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Wednesday, 28 December 2011

The 2012 Outlook for The Netherlands and Europe (part I): a decisive year

This outlook reflects my personal opinion and should not be considered as an investment advice. I don’t take any responsibility for failed investments that were based on my predictions.

Today it is December 28, 2011; three days before the end of the year. A year that many people hoped ‘would bring new economic growth and zest to Europe and the United States’. In reality, it brought in Europe the second leg of the credit crisis.

And in the US? A situation of stagnation at best, with stagnating unemployment rates, a stagnating consumption and a stagnating housing market. Although there have been the proverbial green shoots during the year, these looked in general like green asparagus in a big bowl of tomato soup.

And now the year 2012 will come. The year of which the Maya’s said, it will bring the end of the world as we know it. And although I neither believe the Maya’s, nor Nostradamus, the Jehova’s witnesses or the position of the vermicelli in my soup bowl after eating, 2012 will be a decisive year.

It will be the year that either decides whether we have a W-shaped recovery, or an L-shaped (L for Long) recession aka depression. And it will be a year in which we hope that the leaders will show their true leadership, strenght and wisdom, but in which we fear their selfishness, indecisiveness and stubbornness close to stupidity.

Like many other newspapers and bloggers I will make an Outlook for 2012, based on a number of topics. Although such an outlook is the (non-)scientific form of ‘reading tealeaves’, it might help you to organize your own thoughts on the economy of the coming year.

Today the first part of this outlook will be issued and tomorrow the second part. As this will be a bearish outlook in general, I hope to be wrong in most cases. But I’m afraid I will not be.


As mentioned earlier, 2011 was not the year in which our leaders surprised us with their leadership, strenght and wisdom. This was the year of: everybody for themselves and God for us all in Europe and Democrats vs. Republicans (Civil War v1.1) in the US.

To be honest: I’m not very hopeful that this behavior of EU and US politicians will change in 2012 and that the true leaders will stand-up. If the situation around the Euro and the PIIGS remains fairly stable and doesn’t become much more desperate at once, the European leaders will continue with only paying lip service to the European cause. They will go on with pleasing and serving their (more and more xenophobic and autistic) grassroots instead, while ignoring the European big picture.

In that case the financial markets will continue firing warning shots and the Euro will remain under continuous pressure, without breaking really. Europe will run a substantial risk of getting into a situation of stagnation and a long period of minimal growth that might last for ten years or even longer (the Japan scenario).

As we speak, President Barack Obama is busy with trying to lift the debt ceiling in the United States, as he did before on a number of occasions in 2011. And every time this led to a brawl between the Democrats and the Republicans, as both parties tried to get their portion of pork in the emergency laws that were necessary to fix the debt ceiling. By the way, until now the Democrats have been less succesful in saving the social security system than the Republicans have been in saving their tax cuts for the richest 1% of the American population. This is a bad omen for American leadership, I guess.

The only trigger for really new leadership might be when the economic situation in the EU and/or US deteriorates in such a tempo, that new leaders must rise to save the day and push the old leaders to the side. This might not be a pleasant process, however.

The Euro and the European Debt Crisis

In spite of all the sensational, short-winded and gloating news from ‘the Anglo-Saxon regions’, like the US, Canada and the UK that predicted ‘the fall of the Euro within ten days’, the Euro is still here and it is here to stay.

Forget Mish and all the other false prophets of Euro-doom and gloom. And forget British members of the European parliament screaming at the chairman about the subject of their wrath: the Euro.

Just look at the facts: The Euro-region as a whole is still much healthier than the United States’ and British economies. It are the exceptions, however, that cause everybody getting the willies: Greece, Portugal, Spain, Ireland and Italy (i.e. The PIIGS).

The fact that I’m not optimistic on European leadership in 2012, makes that I’m not optimistic on the Euro in 2012. But I’m not so pessimistic that I think that the Euro will be abolished in 2012; there is simply no alternative for it.

The European debt crisis, however, will not be solved in 2012, unless there is an immediate cause for it. This is clearly a leadership problem, as I wrote before in this article.

It is much easier to play the ‘blame-game’ towards the peripheral countries and to ‘save our own export’ than to push all acrimony to the side and create a giant Marshall-plan 2.0 for the PIIGS-countries, helping them to recreate their economies. But ‘easy does it’ does not work here! If the ECONOMIC problems in these countries will not be solved in 2012, than the European debt-crisis won’t be solved too. And the economic problems won’t be solved, before the structural imbalances in Europe (huge net-exporters vs huge net-importers) are taken away.

Now the only thing that happens is that the EU and the IMF are cutting down the living daylights out of the PIIGS. As a consequence of the austerity measures that were introduced in Greece, some Greek people started to live in caves again (sic), as they can’t afford their houses anymore. And one in two shops in Greece is vacant currently. Economic recovery for Greece is a mirage and the situation in Spain and Portugal isn’t much better.

