John Mauldin: European Banks Are Just a Disaster Waiting to Happen

Henry Truc  |

For investors of any level, understanding the economic climate and directional trends of the market is critical to forming sound strategies. recently spoke with John Mauldin of Mauldin Economics and Millennium Wave Advisors, to discuss his thoughts on the U.S. stock market's recent run to record heights, the precedent set with the Cyprus bailout, and why he actually wants gold to go down further.

EQ: Was the Cyprus bailout a game-changer in the European debt crisis?

Mauldin: It’s a game-changer to the extent that, if you’re a European depositor in banks, anything over €100,000 is now at risk. The one thing that I don’t think people emphasized enough is that the Eurozone came in and said that every bank in the country is going to be created equally. They didn’t give a chance for the banks that are fine; the ones that have enough money to meet all their deposits and credit. Everybody got wiped out, and so now it’s no longer just enough to look at a bank, if you will. It’s become a situation where everyone has to look at their actual country to determine if it’s solid. Is the country that you have money with capable of backing up your deposits? Because if they are not, and you think you have a solid bank, we just saw them get treated the same along with all the other bad banks. That was a, I think, a very bad message to send to the markets.

EQ:  It compromised the trust people had in the financial system?

Mauldin: Well, sure. Trust is most the ephemeral for all things. And the problem is that when you lose trust in the government, and lose trust in your banks and agencies, you just now lost the one thing that’s required for a functioning economy. This was telling investors that they didn’t see €100,000 as a sacrosanct amount, even though that was the insisted regulation. It requires a government coming in and saying, “No, you can’t do that.”

What we are going to find out, and it’s beginning to come out, is that it looks like certain Russian investors knew early on a few weeks ahead that this was getting ready to happen and that they transferred enormous sums of money out. We don’t know yet how much left the bank, but those that were still invested, the locals if you will, ended up having to pay even more. This was not an even playing field.

EQ: What kind of unintended consequences does this create in terms of deposit requirements and the health of banks?

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John Mauldin: First of all, you have to realize that, as much as we malign the banking system in the U.S., we talk about big banks and too big to fail, the U.S. stepped in and put $800 billion to work, much of which was paid back. But we recapitalized our banks and the big banks that were over leveraged are now leveraged about half of what they were--and some of them are even being required to come up with more equity and less leverage--and they are in much better shape than they were. That’s not happening in Europe. The European banks are in just as bad of shape as they were. They are still leveraged 30-to-1 or 40-to-1, and they are still are not reserving their sovereign debts. They are assuming sovereign debt is still money good. Their banks are still at risk and are far more at risk to a crisis scenario then U.S. banks. I am not trying to argue that we should forget about our banks, either. In fact, I think that we should break the big banks up, but relative to Europe, the U.S. banks are in far better shape. European banks are just a disaster waiting to happen.

EQ: In terms of being too big to fail and being too big to manage effectively, do you think that is the case with the Eurozone? Would they be better off if it broke up?

Mauldin: No, the problem that you have now is that they spent so much money in putting the euro system together, and it would cost more to break up. And the longer they go, the more that’s the problem. They have just put way too much money into foreign debt and those countries are still in debt. They haven’t reduced their debt exposure and countries are still borrowing money. Many of them are still running large deficits and while we all say austerity, the problem is that it’s not working. Austerity is working just like it’s supposed to. It’s reducing the leverage, but austerity is not a growth tool. That’s where I think that most of market participants have made a mistake. They are thinking that if they cut their budgets, they’ll get growth. That’s not what happens. If you cut your budgets, you reduce your growth potential for the near term.

EQ: Looking at the U.S., stocks hit a new high in the first quarter of 2013 despite many economic concerns. Do you see a major pullback soon as the economy shows softness?

Mauldin: Well, the relationship between how the economy does and how the stock market does is not as one-to-one as a lot of people think. So, the answer is that if we saw some economic weakness, I think that you would definitely see some market pullback. You nearly always see a significant restructuring of stock prices if you get a fall within the economy or a recession. I don’t think that we are going to see a recession this year. It certainly doesn’t look that way, but I don’t think that we are going to see a period robust growth either. It’s going to be a muddle-though economy.

EQ: Gold and silver have not been a major performer despite aggressive stimulus programs. Is this a good opportunity for investors to accumulate for the long term?

Mauldin: Well, I accumulate a little gold. I don’t do anything for silver, but I accumulate a little gold every month and have been for a long time. Right now, I actually wish the price of gold would go down because that means I am buying it for cheaper prices. Gold is still insurances; it’s not an investment to me. To me, it’s just central bank insurance. What you are really desperately hoping, if you’re paying attention, is that you are never going to have to use your gold. You hope that gold becomes worthless because that means everything else has worked.

EQ: You participated the Downturn Million webinar with a lot of other highly expert respected panelists can you talk about what you discussed and what the goal for this webinar is?

Mauldin: It’s a webinar on gold stocks and the long-term serious bear market that the gold stocks have been in. Basically, the question that they are asking is whether that is going to continue. Is buying gold stocks right now a good opportunity? My short-term answer is, “Probably.” If you’re looking for immediate validation, then no, but valuations in the gold stock market are compelling right now.

More of John Mauldin and Mauldin Economics:

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