Note: if house and land prices drop in Spain in the next two years by such rates it strikes me that Spain will have problems that extend well beyond under-capitalized bank balance sheets.
Seven of those fourteen banks are reported as having failed the stress tests imposed on them by Oliver Wyman.
Oliver Wyman is said to have been assisted by the ‘Big Four’ audit firms, and supervised by the European Central Bank and the International Monetary Fund.
As might be expected, the Oliver Wyman report includes very specific qualifications, assumptions and limiting conditions. Specifically:
- the “criteria, working methods, assumptions and processes … have been formulated, specified and required” by the Banco de Espana and/or a Steering Committee (comprised of representatives of the ‘Expert Committee’) and an Expert Committee (comprised of the Banco de Espana, the Misisterio de Economia y Competitividad, the European Banking Authority, the European Commission, the European Central Bank, and the International Monetary Fund);
- the Steering Committee provided Oliver Wyman with the base and adverse macro-economic scenarios Oliver Wyman adopted when making its Spanish bank stress test calculations. As noted at page 83 of the report, the adverse macro-economic scenario was deemed by the Steering Committee to be conservative on two counts:
- relative to a 30 year Spanish history, and
- relative to scenarios used in stress tests conducted in other jurisdictions;
Note: On their face, neither of these criteria strike me as being good rationalizations for ‘conservatism’. This is because the globalized world today is very different from what it was 15 years ago, much less 30 years ago, the Eurozone has only existed since 1999 while the euro currency began circulating only 10 years ago, and because Spain and its economy can be presumed to have its own unique characteristics and prospects.
- Oliver Wyman specifically disclaimed responsibility for said “criteria, working methods, assumptions and processes”;
- information, reports and valuations produced by real estate specialists were not independently validated by Oliver Wyman;
- importantly, Oliver Wyman quite properly stated its report was relevant as at “a particular date” (presumably September 28, 2012, the date of its report) and that changed circumstances after that date could impact the conclusions expressed in its report; and,
- while I may have missed it, I could find no ‘sensitivity analysis’ in the Oliver Wyman report.
The bottom line of this would appear to be that Oliver Wyman calculated a result based on assumptions and information provided to it by others, which assumptions and information it assumed no responsibility for.
There is nothing really wrong with that, so long as no one reading the Oliver Wyman report or media coverage with respect to it does not conclude that Oliver Wyman developed its own assumptions, tested the data provided to it, and hence expressed its own independent opinion as to the extent of the current undercapitalization of Spain’s banks.
For me, all of the foregoing goes to the following question: What weight ought to be placed on the ‘undercapitalized amounts’ stated in the report under each of the ‘base scenario’ and ‘adverse scenario’ as quantified in the report? Given all of the foregoing, for me the conclusions set out in the Oliver Wyman report may be credible, or may prove to be credible, but for the time being I am far from being convinced.
The Oliver Wyman report received, as one would expect, favourable review from IMF Managing Director Christine Lagarde. One can only hope that Ms. Lagarde has taken the time to thoroughly understand:
- the assumptions and qualifications that underlie that report, and that she understands and agrees with them; and,
- the detail underlying the report.
If interested,
you can read the ninety-five page Oliver Wyman report here. Given what might prove to be serious contagion issues, whether or not this report turns out to have reached credible conclusions is potentially important beyond Spain in a Eurozone, European Union and World economic context. Accordingly, as a minimum I suggest you read the:
- Qualifications, Assumptions & Limited Conditions section (2 pages);
- the Executive Summary (5 pages); and,
- Appendix 2: Macroeconomic scenarios (2 pages)
and reach you own conclusion(s) as to the weight one ought to give to the conclusions set out in this report.
Finally, you might want to read
Spain debt rises on aid to banks, regions, finance costs. That article discusses what currently is being forecast by Spain’s government as that country’s debt:GDP ratio by the end of 2013 (90.5%), continuing protests, and notes once again Spain’s Catalonia region’s ‘calls for independence.
Topical References:
Spain banks need a 60-billion euro bailout, stress tests reveal, from
The Financial Post, from Reuters, September 28, 2012 – reading time 3 minutes. Also see:
- Spanish banks need 60 bn euros, independent auditors say, from The Telegraph, Louise Armitstead, September 28, 2012 – reading time 4 minutes;
- IMF Managing Director Christine Lagarde Welcomes the Completion of Spain’s Banking Sector Valuation, from The International Monetary Fund, September 28, 2012 – reading time 1 minute; and,
- Spain debt rises on aid to banks, regions, finance costs, from Reuters, September 30, 2012 – reading time 4 minutes.
North America >> United States: Commodity price trends as economic and stock market indicators
Why read: To test the contemporaneous views I expressed four years ago, to observe similarities and differences then and now, and to determine if you agree with my current views.
