You know …

… things are really bad for a bank when it fails a 'stress test' that was probably explicitly designed to only test the most benign imaginable scenarios (based on current and fairly recent price discovery in debt securities). We are writing tongue-in-cheek of course, but the fact is that analysts far and wide have criticized the stress tests for what they very likely are: a propaganda exercise that avoids the very worst case scenarios it is purportedly testing.

 

Our  dear bureaucratic leaders think it is all about 'confidence' and not so much about reality. If confidence can be restored, reality will follow suit, or so the thinking goes. This isn't even completely wrong – you can certainly buy time that way. In the past few decades, this trick has always worked as it were. Papering over crises has come to be seen as a tried and trusted method of dealing with them.

The restoration of faltering confidence about the sustainability of the debt-based system was regularly achieved by creating even more credit in even greater abundance than in the previous iterations of the long boom.  Alas, the engines of inflation appear slightly stalled since 2008, at least as far as the 'normal' modus operandi of this method is concerned.

Hypo Real is a German bank, but it was part and parcel of the Wall Street money creation machine in its hey-day. Looking back at the 1998 crisis in Russian/Asian debt, or the 2000-2002 crisis (when it was discovered that vast malinvestments had taken place in the course of the technology boom), it was always the same well-oiled machinery that sprang into action.

The Federal Reserve would cut its interest rates, and the US-based GSE's Fannie Mae and Freddie Mac would begin to balloon their balance sheets at unusual speed, buying up mortgages from the banks and bundling them into securities. This in turn would free up bank reserves and allow banks to lend money at accelerated rates. Much of this lending naturally went into real estate and the associated industries, a tendency that became especially pronounced after 2002.

Hypo Real was taking part in this particular boom by becoming one of the countless 'borrow short, lend long' vehicles that financed themselves in the commercial paper and repo markets and then went on the 'hunt for yield'. The  'brilliant' financial innovations that allowed complete garbage to masquerade as investment grade debt were a godsend for this kind of activity. It seemed like a vast, indeed sheer limitless free lunch, as AAA rated assets of course do not require much by way of a regulatory capital cushion – so there was nothing to restrain leverage. Never before were so many air-castles built on the quick-sands of debt and leverage.

 

Good banks, bad banks and worse banks

When it all inevitably came crashing down, Hypo Real became a household name in Germany, due to the sheer amount of wealth it had evidently squandered. Naturally, this also meant that it was deemed 'too big to fail', and  German tax payers suddenly became an involuntary participants in propping up Hypo's unsound investments. A total of nearly € 104 billion in bailout credit lines and state guarantees were funneled into Hypo to keep it afloat after its Irish subsidiary faltered. Unfortunately, all indications are that Hypo's book of real estate related assets has continue to deteriorate  ever since – the bank keeps reporting 100ds of millions in quarterly losses.

However, after having been stung by the seeming free lunch in real estate credit, Hypo decided to 'Play it safe', and went looking for other investments that did not require it to put up much capital and could be leveraged  into producing a nice return. The solution: euro denominated government debt.

According to Bloomberg:

 

“Hypo Real Estate’s Tier 1 capital ratio was 7.7 percent at the end of March, according to a presentation on its website dated June 2010. The lender said in May that it holds 72.1 billion euros ($93.4 billion) of debt in Greece, Italy and Spain, among the highest held by a bank in Europe, according to data compiled by Bloomberg.”

 

Hypo mistakenly believed this debt was 'safe', and nowhere do we see the circular nature of the current debt-based monetary system in more stark relief: the banks need government money to be propped up, and in turn use this money to buy government debt, as a result of which they need even more government money to be propped up as some of the governments that so generously helped the banks to survive careen toward insolvency themselves. In between sits the central bank, which accepts said government debt in its discounting operations, transforming it back into 'money'. A beautiful racket to be sure, the ultimate in Ponzi schemes if you will. Only, it doesn't quite work anymore the way it used to.

