn (£566bn) by 2010. Euro area banks will have to raise a further $375bn in fresh capital, compared with $275bn for US banks. The Tier one capital ratio is 7.3pc in Europe, and 10.4pc in the US.

The German bad bank plan has been heavily criticised as an attempt to brush the problems under the carpet until after the elections in September. It allows banks to spread losses over 20 years in an off-balance sheet vehicle – much like the “SIVs” that masked their extreme leverage in the first place – and risks repeating the Japanese error of letting “zombie” banks limp on rather than purging the system.

The recession has hit Europe much harder than expected. German GDP has contracted by 6.9pc over the last year, and the eurozone as a whole has shrunk 4.6pc, although there are signs that the economy may be through the worst.

Germany’s IFO business confidence index rose to 84.2 in May, the highest since December, and German exports have started to rise again after a catastrophic fall of 16pc. But Carsten Brzeski from ING said it is too early to celebrate.


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5 Responses to German debts set to blow ‘like a grenade’-Pritchard

  1. warren mosler says:

    i’d call the euro ‘unstable’
    it could go anywhere depending on a whole variety of possible shocks


  2. Dissenting Comments Encouraged says:

    This is what happens when car makers get that keynes monetary disease, instead of making better cars, they live or die by monkeys clicking buttons back and forth on a bloomberg terminal – disgraceful.

    Recall that Porsche engineered a massive short squeeze of Volkswagen common stock (VLKAF.PK) just a few months ago. Volkswagen’s common had been shorted by arbitrageurs who went long the undervalued preferred at the same time. When Porsche announced that it had acquired 75% of Volkswagen through options and intended to take over the firm, the common stock soared while the preferred didn’t budge. This led to large losses for the hedge funds when they had to cover their short positions in the common.

    The flipside of Porsche’s large position in VW option is that their exercise is coming up on June 19th. Options on 23% of outstanding VW shares will expire that day, representing almost half the free float. Currently, Porsche owns 50.8% of the common. Most of the outstanding options are likely to be held by Porsche, which has announced that it controls some 75% of VW shares through direct ownership and OTC options. Many of the options are cash settled. The banks that sold Porsche the options are likely to have hedged themselves through exchange-traded options and also by acquiring underlying shares and hedging them with puts. This would explain the large number of outstanding puts with strike prices between Eur 100 and 800.

    The risk is that the unwinding of the hedges on cash settled options will lead to massive selling of the VW shares. This would depress the value of Porsche’s holdings of VW, and flow through the income statement. Much of last year’s gains by Porsche were realized through the appreciation of VW shares during the short squeeze. Upon the expiration of the options, the opposite effect may happen, and Porsche will face losses of billions of Euros.


  3. Curious says:

    Can somebody explain (or post a link) why the eurozone is different than the US? If I’m understanding correctly what Warren wrote, they are revenue constrained?


    Matt Franko Reply:

    this may help
    Im not sure about his conclusions but in the front of the article he quickly summarizes the contraints.


  4. knapp says:

    Would you attributre $us weakness vs. Euro to the larger US budget deficits coupled with the rise in commodity prices (making US$ easier to get)? How else to explain the Euro strength?

    In order to save the Euro, it appears the ECB needs to let it crash (to parity with the dollar??) by aggressively relaxing its fiscal fetters. If the Euro continues to strengthen without structural change, it will likely blow up instead, especially since the rating agencies, having messed up with the subprime crisis, have a born-again zeal for downgrading.


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