Commentary then: On
April 12, 2009 I commented as follows:
An article today titled ‘Preparing for the Dollar’s Next Down Cycle’ begins with the author saying “One thing I learned early on in my investing and trading career was that I can’t trust analysts or the news media! I learned that not only are these guys not as knowledgeable as they should be, but that they also don’t alert everyone to the fact that things are changing until well after the fact”.
The author attributes this to “analysts and the financial news media (being) horrible investors”, and because “analysts work for firms that are biased”.
The author then says that he relies on commodities “like gold, copper, oil, steel, lumber, and even a commodities index…the CRB index (which holds a basket of commonly used goods)” as an indicator for buying stocks and currencies.
His rationale for focusing on commodities as an economic and market indicator is that he believes “when an economy is turning around, companies will need to use these raw commodities to make their products in order to expand their corporate earnings”, and that “when an economy comes out of a deflationary (or even disinflationary) period back into a typical inflationary period, you will see it first in the rise of commodity prices”.
He then says he thinks (in April 2009) the “The Worst is Over, yet (there are) Still Some Bumps Left” since oil, copper, gold, lumber, etc. have all started to perk up and have broken their downtrends.
While I think the author has it ‘generally right’ with respect to analysts and the news media, I that he goes ‘far to far’ by making such broad statements. I think there are many thoughtful media writers and quite a number of good and careful analysts. That analysts may have inherent conflict of interest issues depending on who employ them is something that needs to be weighed when considering their advice. I also think the author’s analysis is very shallow with respect to what he sees as a ‘fact’ that many commodities have now (in April 2009) ‘broken their downtrends’. Thus, while I think the author of the referenced article may be directionally and conceptually correct with respect to commodities and commodity prices as indicators of economic and stock market prospects, I think he is a little, and perhaps more than a little, early in his conclusion that ‘The Worst is Over’.
A principal reason I have spent a substantive part of my time in the past two years developing the StockResearchPortal.com is because I believe intelligent investors will be more careful and doing more of their own investment research going forward, because I believe in the long term future of precious metals as a safe haven, and because I believe investments in carefully researched commodity stocks will do well going forward.
Commentary now: In the past three plus years I have become more focused on what I perceive to be a significant shift in the financial markets over the past decade from being far more trading markets, and far less investment markets, than they historically have been. Given the evolution of high frequency algorithmic trading, and its instantaneous reaction to news and events, if anything it strikes me that commodities prices in theory ought to be even better short-term indicators of economic and stock market prospects today than they were in April 2009.
That said, I struggle to apply that same conclusion to longer-term economic and stock market prospects today, as I continue today to believe there is a significant dichotomy between current financial markets performance and longer-term world economic conditions.
Brief Commentaries prompted by world headlines (collective reading time 2 minutes)
Eurozone >> Portugal >> Spain: Austerity protests in Portugal and Spain on Saturday
An article reports on further austerity protests in both Portugal and Spain. No surprise. No one is happy when their lives are negatively impacted financially. Unfortunately, it seems likely that there will be more of this type of activity both in those two countries and likely other developed countries going forward. So far, developed country protests have been reasonably peaceful. But are they going to continue to be?
Topical Reference:
Portugal, Spain hit by mass protest against austerity, from
Deutsche Welle, from Reuters, September 29, 2012 – reading time 2 minutes.
North America >> United States: Bankers complain about bank regulations and capital requirements
A recent article reports that Goldman Sachs analysts have said that new banking regulations and capital requirements are more responsible for declining bank profits than is the ‘U.S. economic slump’ – calling the changes ‘structural’ in the context of the banking industry.
I think importantly, the article reports that those same analysts have said that over half of the top 25 U.S. banks are not earning enough to cover their cost of capital. If that is true I see this as very worrisome, particularly if in the end I prove to be correct that U.S. bank book equities likely are overstated following from the 2008-2009 changes then made to the mark-to-market accounting rules.
Topical Reference:
Goldman Sachs Analysts Say Bank Slowdown Isn’t Temporary, from
Bloomberg, Christine Harper and Donal Griffin, September 10, 2012 – reading time 2 minutes.
Important Snippets From Today’s Commentaries
Snippet #1: For me, all of the foregoing goes to the following question: What weight ought to be placed on the ‘undercapitalized amounts’ stated in the September 29, 2012 Oliver Wyman Spain Bank Stress Test report under each of the ‘base scenario’ and ‘adverse scenario’ as quantified in the report?
Snippet #2: No one is happy when their lives are negatively impacted financially. Unfortunately, it seems likely that there will be more of this type of activity both in those two countries and likely other developed countries going forward. So far, developed country protests have been reasonably peaceful. But are they going to continue to be?
Snippet #3: Those same analysts have said that over half of the top 25 U.S. banks are not earning enough to cover their cost of capital. If that is true I see this as very worrisome, particularly if in the end I prove to be correct that U.S. bank book equities likely are overstated following from the 2008-2009 changes then made to the mark-to-market accounting rules.
