Strikes, Stuck Negotiations, Illiquid Banks

1. Unrest in Greece

Yet another wave of violent demonstrations and strikes has engulfed Greece. If we were a 'troika' official, we'd put on a false mustache and ditch the suit, just in case. Papandreou and Venizelos might also consider putting on a wig or some other disguise.

As a reporter in the Austrian press remarked a few days ago, you have to give the Greeks this: they got €200 billion out of their neighbors in Europe without having to lift a single finger for it. That proves that the Greek entrepreneurial spirit is well developed and married with a certain criminal energy.

The reporter in question thinks we should consider the Greeks for the Nobel prize in economics for having pulled this caper off. Instead of working hard for prosperity, they have found a method of getting billions for nothing (well, they did have to tell a few lies, so there's that).  Greece, so the author,  has no notable industries, except organized tax evasion and EU subsidy fraud and the country's biggest export consists of dirty money.

For many years the Greek political class was able to hand out free lunches to its supporters – in the case of the ruling PASOK party the constituency consisted inter alia of the 'civil service' (a den of corruption unsurpassed in the Western world)  and the militant unionists in the state-owned industries. If Greece were to shut down its state-owned railways and pay the taxi cab fare of everyone who uses them, it would actually save a nice chunk of money.

Unfortunately the free lunches have now been cut off. Greece's creditors insist on getting paid back the money they (foolishly) lent to the country in the past, a demand that meets with little understanding from the Greek citizenry – least of all the aforementioned unionists and civil servants (we could probably subsume them under the term 'association of thieves' without causing too much offense;  finding a single honest bureaucrat in a Greek ministry is generally considered a sensation and may cause some to question the sanity of the person concerned).

However, these groups do not truly represent Greece to our mind. The great bulk of the citizenry consists of honest, hardworking people, even though many of them have – by necessity – arranged themselves with the corruption all around them. These honest hardworking people are of course very much deemed to be eligible for paying the price for the government's past follies and the intransigence of the country's creditors. In fact, the honest hardworking people are the only ones that can possibly create the wealth that will be required to pay up and keep the economy going.

So the protesters now thronging the streets of Athens as Greece is hit by yet another nation-wide strike are a mixture of all the sectors of Greek society and it would be a grave mistake to condemn them out of hand without differentiation. Alas, it appears to us that the country is coming close to being ungovernable. It won't become any easier for economic growth to return when there's a big strike every few weeks, so the vicious spiral is becoming that much more vicious. The illusory idea  that it will be possible to 'bail Greece out' and return to the status quo ante should be thoroughly shattered by now.

As Reuters reports:


Greek police cleared the square in front of parliament on Wednesday after clashing with black-clad demonstrators during a mass anti-austerity rally called to coincide with a vote on a bitterly resented new round of belt-tightening.

The view of the ancient Acropolis was obscured by smoke from burning piles of rubbish and a bank building was evacuated after being set on fire by molotov cocktails as a strike called by Greece's two main unions degenerated into violence.

Much of the country was shut down by the 48-hour general strike, the largest since the outbreak of the crisis two years ago with government departments, offices and shops closed and at least 100,000 people taking to the streets of Athens.

Prime Minister George Papandreou, trailing badly in opinion polls, has appealed for support from Greeks before parliament votes on the latest measures which include tax hikes, wage cuts and public sector layoffs. But the mood was furious among demonstrators, fed up after repeated doses of austerity and increasingly hostile to both their own political leaders and international lenders demanding ever tougher measures to cut Greece's towering public debt.

"Who are they trying to fool? They won't save us. With these measures the poor become poorer and the rich richer. Well I say: 'No, thank you. I don't want your rescue'," said 50-year public sector worker Akis Papadopoulos.

The boom of tear gas canisters fired by police rang out, and black clouds of smoke from petrol bombs hung over Syntagma Square, scene of violent clashes between police and demonstrators at anti-austerity protests in June.

