July 14, 2014

Doug Kass shares his worry on EU Banks effects on European economy

I spent the better part of my early Wall Street career following the banks. I have some Street cred.

It all began when I was a Nader Raider, and I wrote three chapters in Ralph Nader's book Citibank while an MBA student at Wharton. (It began my master's thesis, and I got an A+!) I then went on to the research department at Putnam Management, where I covered the banks, government-sponsored agencies, savings and loans and selected financial companies. (Institutional Investor Magazine voted me the No. 1 buy-side banking analyst in the 1970s.)

Leading up to the Great Recession, I accurately forecast that the deepening problems in the U.S. financial sector would lead to a massive global credit crisis and economic contraction. I made a lot of money being short Countrywide Financial, Citigroup  (C), Bank of America  (BAC), AIG  (AIG), MGIC Investment  (MTG), PMI Group, Radian (RDN), Ambac  (AMBC), MBIA  (MBI), Fannie Mae, Freddie Mac and others. Most of these stocks declined by over 90% when I was short them. At one point, several dropped by 99%!

Which brings me to the current situation in Europe's financial community.

Banco Espirito Santo has been viewed as a primary source of concern in the global markets this week. In reality, the Portuguese lender's credit problems and accounting irregularities are a one-off and don't represent a systemic problem.

There are more significant skeletons in the European banking closet, however, and Banco Espirito Santo doesn't reside in it.

Over the past two years, verbal jawboning by European Central Bank President Mario Draghi has artificially buoyed sovereign debt prices/values and depressed sovereign debt yields -- the banks in Europe are loaded up with this paper.

If the ECB experiment fails, the entire EU banking industry is in jeopardy, and a systemic failure will follow.

It is important to note that the European banking system is much more leveraged than that of the U.S. -- oversight and regulation is weaker, and EU banks play a greater role in their economies, as they are far larger relative to European GDP than in the U.S.

Thus far, the markets are not disconcerted and have accepted ECB policy/influence (artificial as it is).

But if, as it appears, the European recovery might be weakening (see below), therein lies the skeleton in the European banking closet. EU banks' balance sheets are filled with artificially priced and inflated notes and bonds.

via thestreet.com