Editor’s note: This article was first published in August 2013; Bridgewater’s assets under management, the upcoming bank stress tests, the expected second rescue for Portugal and the capital needs of Spanish and Italian banks reflect that time. Portugal exited its programme in May 2014 without a second rescue.
Bridgewater Associates manages more than 150 billion in global capital. Its latest report, covered by ValueWalk, is devastating for Europe and would reflect institutional investors’ true feelings towards our European Union, where, according to them, a new perfect storm could break out within a matter of months. To that end, they point to five initial signs to keep a very close eye on.
Bridgewater begins by saying that it is paid to keep its eyes out for “storms” and to protect its clients’ capital by identifying the problems that others are not paying attention to.
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The stress tests of the financial system could once again heighten the problems around some specific banks.
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The plans for dealing with troubled banks could lead to a situation that reminds us of what happened in Cyprus.
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Portugal’s debt problems.
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The continued build-up of debt in France could cause serious problems.
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International attention on all these problems could make them worse.
They explain:
In the coming months there will be stress tests, and Portugal will have to arrange another bailout. Both issues could raise new questions for creditors. With the sovereign debt problems Europe has to face over the next two years, a loss of confidence could quickly set off another crisis.
Some of these issues could once again push up banks’ short-term funding costs, reduce the availability of credit and trigger capital flight, because after seeing how the Cyprus crisis was handled, big money needs only one doubt to pull out of the eurozone, especially knowing that deposits above 100,000 euros are not insured.
Perhaps the biggest problem Europe faces is the memory of how Cyprus was handled, since it showed that Europe does not know how to manage its crises.
Portugal, Spain and Italy
Bridgewater says that Portugal is still “stuck” in a “very ugly deleveraging”. The decisions that have to be made in Europe, including the bailout of Portugal, will be quite difficult, since it could no longer be said that Greece was an exception if Portugal ends up needing to restructure its debt.
A restructuring of Portuguese debt would seriously frighten investors about Spanish and Italian debt, and Portuguese banks also hold large amounts of government bonds.
Despite the prolonged recession in Italy and Spain, the banks are in very good shape thanks to the ESM (the European Stability Mechanism), liquidity from the ECB and so on. However, because Italian and Spanish banks are among the largest holders of that debt, and have increased their exposure, this will make investors extremely cautious. Combining their private and sovereign debt exposures, the banks of Spain and Italy would need roughly 75 billion in capital, and the scale of those capital needs could be even greater if these banks were hit by a Greek-style PSI (private sector involvement, that is, losses imposed on private bondholders).
On top of all these risks, the firm points out that European banks also face pressure from Basel III and the EBA (the European Banking Authority), including leverage ratios, capital ratios and much more.
And of course, there are still many investors who keep saying that the single currency is not viable because it lacks a rebalancing mechanism like the one the dollar has.
Featured image: Jsobral, CC BY-SA 3.0, via Wikimedia Commons.
