Some readers will remember that last summer (June 2011) Europe performed a stress test on its financial institutions. Some will even remember that Dexia came rated very high scores (very safe) on certain scales Dexia was Europe's best capitalized bank -- the results so far this week is that the whole mess of a bank is being sold, and taken over by the French and Belgian governments.
Last night Austria's largest bank reported losses of Euro 1.6 billion. Aside from getting screwed by the Hungarian government -- Erst had been writing Hungarian mortgages in Euro in a Forint denominated country. The reason was that Euro interest rates were low, while the Forint interest rates were high... of course this could only end well (sarcasm). When the Forint was devalued against the Euro (because the economy is in trouble) those who had taken a Euro loan were screwed, so the government came to the borrower's rescue, and made the F/X contracts "illegal". Erst should have known that this was a very stupid trade (Erst was not the only players, but was the largest), entering into sophisticated transactions with unsophisticated counterparts. So we know that Erst is stupid, but it turns out they are also liars, because in the June stress test Erst audited indicated that it had no CDS exposure -- Ernst was not a "participant in the credit derivative swap market". Imagine everyone's surprise when yesterday Erst revealed a loss of Euro 460 million on its Euro 2.8 billion CDS portfolio -- that didn't exist!
Some will ask how was this done? Simple, Ernst "hide" the CDS business in its "assets held to maturity" which are marked to model (or to whatever you want) -- moreover the regulators never saw these books (or didn't look). Further proof (if any where needed) that the European stress test of last summer (again June 2011 -- 4 months ago) was only a exercise in public relations.