NEW YORK (TheStreet) -- Doug Kass of Seabreeze Partners is known for his accurate stock market calls and keen insights into the economy, which he shares with RealMoney Pro readers in his daily trading diary.
Last week, Kass wrote about problems in the EU banking industry and jobless claims data.
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The Real Skeleton in the European Banking Closet
I spent the better part of my early Wall Street career following the banks.
I have some Street cred.
It all began when I was a Nader Raider, and I wrote three chapters in Ralph Nader's book Citibank while an MBA student at Wharton. (It began my master's thesis, and I got an A+!) I then went on to the research department at Putnam Management, where I covered the banks, government-sponsored agencies, savings and loans and selected financial companies. (Institutional Investor Magazine voted me the No. 1 buy-side banking analyst in the 1970s.)
[Read: Banco Espirito Santo Tries to Calm Capital Worries]
Leading up to the Great Recession, I accurately forecast that the deepening problems in the U.S. financial sector would lead to a massive global credit crisis and economic contraction. I made a lot of money being short Countrywide Financial, Citigroup (C - Get Report), Bank of America (BAC - Get Report), AIG (AIG), MGIC Investment (MTG), PMI Group, Radian (RDN), Ambac (AMBC), MBIA (MBI), Fannie Mae, Freddie Mac and others. Most of these stocks declined by over 90% when I was short them. At one point, several dropped by 99%!
Which brings me to the current situation in Europe's financial community.
Banco Espirito Santo has been viewed as a primary source of concern in the global markets this week. In reality, the Portuguese lender's credit problems and accounting irregularities are a one-off and don't represent a systemic problem.
There are more significant skeletons in the European banking closet, however, and Banco Espirito Santo doesn't reside in it.
Over the past two years, verbal jawboning by European Central Bank President Mario Draghi has artificially buoyed sovereign debt prices/values and depressed sovereign debt yields -- the banks in Europe are loaded up with this paper.
If the ECB experiment fails, the entire EU banking industry is in jeopardy, and a systemic failure will follow.
[Read: European Stocks Recover as Panic Over Portugal Banks Subsides]
It is important to note that the European banking system is much more leveraged than that of the U.S. -- oversight and regulation is weaker, and EU banks play a greater role in their economies, as they are far larger relative to European GDP than in the U.S.
Thus far, the markets are not disconcerted and have accepted ECB policy/influence (artificial as it is).
But if, as it appears, the European recovery might be weakening (see below), therein lies the skeleton in the European banking closet.
EU banks' balance sheets are filled with artificially priced and inflated notes and bonds.
Eurozone Manufacturing PMI® -- final data
(Countries ranked by Manufacturing PMI®: May)
Netherlands: 53.6, 2-month high
Italy: 53.2, two-month low (1.2% month-over-month decline in industrial production, 0.2% increase was expected)
Spain: 52.9, 49-month high
Germany: 52.3 (flash 52.9), seven-month low
Greece: 51.0, two-month low
Austria: 50.9, 10-month low
France: 49.6 (flash 49.3), four-month low (1.7% month-over-month decline in industrial production, 0.2% increase was expected)
Source: Markit Economics
Parsing Jobless Claims Data
Initial jobless claims came in at 304,000, down a bit from the prior week and better than consensus.
The four-week average is now 312,000, slightly above the low point in May.
Continuing claims rose for a third straight week, but only modestly.
[Read: When Will the Federal Reserve Raise Interest Rates?]
The labor market is recovering with gains of over 220,000 on average per month for five consecutive months.
The key question remains for economic growth and corporate profit margins is whether the climb in hirings and average hours worked can be matched by an increase in output and expanding productivity.