Germanys bad bank plan, The Baltics and analysts - are they for real?

* The German bad bank plan

A week or so ago, in another market sentiment world, this plan would probably have been applauded. However, if, as I believe, market sentiment over the summer will shift towards an increased focus on the debt dilemma in Europe, the German bad bank plan will likely not be appreciated by the marketplace. Admittedly, there was a proper intital attempt from the Germans to offload toxic assets from Landesbanken and commercial banks to a government owned "bad bank".

However, since this suggestion was based on making the transfers at marketprices it failed. Reason being that the vast majority of German banks would simply have been, you´ve guessed it, - insolvent.
The discrepancy between booked value and market value was simply too big.

Back to the drawing board again. New suggestion. Plan B - sweeping it all under the rug, almost. The new bad bank plan also includes a state owned "bad bank". German banks will transfer their toxic assets to the "bad bank" at 90% of their booked value. They will then pay a yearly fee (out of their dividends, not their profits), with the purpose of building up a cushion for potential future losses.

The "bad assets" vehicle will not be marked to market and will not be settled with the banks til the end of the instruments maturity. The "bad bank" will be financed via government guaranteed "toxic" bonds. Taxpayers - you like? I wouldnt. Anyway, in my view, this strategy is based on the, these days, global government standard response - the Ostrich method. Slogans; "If you cant see it - it isnt there", "Out of sight - out of mind".

Europe is counting on the US and Asia dragging Europe out of the mud soonish. There sure does not seem to be any European plan as how to do anything about it themselves, so far. Well, Im not sure the US and Asia are sound and healthy enough to pull it off this time around. If not, Europe will be in for a very, very tough period ahead.

With the German bad bank plan lacking mark to market ingredients, it becomes a static approach, with no riskmanagement taking place. This means the German taxpayers are potentially faced with a 1 Trn (likely to be less) Usd bomb detonating at some point in the future. Clearly, the "fingers crossed" riskmanagement approach rules over there.

German CDS spreads should widen on the back of this plan. To top it off Germany is facing an estimated 350 BN Eur shortfall in tax revenues til 2013. Hence, an increase of the budget deficit or a reduction of expenditure will be the outcome. I would guess the first alternative is the most likely from a political point of view. In either case, it will not assist in any recovery.


* Analysts are analysing the "worst case" scenario for the Baltics - or are they?

There seems to be one big factor missing when analysts are coming up with a "worst case" scenario for the Swedish banks credit losses in the Baltics. The level for Swedish creditlosses during the crisis in the early nineties is often referred to as a benchmark for creditlosses also in the Baltics. To me this is grossly misleading and a vast underestimate of the real risks for creditlosses in the Baltics.

The Swedish credit stock during the beginning of the nineties was almost entirely in local currency. In the Baltics, hard currency loans account for 60%-80% of the outstanding loan stock!Thus, a devaluation will have a devastating impact on creditlosses.

During the Asian crises in the late nineties, creditlosses reached levels of 40% - 50% in countries suffering devaluations and with a large share of hard currency loans in their loanstocks. This is a classic macro development. Fixed exchange rate regimes drastically increases the risks for overleveraging, overconsumption and misallocating investments. "Arbitraging" by borrowing in foreign currencies with lower rates, in the belief that the fixed currency regime will stay on just as the politicians has promised.

It is a downward spiral that at first appears as an upward one. This time is no different. The Baltics will hit Sweden´s taxpayers hard, you´ve better believe it. Hopefully politicians will make sure the bank shareholders and debt owners will pay their due price as well.
15%-20% creditlosses is not a "worst case" scenario. 40% - 50% I believe is more like it, based on a 40% - 50% devaluation across the board of the Baltic currencies. Social upheaval not included.

Disclosure; Long Eur/Lvl Forwards, Long Swedbank puts.

* New positions and position changes
- Took profit on my long Eur/Pln




As usual, good luck




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