Bloomberg notes:

 

“Germany’s Soffin bank-rescue fund had provided Hypo Real Estate with 7.87 billion euros in funds by the end of March. The bank has said it may require a total of 10 billion euros from the fund.  The lender said on July 8 that it received approval to establish a so-called bad bank to transfer as much as 210 billion euros of investments consisting of “non-strategic assets and risk positions.” The amount represents more than half of Hypo Real Estate’s total assets at the end of 2009.”

 

In short, half of Hypo's real estate debt securities and loans portfolio is a mass of toxic waste. You can bet that not a single government bond was scheduled to be transferred to the 'bad bank' (we're not quite sure what the point of creating yet another 'bad bank' is – is Hypo not bad enough as it is?). This means that the allegedly remaining 'good bank' once again holds a portfolio consisting of about 40% of potential toxic waste – only this time its government debt. Possibly there will eventually be a second 'bad bank' spun off, which would leave us with one 'good bank', one 'bad bank' and one even 'worse bank', with the latter two belonging to the tax payer.

Never fear though, Hypo is apparently the only bad apple in sight – as we mentioned at the beginning, the 'stress tests' are not really about stress-testing anything (if they were, a great number of banks would logically have to fail given the nature of the fractionally reserved system, in which virtually all banks are insolvent a priori).

According to Bloomberg:

 

“A summary of results of the stress tests will be released on July 23 at 6 p.m. CET, the Committee of European Banking Supervisors said in a statement on its website yesterday.  “The association doesn’t expect any other banks, private and public, to have failed the test beyond Hypo,” said Stephan Rabe, Berlin-based spokesman for the Association of German Public Sector Banks, which represents 62 institutions including the state-owned Landesbanken. “We’re relaxed about Friday.”

 

Cool, eh? Everything is a-OK. Confidence, and with it reality, shall be molded according to the directives of the ministry of propaga…sorry, wrong decade. Definitive proof shall be furnished that all our banks are sound! And besides, all your base are belong to us.

 

“German Finance Ministry spokesman Michael Offer yesterday said he doesn’t have any knowledge of the stress-test results.

According to CEBS, the other German lenders tested are Deutsche Bank AG, Commerzbank AG, Deutsche Postbank AG, Landesbank Baden-Wuerttemberg, Bayerische Landesbank, Norddeutsche Landesbank Girozentrale, WestLB AG, HSH Nordbank AG, Landesbank Hessen-Thueringen Girozentrale, Landesbank Berlin AG, DZ Bank AG, WGZ Bank AG and DekaBank Deutsche Girozentrale. “I don’t think any of the listed banks will fail the stress test,” said Merck Finck’s Becker. “I can’t exclude that one of the weaker Landesbanken may not achieve passing the test, but I think it’s unlikely.”

 

You bet it is 'unlikely'. The tests are not designed to let anyone fail, which as we said at the outset tells us how irretrievably bad the situation at Hypo must be, even  after € 104 billion have already been pumped in. Among the banks on the list above, we note that e.g. Commerzbank has leverage of roughly 150:1  (tangible assets divided by tangible common equity), Landesbank Berlin  has leverage of 75:1, WestLB 68:1 and Deutsche Bank 56:1. For the sake of comparison, by the time of its demise, Lehman Brothers is said to have been leveraged about 30:1.

How can any of these banks not be de facto insolvent? If they hold any PIIGS  bonds at all (and some of them  do, in spades – e.g. 468% of Commerzbank's tangible book value was invested in PIIGS bonds as of about six weeks ago), it is a near mathematical certainty that they are. No matter how we slice it – the system of irredeemable currency and endless debt creation appears rotten to the core, and the reality is that is is broken already. What's left is merely a collective effort to pretend that it isn't.

 


 

Hypo Real Estate – the writing are words from a song proposed for an advertising campaign with which the insolvent bank wants to repair its severely damaged image. It says: “Something is left….give me a little bit of security”

(Image source : The Web, author unknown)

 


 

 

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