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Out of the Box: Europe — The Big Short

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Of all of the troubles, the problems, the “Risks” that abound in the markets, the global dangers, the biggest, by far, are now in Europe. You can talk about China, the raucous behavior between the Democrats and the Republicans in the United States, the backflip of the Fed, pick any subject that you like and two upcoming events in Europe overshadow them all. Unless you have a mandate to invest in Europe now, I wouldn’t put one plug nickel in this space.

“The ratings agencies, the banks, the government, they’re all asleep at the wheel?”

-The Big Short

There is a pot full of news everyday about Brexit. It all centers on the political implications. Politics be damned, in my view, it is the financial and economic implications that are concerning, and virtually no one is focused on them. We are but 4 days away from the Brexit deadline now and nothing that should be happening, is taking place.

The British Parliament has reached no conclusions and, frankly, given the consortium of their members, I am not sure that it is possible for them to reach a rational outcome. The people in the British Parliament are log jammed and the significance of this is frightening.

For the banking institutions all Hell could break loose, if the EU does not recognize British law and Britain does not recognize the European laws and the inter-bank commitments, derivatives, bonds, CoCo bonds, are governed by no laws at all. We can all speculate that everything would return to “local law” but this would invalidate most indentures and so you end up in Dante’s Inferno with no way out in sight.

At the same time the “Zero Risk” weighting of sovereign debt becomes invalid in both the EU and in Britain, with a break-up. One can only imagine what will happen to both the British banks and the European banks balance sheets if they have to come up with new capital to replace their exposure to “Zero Risk” sovereign debt. You are talking here about massive hits to the balance sheets of banks all across the Continent and the possible bankruptcy of some banks. It will be a disaster, in my estimation.

As April 12 approaches, now just four days away, we are down to the wire. The EU has called a special session on April 10 and Britain appears to be asking for another extension but it must be unanimous to grant it and any one of the 27 EU nations could veto it and the Czech Republic, Italy, Poland, Hungary et al might do just that.

Prime Minister Theresa May said there was now a clear choice between Britain exiting the European Union with a deal or not leaving at all as she tries to find a compromise with the opposition Labour Party, The Observer newspaper reported. “Because Parliament has made clear it will stop the UK leaving without a deal, we now have a stark choice: leave the European Union with a deal or do not leave at all,” May was quoted as saying by the newspaper. “The longer this takes, the greater the risk of the UK never leaving at all,” she said.

The problem here is that is not just Britain’s choice. She is grasping for straws as the final days and hours run out. In the end, it is up to the European Union to make the final decision now and even France is making noises about just saying “No.”

“It ain’t what you don’t know that gets you into trouble.

It’s what you know for sure that just ain’t so.”

-Mark Twain

My take, if Britain exits, one way or another, is that the ECB, and Britain’s central bank, are  going to be forced back on the playing field and in short order. Our current $9.7 trillion in negatively yielding bonds may become $15 trillion or even $20 trillion, and in a very short period of time, otherwise the European banks and the British banks may be in for seizures. This could literally be a 2008/2009 re-do and virtually no one is focused on just how serious the current situation is for the world’s global financial system or the economies.

This could also cause the Fed to react. It may not by the President, or some member of Congress, call for the Fed to lower rates again. It may be that the Fed is forced to cut rates again because of the American banks “counterparty” risks with the British and European banks.

They may have no choice.

Then you have the May 23 European elections. A recent poll gave the populists, the nationalists, one-third to one-half of the seats in the elections. Heck, it could be over 50% if some of the countries in Europe have their way, and if Britain also votes in these elections.

My conclusion here is that the Franco-German alliance, which has governed the EU since inception, is about to give way to the policies and beliefs of other countries in Europe. What was, will no longer be, and what is coming is something we have never seen before, as the old European Union falls headfirst into the ashes. The EU is in serious danger now of just coming apart and, again, no one is concentrating upon this because no one wants to believe it might happen.

This is a “Capital Mistake” and I bring it to your attention today!

“A few outsiders saw what no one else could: The whole world economy might collapse.”

-The Big Short

Mark J. Grant
Chief Global Strategist, Fixed Income
Managing Director
B. Riley FBR Inc.
U.S. 954-468-2366

Information herein is for general use; is not unbiased/impartial; is current at publication date, subject to change; may be from third parties; and may not be accurate or complete. Opinions are the Author’s, not B. Riley FBR, Inc., or their respective affiliates or subsidiaries. This is not a research report or solicitation or recommendation to buy/sell the subject securities. Investment factors are not fully addressed herein. B. Riley FBR Inc. and their affiliates may have a proprietary position in the subject securities.

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