${Html.ActionLink("My MarketWatch", "index", new { controller = "composite", area = "section", page = "my" })} | !{Html.ActionLink("Sign out", "LogOff", new { area = "User", controller = "Account" }, new { id = "signOutLink" })}
Welcome, ${UserDisplayName}
Sign in
Become a MarketWatch member today
Jon Markman's Speculations Archives | Email alerts
Oct. 25, 2011, 4:15 p.m. EDT
By Jon Markman, MarketWatch
SEATTLE (MarketWatch) "” For once, the week started with no major press conferences, news releases, bird songs or alien spaceship emanations out of Europe. That gives us a chance to recap what's happening over yonder.
Supposedly Germany and France have inched closer to making a deal on how to bandage up their banks with taxpayer capital, a process known as recapitalization, and to leverage the emergency funding vehicle known as the EFSF in a way that wouldn't make even Bernie Madoff grimace.
The latest idea for the EFSF is that it would include a first-loss guarantee to support the primary government debt market, and, also possibly a special purpose vehicle that would support the secondary market and be funded by sovereign wealth funds and the International Monetary Fund.
Now anytime you hear the term "special purpose vehicle," or "special investment vehicle," or anything that is "special" in the finance world, plug your ears and run the other way. "Special" means someone is about to be taken, and if you don't know who it is it is probably you.
As for the bank recapitalization, reports suggest that euro zone leaders have decided that the banks need around 100 billion euros in new capital. And as for the losses that bond holders will be encouraged to take that create that need "” now called "haircuts" by the EU Departmente de Euphemisms "” it looks like France and the banks have said they won't accept more than 40% while Germany and the IMF insist on 60%. That's a difference large enough to drive a small country through "” Luxembourg, say "” and presents the largest obstacle. Read more: Europe tries to get a grip on the debt crisis.
No matter how much policy makers beam on the podium when a deal is ultimately announced, you should be aware that the combination of haircuts and recapitalizations will wreak havoc on the region's economy. The money doesn't come from outer space. It comes from ordinary citizens "” coal miners in Silesia and hairdressers in Slovenia. It means a lot less money is going to be available at banks for lending to legitimate businesses that want to expand and to people seeking mortgages.
WSJ's Thorold Barker stops on Mean Street to discuss European leaders postponing Wednesday's planned resolution on a rescue plan for ailing euro zone economies.
Banks scrambling for funds will need to shrink their lending books so much in the wake of these actions that when we look back it will seem that the euro zone forced itself into recession in order to deleverage. That could be good over the long run, but extremely tough in the short-term. Read more: Europe must do debt deal quickly.
Before you get too pessimistic though, keep in mind that success depends not on the EU bureaucrats but on the attitude of the credit community toward the end result. If "real money" credit buyers at global pension funds decide that they are willing to fund these new vehicles in return for a higher yield, they could do so and we would be off and running on a new leg of the bull market.
Here's why it could happen: Pension fund managers have a daunting task. Retirees have been promised 7% to 8% annual returns so that they can have pensions and medical care for the rest of their lives. And yet, markets have been unhelpful the past 12 years, and pension funds are way behind their bogies. So, managers may decide to roll the dice and fund these new special purpose vehicles in Europe in return for, say, a 6% yield. And they will lever that to make it 12% or more.
That may shock people, but it has happened in the past and it could happen again.
In other words, it is not just about what "makes sense" to laymen. It is what fits the needs of the sophisticated but desperate buyers of stocks and bonds in the market.
Crazy, huh? Well that's just the start.
You see, there seems to be a lot of hope that the deal forged over the weekend and on track to be revealed on Wednesday will bring the region's debt crisis to an end.
Yet that's not the betting line. The new house of horror is Italy, where 10-year government bonds are close to yielding 6% "” more than double that of U.S. Treasurys "” as buyers demand more return in exchange for the risk. Moreover this talk of a 100 billion-euro bank recap might be getting the headlines, but keep in mind that the markets think 200 billion to 275 billion euros are needed to prevent the region's banks from collapse. And let's not even start talking about the looming demands of Portugal, Ireland and Spain, whose debt shortfalls are not yet even in the mix.
Why the disconnect? Well, politicians on the Continent haven't been exactly transparent and honest about their progress on talks in the past. Analysts at Capital Economics noted today that German Chancellor Angela Merkel and French President Nicolas Sarkozy have used "a lot of smoke and mirrors in the past to make their deals seem more impressive than they really are.''
Plus even if this banking deal is the real deal it still is not going to end the crisis. Most of the southern European economies are uncompetitive and suffer from persistent unemployment. New austerity to get budget deficits under control are going to eat away at growth estimates like acid on copperplate.
The uncomfortable truth that no one wants to utter is that all the plans that they are making in regards to the recapitalizations and haircuts are based on what credible analysts consider unrealistic growth forecasts. The euro-zone composite PMI Index for October, published Monday, reflected sharp declines in manufacturing and services and is at a level that CapEcon analysts say is consistent with a GDP contraction of 1%.
In short, a crisis-spawned recession is coming in Europe, if it's not there already, and that is going to throw the estimates, hopes and dreams of euro zone officials into the shredder of history "” especially when corporate debt losses are eventually thrown into the mix.
Remember it's all about the deleveraging, and that is not a short or pretty process, as the Japanese will tell you.
Jon Markman is a money manager and investment adviser in Seattle. His easy-to-follow E-mini futures timing letter, Gemini 252 has recorded a 88% gain this year with no losing months. Past results may not be indicative of future returns. He also publishes a daily investment newsletter, Strategic Advantage , in partnership with MarketWatch His Twitter feed is @jdmarkman.
Wednesday's biggest gaining & declining stocks
Strange allies Huntsman, Vatican join bank critics
Dysfunctional Greece stares into the abyss
Wall Street neighbors should get used to noise
More risks ahead, so safeguard your portfolio now
Gold and Stocks Return to Historical Trading Form
Tricky to Time Stocks in Presidential Cycles
What Would Occupy Boston Ask Bernanke
Recession Investing: Emerging Markets In Focus
Jon Markman is a money manager and investment adviser in Seattle. For more ideas like these, try a two-week trial to Markman's daily investment newsletter... Expand
Jon Markman is a money manager and investment adviser in Seattle. For more ideas like these, try a two-week trial to Markman's daily investment newsletter, Strategic Advantage, published in partnership with MarketWatch, or his daily trading newsletter, Trader's Advantage. His Twitter feed is @jdmarkman. Collapse
Tech Investor
HomeAway workers distracted by riches
On the Markets
Why gold is rallying
Your Portfolio
More risks ahead, so protect portfolios now
Political Capital
Read Full Article »