Europe is in a mess at the moment. The once sturdy Euro has suffered some substantial blows, and a lattice of cracks have appeared in the foundation. TRG has (belatedly) come around to the idea that Greece will leave the Euro, which immediately raises the question 'what will happen to the Euro then?' Exit for Greece is bound to be messy, and the politicians have shown over and over again that they are incapable of getting in front of this crisis. If Greece leaves, then that is likely to trigger more events that will spread pain through Europe, and the world. However, Greece leaving the Euro may not even be the first event. Clearly, we are no longer talking exclusively about Greece when we discuss threats to the Euro, and TRG believes that limiting the discussion to even Portugal, Italy, Ireland, Greece and Spain (PIIGS) is too narrow. The cracks in the Euro spread far wider, for example, a credit rating downgrade in France could easily spark another moment of deep crisis.
'Fault Lines' will be a regular feature on the That Retired Guy blog, hopefully once every week or so. The idea is to look at the coming two weeks and suggest what seem to present the Euro threats. These threats are sure to change overtime, and TRG is hoping to chronicle where we are in each step.
Running (on) the Banks
The most likely catalyst for the next crisis would be if the current slow motion 'Bank jog' turned in to a full scale 'Bank Run' in Spain or Greece. The smart money (corporate deposits of international companies) has likely already left these countries, and individual deposits are slowly leaking out too.
All banks have an implicit risk of becoming insolvent if depositors all ask for their money at once. Typically, this happens when a roomer circulates that the bank is going to fail and anyone who does not get their money out fast will loose it. If this were to happen to any significantly sized bank in Greece or Spain, it would create an instant Euro crisis, that could easily result in a breakup of the currency.
The sad fact is that some people are being awfully foolish. TRG has read stories of people pulling money out of the banks to keep it in cash at home. Aside from the obvious security risk this creates, it is also completely ineffective as insurance in the event of Euro exit. In an exit scenario, ALL money inside the borders of the country will be re-denominated INCLUDING NOTES AND COINS, the military will secure the border to prevent cash from leaving. So keeping money as cash at home will not protect it. Better to open a bank account in Switzerland, or use the money to buy an asset (such as Bunds) that will continue to be denominated in a currency worth having if the Euro splits. TRG is not a big fan of gold, but it would also work as a short term store of value if the Euro breaks apart.
A Large European Bank (Anywhere) Has A Big Unexpected Loss
JP Morgan recently demonstrated that big banks have not learned any lessons from the past crisis. TRG believes this is no accented, but rather a result of the broken banking culture that continues to fester, and is decaying the banking system from the inside out. If a large European bank (Deutsche Bank is TRG's favorite candidate) suddenly announced that a few billion Euro's had gone missing due to some sloppy risk control, and/or 'rouge' trader then it would set of a shit storm in the market. Deutsche Bank is TRG's favorite candidate for such a misfortune because like JP Morgan in the US they have been a big proponent of the "But our shit doesn't stink!" line of reasoning. The reasoning is that because they survived the last crisis without any major scars, they should be seen as special. Deutsche Bank has a ridiculous leverage ratio, and a weak capital position, one reasonably sized loss is all it will take before they are suddenly looking very shaky, and the fact that the German government would inherit the problem could leave the rest of Europe in a poetically ironic state of schadenfreude. Deutshe Bank is not the only bank that could set off trouble, Societe Generale, Barclays, Unicredit, and Santander have all drunken deeply from the "But our shit doesn't stink!" trough, and any of them would suffer double if an unexpected loss were to come to light now.
The Ever-Present Political Risk
When times are rough, the simplest political mis-step can set off a major problem. We came close last week when Spain's Rajoy suggested Europe help with the Bankia bailout without getting Angela Merkel's take on the idea first. It looks like Europe will be coming to the rescue of Spain's banks regardless but the bullet seems to have been only narrowly dodged (and the Bankia story is not over yet). Political risk could also come on the campaign trail in Greece, although the real political story will be latter in June with the election itself happens.