- As US double-dip worries eased last week, investors refocused on Europe after a report called sovereign debt holdings at European banks into question Tuesday.
- Similar worries surfaced right after the tests, when investors posited government economic and sovereign default estimates were too lenient.
- No set of criteria will be perfectly acceptable to all (a weakness of stress tests).
- Though the revelation may knock perceived bank health, recent news is a significant counter weight.
Worried investors may not have time to watch US Open tennis this week—but the back-and-forth fretting would have veteran tennis fans mesmerized. Early this year it was European debt trouble. Then it was US double-dip bother (a very common post-recession worry). Last week dealt the double-dippers a few blows—so naturally, this week investors refocused on Europe after a WSJ report alleged officials may have understated holdings of PIIGS sovereign debt in recent stress tests.
The stress tests were designed to allay investors' worst fears, and by government estimates, banks mostly passed with flying colors. So why all the bother? The precise composition of debt holdings was the key. With those numbers public, investors, analysts, whoever felt inclined could crunch whatever doomsday scenario they favored. The end result was favorable—even under worst-case scenarios.
But now, the baseline may not be so steady, and analysts may need to re-tally bank health. The criticism appears to stem from accounting procedures—some long positions were offset by short positions or excluded altogether. The exact methodology used wasn't disclosed, so no one knows just how different holdings are to those reported earlier—thus kicking up dreaded uncertainty. A number of bank representatives directed blame for reporting protocol to the Committee of European Banking Supervisors (CEBS). And indeed, it seems likely CEBS may have needed to determine rules on the fly—until recently there was no standard for sovereign debt accounting.
But we should remember, similar worries surfaced right after the tests, when investors posited government economic and sovereign default estimates were too lenient. No set of criteria will be perfectly acceptable to all (a weakness of stress tests). And further, though the revelation may knock perceived bank health, recent news is a significant counterweight.
Sovereign offerings in PIIGS countries have been vastly oversubscribed at low rates. Major PIIGS funding is finished for 2010. Fewer European banks are tapping the European Central Bank (ECB) for liquidity—many finding lower rates at market—proof positive (on the ground) the European financial system is on steadier footing. European growth has been stronger than expected (4.1% q/q annualized in Q2). And of course the kicker—even if banks are more heavily exposed to sovereign debt—they are backed by a $1 trillion sovereign debt guarantee and flexible ECB.
Every recovery features a good long rally between dueling bearish theories—this year's appears to be no exception.