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ECB: Waiting for the Other Shoe to Drop?



October 08, 2011 – Comments (0)

The European PIIGS debt problems has left the European Central Bank to survey a sobering landscape. The downgrades by credit agencies on sovereign debt is a re-affirmation of the trouble right now. The exposure of banks and governments to the PIIGS is firmly in the crosshairs of investors. US bank exposure is estimated at over 600 billion while the German and French have 1.2 trillion in the troubled region. One could argue that international banks with large Eurozone exposure are starting to price in wide scale dilution and credit loses that could be realized if the crisis widens.

The political willingness of France and Germany to boost the European Financial Stablility Facility  (EFSF) from 440 trillion euros to 1 trillion euros has been labeled as a move of last resort. French and German leaders want banks to raise money through stock offerings first.

The recapitalization request appears to be a move to delay the inevitable. Its almost as if the ECB is convinced for every action they take will lead to a worse reaction by the market. This may be true, but it doesnt mean they should move slowly on addressing the problem.

The inevitable is that the ECB will be forced by the market to provide liquidity by using the (EFSF) emergency fund at an unscheduled point in time. I tend to believe that as borrowing costs soar and downgrades worsen, the exposure levels of big banks and borrowing costs of Eurozone nations will unnerve the system more each day. It is just a matter of time

While comforting words by Geithner or Merkel sure up some confidence in a broad solution, it is not the resolution. The October 16-17th regularly scheduled meeting of the ECB may result in some action, but its likely something more comprehensive may be pushed to November. They want this to be fixed in an orderly way. However it is foolish to think that if only a few nations of the 17 are raging out of control that they can still have an orderly conclusion. Contangion can wake up the soundest of sleepers.

On the other hand, it may be that the political ground cover these leaders are looking for is a capitulation type sell off that sends shock through the markets a la 2008. Only when people cry "do something now", will something be done. With these realities in mind, I am bearish until the panic switch is hit.

At the very least the complexity of the problem leads me to believe it will remain unresolved in the next 30-60 days. Also the size of the bailout will likely expand each day it is unresolved. In light of this mess, I am very bearish on the Euro and Bullish in the dollar over this 1-2 month time frame, and would not own equities until the EFSF is unleashed or the other shoe drops. 

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