How soon we forget. It really did look like the end of the world out there at the beginning of the year  and gold looked like the only thing worth owning.

Governments can bail out financial institutions, but who will bail out the governments? If the prospective cost of a bailout gets too large, it will take down the relevant government, as in the case of Iceland. In February the British press ran headlines like “Reykjavik-on-Thames.” Bank deposits as a proportion of GDP are far higher in the UK than in the US, and protection on the British sovereign had shot out to LIBOR +160 basis points, higher than Brazil protection was trading less than a year ago.

Sovereign credit depends on bank credit. The prospect of bank nationalization followed by a chain-reaction collapse of the insurance sector threatened to take the sovereigns down with it. That is why it was not in the cards. To the extent that governments toyed with the idea as promoted by academic tinkerers like Krugman and Stiglitz in the US, or the ultimate left-wing social experimenter George Soros, a trip to the brink convinced governments otherwise. I warned about this on January 4.

Now we have Soros complaining that the governments are keeping zombie banks alive. Precisely correct: zombie is as good as it gets. By doing so they keep themselves alive. Call it cannibalism and incest, or corruption: it’s better than two, three many Icelands. This isn’t the stuff of a general economic recovery or a stock market boom. It simply means that the banks are worth something rather than nothing. My best guess for that “something” is north of $4 for Citigroup and perhaps around $10 for Bank of America, but this is clearly guesswork. I have a small position in Citigroup preferreds which I bought at a low dollar price and will do quite nicely if Citi converts them to common at a $3.25 price with a 5% haircut, as announced.

Things have calmed down a bit since then. Protection on the UK is down to +116, and Russia is in more than 300 bps from the wides.The tables below show the biggest changes in industrial as well as developing countries’ 5-year credit default swaps, courtesy of Markit:

This entry was posted on Tuesday, April 7th, 2009 at 7:00 am and is filed under General. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.