The latest outbreak of violence overshadowed the start of a 48-hour strike which shut down government departments, shops and public buildings across the country and which unions said was one of the biggest stoppages in years.

A huge crowd gathered in front of parliament earlier in the day but after hours of confrontation with a hardcore group of mainly younger demonstrators, police cleared the square. Groups of hooded youths continued to clash with police on side streets.

At least seven people were hospitalised, and there were several other injuries reported mainly from breathing problems, minor burns and cuts to the head. There were also serious clashes on major avenues away from the scene of the main rally.

More than 7,000 police had been assigned to Athens to deal with anticipated trouble with hundreds deployed in riot gear near parliament.”

Just wait until the riot police go on strike too.



2. EFSF Negotiations Going Nowhere Fast


For all those expecting a 'big bang' solution on October 23rd, the chances of that happening are now receding very fast indeed.

As Der Spiegel reports:

“Wednesday's emergency meeting in Frankfurt, attended by French President Nicolas Sarkozy, Chancellor Angela Merkel and important European Union leaders, was hastily convened. And its last-minute nature underscores how dramatic the situation has become in the run-up to the EU summit in Brussels on Sunday. Sarkozy even missed the birth of his daughter, as wife Carla Bruni gave birth to Dalia Sarkozy on Wednesday evening.

With only a few days to go before the EU summit, Europe's two most important countries still remain divided on a key issue. It is a division that threatens to jeopardize efforts to agree to a comprehensive rescue package on Sunday.

France is pushing for the euro backstop fund, the European Financial Stability Facility (EFSF), to be provided with a a banking license that would enable it to use its assets as collateral to borrow even more money from the European Central Bank (ECB). Both Germany and the ECB oppose the step, but France is insisting.

"You know the French position and we are sticking to it," French Finance Minister Francois Baroin said in Frankfurt before the meeting. "We think that clearly the best solution is that the fund has a banking license with the central bank, but everyone knows about the reticence of the central bank. Everyone also knows about the Germans' reticence. But for us that remains … the most effective solution." Both Baroin and his German counterpart Wolfgang Schäuble also participated in the meeting.

Senior officials in the German government say the country is opposed to the French solution. Berlin instead favors an approach that would turn the backstop into a kind of insurance fund providing guarantees to public and private investors by covering the first 20 to 30 percent losses on their investments in state bonds. Such a move could allow the fund to martial aid worth up to €1 trillion. The German government also enjoys the ECB's support.

Following Thursday's meeting, it appears Germany and France could be facing an impasse in the euro crisis. After two hours, the talks ended without Merkel or Sarkozy providing any statement.”

As it has turned out, the original plan of making a kind of CDO out of the EFSF had to be modified,  after legal advisors to the euro area governments noted it would have conflicted with key provisions of the Maastricht treaty.

As the WSJ reported yesterday:

Lawyers for governments and European institutions have warned that using the bailout fund to provide direct guarantees would violate the European Union's restrictions on bailouts, pouring cold water on the widely circulated notion that the European Financial Stability Facility on its own could simply stand as a guarantor for euro-zone bond issues.

Instead, under versions of the plan being discussed ahead of a critical weekend summit, these people said, countries who want to avail themselves of insurance would borrow an additional amount from the EFSF when they need to tap markets for financing. That extra amount would be kept aside to provide some compensation to creditors in the event of a default.

The collateral scheme would serve a similar purpose as the direct guarantee might have: giving investors an incentive to buy bonds from potentially-wobbly countries that need financing. The difference is that it would increase the volume of borrowing that those countries need to do.”

It seems a bit late to suddenly worry about these legal fine points, but there it is. As 'Der Spiegel' notes, there is a major obstacle to the EFSF leveraging plans that the German government can not possibly overcome:

“In Berlin, Merkel is already facing resistance to any plans to leverage the EFSF. Prior to approval of the expansion of the backstop fund in parliament in September, a number of law makers said they would oppose any moves to leverage it. Leaders of the parliamentary groups of Germany's parties planned to meet to discuss the issue on Thursday. Members of the opposition center-left Social Democratic Party (SPD) and the Greens are demanding that a vote be held in parliament if the euro zone intends to leverage the fund.

