In 2007, Nassim Taleb published his best-selling book “The Black Swan: The Impact of the Highly Improbable.” Taleb contends that banks and trading firms are very vulnerable to hazardous Black Swan events and are exposed to losses beyond those that are predicted by their defective financial models. This proved to be right on the mark as one year later, the financial system almost collapsed due to poor financial models that predicted real estate prices would go up forever.
In our last quarterly letter to clients, we shared our view on the next potential black swan. While many media pundits like to pontificate on the Chinese banking system, we instead pointed to the countries with negative interest rates as the real and present danger.
We are becoming increasingly worried that European and Japanese banks could trigger a potential crisis. In 2008, it was the US banks that almost brought down the entire financial system due to their high leverage and subprime loans. Today the major banks like Deutsche Bank, Royal Bank of Scotland, Credit Suisse, Mitsubishi Financial, Nomura, and Sumitomo Mistui are all trading near their 2008/9 lows. Deutsche Bank reported a staggering loss of $7.3 billion in 2015 and it is expected to struggle with writedowns, litigation charges, and restructuring costs for at least the next 2 years. A strong banking sector is essential for economic growth and in two of the largest economies, the banks are in terrible health.
The surprising Brexit vote has only increased the stress on European banks. The British banks have been hit hardest by the news. Barclays (ticker BCS) cratered from 11.18 on Thursday June 23rd to as low as 6.76 Monday morning. Legendary investor Jim Rogers believes the “leave†movement’s victory last week may threaten the British union and its influence as the financial center of Europe. While any negotiated deal may help assuage the market’s Brexit fears, Rogers foresees a “bad case scenario†where Scotland and Northern Ireland leave the UK and London’s clout diminishes significantly as financial institutions move towards continental Europe.
