The T Report: Killing Vampires, Werewolves, and Zombie Banks
We all know how to kill a vampire and a werewolf. For vampires you need to either trap them in sunlight or drive a wooden stake through their heart. For werewolves, you need a silver bullet. Or at least you did before the Twilight series came out. But killing a zombie bank isn’t necessarily as easy.
We all get caught up in the moment. Every tick down in the stock market adds to the fear and anxiety. Every tick up sends waves of relief through the economy. The reality the stock market and economy move at dramatically different speeds, and that is the case for bank failures as well.
While it is true that occasionally banks or companies default overnight or in very short order, that isn’t the norm. Even Lehman was a known problem for ages. Its debt traded very wide off and on for a year ahead of the eventual default. It was on the cusp when Bear Stearns got saved. Lehman got saved that time without a dime being given to it. It squandered its chance and failed to raise money in the 6 months after Bear, but it did last a long time.
Weak banks can linger for a long time, especially if someone is willing to provide them liquidity at non market (stupid) rates. Rescap affectionately known as Rescrap, although not a bank is a great example.
A solvency problem can’t be solved by liquidity, but if there is a lender willing to provide as much liquidity as it takes, and rates that make no sense for the risk, the default can be pushed off for a long time. It can be delayed much longer than we think and in some cases, avoided all together. While Rescap finally met its fate it should probably have met in 2007 or 2008, MBIA seems to have turned the corner.
MBIA has lasted this long because it didn’t require much funding and time has given it the chance to earn carry and avoid payouts.
While neither Rescap nor MBIA are banks they are decent examples of how long it can take to play out.
In the U.S. only Lehman and Washington Mutual failed. At the last moment Bear Stearns and Merrill were “saved”. Others have lingered along in various states of disrepair for a long time with full government support.
That is the key when looking at the crisis in Spain or at Bankia in particular. A solution of lots of fresh equity capital tomorrow would be ideal. But just because we don’t see capital injections tomorrow doesn’t mean it is about to default or go into full unwind mode. Unlimited 3 month LTRO and other ECB and Spanish facilities can keep it alive for quite some time, so expecting it to be an immediate catalyst to a huge down move is as likely to be true as those that hope for some magic plan from the ESM to make it all better.
Time is the key, and horrible headlines aside, it is easier to kill a vampire or werewolf than it is to kill a bank with an unlimited supply of cheap money.
Central Bank Activity
Our scorecard from yesterday continues to fill in. We didn’t get global swap lines, but we did get a China rate cut, so +1. We didn’t get a rate cut, so -1/2, but they did mention some members had voted for a rate cut, so take that as a zero, with a running total of +1.
Unlimited 3 month LTRO, wasn’t on our list but call that a +1/2. 3 year would have been better, but the focus on unlimited was good. So we are at +1.5 so far in total.
Away from that, the ECB didn’t really do much else, but Germany or someone floated a rumor that the EFSF or ESM could lend to some Spanish entity other than Spain which could then recapitalize the banks. I don’t know the source and it is so convoluted that it is unlikely to work, yet convoluted enough it seems likely some politician is really looking at it. Call that +1/2 max, but when coupled with further rumors that ESM will either get a banking license or have a lots of ECB support, lets call all the rumors and “wink wink” signals as a +1 in total. That gets us to 2.5.
The ECB did put it back on the politicians, but not as belligerently as they could have so only -1/2.
Extremely dovish Fed comments added back at least +1, giving us a current total of +3 heading into Bernanke’s testimony.
After yesterday’s comments, by Yellen in particular, it is hard to imagine anything other than an actual announcement by Ben doing a lot for the market and he could easily undo the work done by Yellen.
Still Targeting May 11th Prices
In addition to the central bank push encouraging risk on, and the overreaction to the Spanish banking crisis, I was surprised that the Spanish sovereign debt auction got done. I suspect that the banks were told to buy and some CDS short covering bids were put in, but it is still a minor positive and far better than pulling the auction.
I was also surprised just how short the market seemed to trade. I thought we were oversold, but the market traded even more short than I would have guessed.
I think the banks can be a catalyst for yet another leg higher. Clearly I’m getting nervous back up at these levels, but I think we can achieve the May 11th prices. Everyone again seems to be fading this rally or too bitter that we are moving up on a Chinese rate cut. No one has embraced the trade off the lows and too many funds seemed to have gotten whipsawed that the pain of this up move isn’t quite over.
Look for a continued bounce in HY and EM debt denominated in dollars. U.S. treasury rates aren’t going up any time soon, the search for yield will resume, and high yield will benefit from a sluggish, but stable economy, and EM will benefit from the “reflation” trade the central bankers so desperately want to see happen.