"If the risk of losses rises in a significant way, then it is no longer the same EFSF" that the Bundestag approved with the support of the SPD, Thomas Oppermann, a senior party official stated on Wednesday.

Bundestag President Norbert Lammert, a member of Merkel's Christian Democrats, has rejected the demands. But in comments to SPIEGEL ONLINE, he warned the government against making major changes prior to Sunday.

"We have told the federal government clearly that the agreed to ceiling for guarantees (from Germany) must remain at €211 billion," he said. "The chancellor and the finance minister have also agreed to this." He said members of parliament would scrutinize the EFSF guidelines closely. Any increase in liability, he said, would require a new decision by the Bundestag's budget committee before the government can negotiate on Sunday.

In other words, the whole 'bazooka' idea is herewith DOA.

Our feeling is that the French plan of issuing a banking license to the EFSF that would allow it to be financed with the help of the ECB (with its unlimited money printing ability) is just about the only thing the markets would deem sufficient at this stage. It is also the only way to at least temporarily avert a downgrade of France's AAA rating and further downgrades of Italy and Spain.

Every other proposal –  especially some watered down version of the 'insurance scheme' – will immediately bring the crisis to a head. Stock markets would probably crash, the bonds of Italy and Spain would continue to sell off (already their yields are perilously close to where they were before the ECB started to intervene), and then the Germans and the ECB would be faced with the choice of letting the euro area fall apart or go down the money printing route anyway.  This is where we now are.

Mind, we agree with the stance of Germany and the ECB – going down he money printing route will not solve the problem, it will merely buy some time and create an even bigger problem down the road. This does however not change our assessment of how the markets will view the decision. European government bonds and stock markets will rally if the French proposal is implemented and the pressure on the banks will be lifted somewhat.

Every other proposal will hasten the ongoing collapse and immediately further unmask the extent to which government finances have become unsustainable and the extent to which the fractionally reserved banking system is tottering on the edge of insolvency after a decades long credit boom. It will likely end with a chaotic dissolution of the euro area – and we're not sure that Germany's government fully grasps this fact. Actually, we believe it completely underestimates the damage already nervous financial markets could inflict if the plans presented after the coming weekend are deemed insufficient.



Italy's 10 year yield lands at 5.94% – perilously close to the 'red alert' level it inhabited just before the ECB began to intervene in the market. We have a sense of deja vu: exactly the same happened once the ECB's interventions in the bonds of the 'GIP' trio (Greece, Ireland, Portugal) had been fully assimilated by the markets – click for higher resolution.


Remember what we said about the potential for a crash wave in the stock market. It can still not be dismissed.


3. Euro Area Banks – Short of Collateral, Shrinking Their Asset Base

Europe's banks are in grave trouble. In fact, it now turns out their problems are even bigger than we hitherto thought. The latest quirk is that they may not even be helped much by the ECB's LTRO's (long term refinancing operations, for details see our previous report on the ECB's 'QE Lite').

The reason is that the euro area banks have now had problems to fund their assets for quite some time, as wholesale and interbank funding markets have dried up. In order to receive funding, many of them have resorted to encumbering collateral. In some places like Spain, Ireland and Greece this has been done to such an extent that banks now have to avail themselves of the euro-system's 'emergency liquidity facilities', where banks borrow funds from their national central banks in exchange for – essentially nothing. Instead of handing over eligible collateral, they simply hand over an IOU they themselves create.

This is also what has tripped up Dexia, as its wrong way derivatives bets required it to encumber more and more collateral, until it no longer had anything left it could pledge. In these deals, lenders usually insist on over-collateralization or significant haircuts, with the end result that not all assets can be funded anymore at some point. This is especially true in cases such as Dexia, where a big interest rate swap trade went totally wrong and more and more collateral was required to keep it afloat.

