Although people around the world are focused on holiday shopping and vacations, the global financial epidemic of too much public debt isn't taking a break.
Since the beginning of Europe's financial crisis, its corporate and political leaders told us the problem was contained. But each step of the way, they've been wrong. And today, all signs indicate that Europe's financial crisis is spreading like gangrene. This is not a scare tactic, but an honest evaluation of the facts. Let's analyze some of the reasons behind this.
1) Europe's banks are undercapitalized. European banks are facing a liquidity crisis, even though they've already received an emergency cash infusion from a coalition of world central banks. The International Monetary Fund (IMF) in its 'Global Financial Stability Report' estimates $408 billion in bank's risk exposure to toxic government debt from countries like Greece, Ireland (NYSEArca: EIRL - News) and Portugal. Because Europe's crisis is moving so rapidly, even IMF is having trouble estimating the true liabilities for European banks. In August, IMF said it would take only $272 billion to cover banks' capital shortfall.
2) Borrowing costs have jumped. Italy paid almost 7 percent to auction 8 billion euros ($10.6 billion) in six-month bills. A month ago, Italy paid just 3.525 percent. The same thing is happening in France, who's now paying around 1.60% more on its ten-year bonds compared to Germany. Why is France's debt not trading like a AAA-rated country? What, besides everything, does the credit market know that credit rating agencies don't? Rising borrowing costs are a worst case scenario for already over indebted borrowers.
3) Banks are clueless on managing risk. Why is the global banking system a mess? Banks are incapable of properly underwriting and managing financial risk. The fact that European banks are overexposed to toxic sovereign debt is proof enough. Furthermore, UBS AG (NYSE: UBS - News) is the latest poster child for incompetence when it comes to supervising its trading desks. It's never a good time to announce $2.3 billion in losses from bunk trades because of a 'rogue trader,' but doing it during the middle of a credit crisis is surreal. How many other banks are at jeopardy for this same kind of nonsense?
4) Credit downgrades, everywhere. We don't advocate putting implicit faith in credit ratings, because history has taught us they are nothing more than financial opinions and frequently, not very accurate ones. Still, a gander at the latest downgrading trend is troublesome. Intuitive observers will note, this is not an isolated phenomenon, but a global trend. Sovereign debt from Greece and Portugal, after several downgrades, is now rated junk, Ireland has been downgraded, Italy has been downgraded, and Japanese along with U.S. debt was lowered in August. The pace at which government debt is being downgrade is accelerating and reversing this trend won't be easy.
5) Too many cooks in the kitchen. One of Europe's (NYSEArca: FXE - News) problems in solving its crisis is its magnificent bureaucracy. Between the Economic and Monetary Union (EMU), European Banking Authority (EBA), and EU finance ministers everyone has an opinion on how to fix things but nobody can execute. Layered on top of this melting pot, are individual countries within the eurozone, each with its own distinct set of financial regulators with their own viewpoints. It's a conglomeration of confusion and the perfect recipe for getting nothing done.
6) Ineffective financial regulation. Financial regulators are prodigious at inventing new rules but much less proficient at enforcing them. In many ways, Europe's crisis is just like the U.S.' - a colossal failure by regulators to regulate. Rules are of no protection if they are selectively enforced or not enforced at all.
7) Over-concentration of financial power. The Oscar winning documentary film 'Inside Job' was too angry of a film for me and badly missed at articulating the 4th grade antics of Wall Street's elite. Nonetheless, it explained how U.S. financial services industry (NYSEArca: XLF - News) became too large too fast. What's changed since then? More assets and power have been concentrated in fewer surviving firms, which has increased everyone's risk should one of these institutions fail. The problem of 'too big to fail' still hasn't be solved domestically or internationally.
8) Squandering public funds. Instead of letting troubled financial institutions or governments fail, regulators and quasi-regulators have thrown (and continue to throw) trillions of dollars trying to save them. In the U.S. it was a $700 billion bailout and in Europe (NYSEArca: VGK - News) it's already topped $1 trillion. These headline bailout figures, which are being funded largely by taxpayers, are probably much higher than reported. While financial bailouts in the name of saving humanity or even a country are excellent devices for delaying the inevitable reckoning day, they don't completely stop its arrival. Furthermore, the financial liabilities associated with massive financial bailouts have already begun destabilizing the financial condition of world governments previously determined as 'strong.'
9) Global flood into 'safe-haven' investments. Regardless of whether you believe in gold as an investment or not, its substantial rise has been fueled, in part, by the failure of governments to prudently manage their finances. As a result, money is flowing out of stocks (NYSEArca: VT - News) and into assets deemed 'safe' like U.S. Treasuries (NYSEArca: TLT - News), gold (NYSEArca: IAU - News), precious metals (NYSEArca: GLTR - News) and Swiss Francs (NYSEArca: FXF - News). As a side note, I grudgingly use the deceitful phrase 'safe-haven' because it suggests a false sense of security. In reality, no single investment security or asset class is technically 'safe,' no matter what persuasive marketers argue. Everything is subject to rises and falls at any given moment.
ETFguide's Profit Strategy ETF Newsletter continues to advocate a fiercely independent view of world events, financial markets and the proper allocation of money. Ultimately, building an investment strategy that can perform during any kind of market climate is a good start.
Ron DeLegge is the Editor of ETFguide.com and Author of 'Gents with No Cents: A Closer Look at Wall Street, its Customers, Financial Regulators, and the Media' (Half Full Publishing, 2011). The book is due out in early December.
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