As I wrote earlier in this article: my most plausible scenario for 2012 is one of stabilization and stagnation of the Euro-crisis, with ‘pivotal’ EU-meetings throughout the year, but without true solutions for the existing problems. The situation won’t become much worse, but it won’t become much better either. The relatively unhealthy Euro-countries (i.e. The PIIGS, France (!) and Belgium(!)) will stay unhealthy and the ‘healthy’ countries (the others) will become less healthy as a consequence of the continuous pounding from the financial markets. Interest rates will go up for all parties involved and the economies of all countries will deteriorate. Unless…

The banks

In my opinion, 2012 will be the year of continuous pressure on the banks, due to:
·    (inter)national legislation and supervisory rules;
·    growing capital demands (i.e. Basel III) that minimize the banks’ possibilities for profitability;
·    the wholesale markets for funding being close to a lock-down situation
·    the lack of mutual trust between banks;
·    deteriorating asset quality;
·    the soaring distrust of banks in their own customers;
·    the classic earnings model turning into a mirage.

Legislation: In 2012, the internationally operating banks will presumably be caught in a web of national, international and supranational legislation. In The Netherlands alone the credit crisis and the stalling housing market led to a boom in legislation and new supervisory rules, all meant to put the banks on a short leash.

It is an illusion to think that all international legislation and supervisory rules will be complementary to existing legislation in other countries. What is mandatory in one country might be a crime in another country. Think for an example of the Swiss banking secrecy vs. US legislation towards tax evasion. I therefore expect the number of criminal cases against banks to go up in 2012, for cases like helping with tax evasion, misfeasance, inadequate information, fraudulent or illegitimate advising and illegal offshoring of assets by using Special Purpose Vehicles.

Capital demands: Another factor are the Basel III capital demands that are getting more serious for banks currently (solvency and liquidity demands) and force banks to either increase their equity or shrink their balance sheets, while keeping large amounts of useless cash in order to meet the Basel demands. Both options are extremely unattractive at the moment and will remain unattractive in 2012. Two questions concerning this topic are:
·    Who wants to buy the assets that other banks abolish, unless for an absolute bargain price that makes the investment virtually risk-free?
·    Who wants to invest in a financial institute, when the current earnings model has become obsolete?

The answer is: nobody.

The only thing that banks therefore can do is cutting costs and hoarding profits. Banks will in return show more and more risk-averse behavior and will be less and less helpful to their customers.

Wholesale markets: at this moment we have the crazy situation that European banks have stored about €412 bln AT the ECB, while 500 other banks borrowed €459 bln FROM the ECB through a special lending facility. This means clearly that the wholesale money markets don’t work at all at the moment, making the ECB in fact the lender of last and only resort.

Mutual trust between banks: This subject has everything to do with the previous subject. Banks don’t trust eachother and especially don’t trust other bank’s assets. They are afraid to find ‘shaky’ assets, like bad sovereign bonds, bad Commercial Real Estate (CRE) loans, bad Residential Real Estate (RRE) loans, mortgages and coverless loans and worthless derivatives with excess book values.

Banks rather stash their whole excess money supply for 0.25% interest at the ECB than to lend it to another bank for 1+% interest. I expect this situation to remain unchanged for as long as banks don’t give full disclosure on their asset quality.

And I am very pessimistic whether this full disclosure will happen during 2012: only when you look under the hood, you can see that a car doesn’t have an engine. Therefore I suspect the hood to be locked tight in 2012.

Deteriorating asset quality: The amount that Dutch banks have written off on their mortgages and especially the collateral for this mortgage, is still minimal. As long as people pay their mortgage, this is not much of a problem. It becomes a problem, however, when people can’t pay their mortgage anymore and can’t sell their house at the same time.

When the collateral needs to be auctioned, the yield might be (far) below the book value that is kept by the bank. That means a substantial write-off for the bank. And now the number of auctions is still low, but I’m convinced this will change for the worse in 2012.

The same problem with excess book value occurs in my opinion within the CRE-portfolio of banks. On December 5, I wrote about the totally failed auction of CRE owned by Uni-Invest , in spite of a 40% discount from the normal sales price.

Since then I didn’t hear or read anything about huge write-offs on CRE at the large banks. My conclusion is: nothing happened. The ticking time-bomb is still there and will be there in 2012.

Soaring distrust: banks not only distrust eachother, they also distrust their customers. It is simple: Small and Medium Enterprise entrepreneurs find it very hard to get a loan at the bank. Would-be homeowners find it very hard to get a mortgage that enables them to buy a house at current prices. Current mortgage holders are urged/begged by the banks to repay their redemption-free mortgage after all. And the only thing that banks are doing currently, is increasing their capital rates. Who is making money here?

Classic earnings model: See the previous subject. The classic earnings model for banks is dead.

The current Basel III solvability and liquidity demands make it much harder for banks to make a decent Return on Investment (ROI) for the ‘little’ amount of money they have left for investments. Besides that, for smaller banks it is extremely hard to acquire cheap capital outside the ECB and therefore these banks are very reluctant to invest this capital again.

The only category of investment that yields good profits are risky investments and most (non-government owned) banks are scared sh*tless for taking risk nowadays. The consequence is that most banks are hoarding cash and don’t want to reinvest this again. Hence: banks must think of a new earnings model, as the old one doesn’t work anymore.

Tomorrow part two in this series.

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