As the FT reports:


With more and more banks resorting to so-called “secured funding” – or financing that is backed by specific pools of a bank’s own collateral – concerns are rising over the growing levels of such asset encumbrance. Or, put another way, whether Europe’s banks have enough free collateral to see them through the crisis.

“The most sophisticated investors are definitely looking at asset encumbrance now,” says Marc Tempelman at Bank of America Merrill Lynch.

Unnerved by the eurozone debt crisis and uncertainty over forthcoming regulation, investors in, and lenders to, Europe’s banks have been demanding more and more collateral. This trend has been most obvious in public issuance of bank debt – where banks have this year sold about €200bn worth of covered bonds backed by their own pools of collateral. Banks are using other types of secured funding, too – for instance, borrowing money from other banks.

In the case of both covered bonds and private lending, deals are “over-collateralised”, meaning they are stuffed with extra assets to provide added security. Indeed, pressure to do more collateral-backed deals means an increasing proportion of a bank’s balance sheet may be tied up in secured financing. While that may make the deals more palatable to a bank’s counterparties, it does little to help its unsecured creditors. In the event of a bankruptcy they will be left to pick over the bank’s assets that are not tied up in secured lending or covered debt.

There are limits in place to battle encumbrance. National regulators dictate how much of their balance sheets banks can encumber through covered bonds, though the rules vary. Rating agencies, too, may start to downgrade the credit ratings of a bank’s senior unsecured debt if they feel assets are being dragged away by secured funding. Banks will also have internal guidelines, looking at how much of their balance sheet is encumbered.

Even so, some Spanish banks may be bumping up against those limits, according to Deutsche Bank covered bond specialist Bernd Volk. In other words, the banks may eventually run out of mortgages and loans to put into new covered bonds, or even to top up existing ones. To help, the ECB has announced two new longer-term refinancing operations, offering cheap loans against certain collateral. But that has sparked a debate about whether Europe’s most troubled banks will have enough eligible securities to make use of the system.

“Some banks might not have sufficient collateral to increase their ECB borrowings from current levels,” BofA interest rate strategist Ralf Preusser writes in a note to clients.”


(emphasis added)

So much for the ECB's full-throated assurances – given only a few months ago – that there is 'over € 14 trillion in eligible collateral in the euro area's banking system' and that therefore there 'can not possibly be a liquidity problem in the  banking system'.  Dexia's case already proves otherwise and obviously by now just about everyone knows that what the ECB contended simply is no longer true.

How this problem can be resolved is a mystery – in fact, the only way out seems to massively shrink the euro area banking system's asset base. Indeed, the banks have already announced they may attempt to shrink their assets by up to € 1 trillion or even more. Note here that euro area banks are the by far biggest lenders to emerging Asia, with € 1.6 trillion in loans outstanding. The credit crunch in Europe will engulf the whole world.

As Bloomberg reports:


European banks, assuring investors they can weather the sovereign debt crisis by selling assets and reducing lending, may not be able to raise money fast enough to prevent government-forced recapitalizations.

Banks in France, the U.K., Ireland, Germany and Spain have announced plans to shrink by about 775 billion euros ($1.06 trillion) in the next two years to reduce short-term funding needs and comply with tougher regulatory capital requirements, according to data compiled by Bloomberg. Morgan Stanley bank analysts predict that amount could reach 2 trillion euros across Europe by the end of next year as banks curb lending and sell loans and entire businesses. A lack of buyers and the losses lenders face on loan sales are making those targets unrealistic.

“Asset sales are impractical in the current environment,” said Simon Maughan, head of sales and distribution at MF Global UK Ltd. in London. “Every bank is selling, and no bank is buying. It just won't work. Beyond that, the magnitude of the cuts the banks are talking about is nowhere near the likely required amount of deleveraging. They need to reduce hundreds of billions more to adjust to the new world order. There has to be a recapitalization.”


