From the August 01, 2012 issue of Futures Magazine • Subscribe!

Trading Europe today: Pay no attention to that central banker in the corner

Seeds of destruction

“The European Union grew out of the European Economic Union, which grew out of the European Coal and Steel Community, which grew out of World War II,” Schindler says. “It was all about peace, and that led to a sort of idealism that promoted expansion at all costs. A lot of stuff got swept under the carpet, and now it’s coming out.”

As it comes out, it erodes the trust that people have in European institutions — leading to a series of failed fixes that provide both opportunity and peril to anyone looking to trade the euro against the dollar or the peripheries (British pound, Scandinavian currencies or Eastern European currencies) or take a swing at Eurex’s futures on French and Italian bonds.

“We already have seen a torrent of figures, proposals, and decisions — all of which are questionable,” Schindler says. “More and more, the market is treating hard news as soft news and assuming that every bit of good news just covers a bit of bad news.”

Bill Black agrees. He’s an associate professor of economics and law at the University of Missouri-Kansas City and the former Executive Director of the Institute for Fraud Prevention, among other things.

“Take a look at the numbers being bandied about when people talk of what a Greek exit from the EU would cost,” he says. “These numbers are massively larger than what Greece actually would cost, because they’re really telling you that Greece will set a precedent, that other economies would follow and that those economies would take banks with them.”

That deduction, he says, flows from the general assumption that banks across the European Union have massive unrecognized losses that would be forced into the open if a country like Spain left the EU.

“This means they actually knew that the Spanish banks were massively under-reserved, which is a great open secret,” he says. “This despite the fact that the Spanish Securities Market Commission (Comisión Nacional del Mercado de Valores, or CNMV) is the one European financial regulator that always gets good press.”

When best isn’t good enough

As the financial crisis unfolded, he points out, the CNMV was held out as a shining example of counter-cyclical regulation. 

“It required extra reserves during the boom time, which is a good thing,” he says. “Unfortunately, the reserves it required were miniscule relative to the size of the losses, so — yes, they were directionally correct — but it’s kinda like you know you have to go up the hill to escape the tsunami, and you go up six feet but the tsunami is 60 feet.”

It gets worse, because as losses began to materialize, the CNMV used its reputation to cover losses. “It became the worst of the regulators in terms of requiring recognition of losses, and that has continued all the way up until the last week of June, when they had this silly exercise of bringing in the foreign experts to do their supposed scrub,” Black says. “The trouble is, they actually don’t look at the bad assets.”

The Spanish stress tests were carried out in cooperation with the European Banking Authority (EBA), a London-based regulator created in January of last year to monitor the financial soundness of banks. Both the EBA and the CNMV lost credibility when Spanish banks got rubber-stamped despite obvious evidence that they were in trouble.

“Spain went through almost as big a residential real-estate bubble as Ireland did, which was twice as bad as in the United States in terms of percentage of GDP,” Black says. “Yet they said everything was fine here.”

Worst of all are the country’s caja de ahorros, the savings banks that made the bulk of the housing loans. In 2010, seven of them were scooped into a conglomerate called Bankia, which was nationalized in May to prevent a collapse.

“People ask why the market goes bonkers immediately after good news, and the answer is clear,” Black says. “It’s because nobody believes them anymore.” 

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