Irene and Other Storms

Irene made landfall this morning in North Carolina. Winds mostly under 100mph. Will head back out over water before slamming Long Island tomorrow. Huge amounts of rain over a very large area. Signs are that the storm is somewhat less intense than originally forecasted, that folks have taken the advance warnings seriously, and that the state and federal efforts to prepare in advance seem effective. We'll have to wait, watch and continue to pray.

And what about all the other storms? The economy is in much worse shape than most pundits thought, and we seem to be out of ammunition to launch restorative programs. At Jackson Hole yesterday, Chairman Bernanke signaled that the Fed was in a "watch carefully, but take no immediate action" mode. So monetary policy is in neutral. And fiscally, Congress is in gridlock, and the chances of stimulative spending seem remote.

And then there's Europe. Will Germany and France keep supporting the issuance of Eurobonds in quantities necessary to keep all parts of the system liquid? The consensus answer seems to be "Maybe." And that might not be good enough, and the system might not respond fast enough if some sort of bank run develops. And there is probably no such thing as a banking crisis that is confined to Europe.

And then we have our own banks. Readers know how skeptical I am of their real balance sheets, when you adjust for overstated mortgage assets and add large additional reserves for the mortgage litigation liability that is still deeply underestimated. Last week, financial bloggers were doing a real number on BOA's balance sheet, concluding that its $220 billion book value might really be worth next to nothing. While this discussion was happening,  the market bid the economic value of BOA down to below $65 billion, when Warren Buffet stepped in with a $5 billion investment, and market value popped back up near $80 billion. But investors still remember Buffet's last $5 billion investment, which was in Goldman Sachs on September 25, 2008, just before the market crashed, taking Goldman with it, dropping from over 160 to near 50, before recovering. Buffet did just fine on his investment, but for a good time there in October 2008, it was not a sure thing.

So what are the chances of a "crisis" or some kind of market shakeout? I think they are at least one in three, and possibly considerably higher. And I think Europe will be the trigger. I just don't see the political willpower to forge a program that will commit the ECB funding necessary to essentially remove liquidity risk from the picture. They could do it tomorrow, with a simple announcement, but that means the rich North would be on the hook for the "sins" of the perceived to be "profligate South". It's possible; but I don't see it. Without it, chances of a liquidity event are pretty good. And the ripples will cross the Atlantic in no time.

Would such an event trigger a run on a major bank like BOA? It might. The Fed has shown itself very adept at injecting liquidity into the system very rapidly. But the "event" might trigger the need for a TARP II, and I do not think that will fly politically, which means the bank would be taken down.

Yes. I will stick with that: a one in three chance that a European credit event will spread to the US, catching one of our banks badly enough that they need to be put into resolution authority. Time frame? Within the next 12 months, and more likely sooner than later.

Not a pretty picture, but this sort of eventuality could lead to a "wiping the slate clean" scenario, that will help us move through to a healthier, more grounded future path of economic growth.