(emphasis added)

These efforts could have wide-ranging effects. For instance, French banks are among the biggest trade finance lenders in the commodities business. Already small to mid-sized commodity traders are feeling the pinch as the French banks are pulling back.

As the FT reports:


The European banking crisis is spilling over into commodities trading with French banks, the main financiers of trading houses, reining in their lending.

BNP Paribas and a handful of other European banks, including Société Générale and Crédit Agricole, provide most of the credit lines that underpin the business of the publicity shy Swiss-based traders that dominate commodities markets. Trade finance is a huge business, with lending hitting $114bn in the first nine months, down 6 per cent year-on-year, according to Dealogic.

Industry executives said that as the banks have to boost their capital buffers, credit to the trading industry is becoming scarcer and costlier, particularly in US dollars, the currency of the global commodity markets.

Julien Garran, commodities analyst at UBS in London, said it was “increasingly likely that the French banks will wind down their commodities trade financing business”. In a report, he quoted an industry executive warning that if BNP were to quit the business, “it would most likely cause a panic”. BNP’s Geneva branch alone accounts for up to a quarter of the sector’s credit, according to industry estimates. The bank said commodity trade finance activities “will be part” of its “global deleveraging effort”, but it “had no intention to exit the business”.

In 2008, a sharp reduction in credit to the trading industry exacerbated the financial crisis by almost freezing global trade flows, pushing commodities prices sharply lower.”


(emphasis added)

Once again, we actually doubt that the political leaders of Europe are fully aware of the complexity of the financial system and the many consequences the current crisis bring with it. Meanwhile it was reported yesterday that Euro-area politicians are coming up with new fantasy numbers as to how much capital the banks actually require. These newest estimates are based on the findings of the EBA, the very institution responsible for the first two 'stress tests' charades that have been such laughable exercises in spin and propaganda. Note here that the stress of last July asserted that Dexia was the by far healthiest bank in all of Europe and required no new capital. Fast forward four months and the bank is insolvent and has to be nationalized!

Anyway, based on EBA data, it has now been decided that euro area banks need only € 100 billion in new capital, and not all at once –

as CNBC reports:


“Europe’s grand plan to strengthen its banking system is set to fall well short of current market expectations, identifying a capital shortfall of less than 100 billion euros that must be made up over the next six to nine months, according to the latest official estimates.

The European Union’s estimate of the necessary recapitalisation effort compares with a recent Inernational Monetary Fund report that identified a 200 billion euro hole in banks’ balance sheets stemming from sovereign debt writedowns. It also falls far short of analyst estimates that banks might have a capital deficit of up to 275 billion euros.

Two people familiar with the outcome of an emergency stress test of Europe’s banks said the European Banking Authority, which ran the exercise, had suggested between 70 billion and 90 billion euros should be raised.


(emphasis added)

You couldn't make this up.

In summary, we would say that risk remains extremely high. Unless a miracle happens and the German government and the ECB can be talked into lining  the ECB up behind the rescue fund, things will likely spiral out of control sooner rather than later. Traders and investors should brace themselves accordingly.



We will provide our next chart update o  f CDS prices, bond yields, etc. tomorrow.

Addendum 2:

After this article was written, 'draft guidelines' for the new EFSF were apparently leaked. The most important point about the draft seems to be that it would allow the 'EFSF to circumvent the poltical process' and allow the bureaucrats to make important decisions themselves without having to ask for parliamentary approval. As Marketwatch reports: (link.
"Dow Jones Newswires, citing a draft document, said the guidelines would allow the EFSF to buy debt directly from countries issuing new bonds or on the open market. Purchase decisions would require an application and approval by the Eurogroup Working Group and the EFSF board, meaning decisions would be made quickly by European Union bureaucrats rather than via a political process."
This certainly sounds convenient, as it would hasten the decision making process considerably. Democratic political processes would have almost tripped up the entire bailout scheme after all. So this is fairly typical for the centralizers in the EU, who want to get rid of as much national subsidiarity as possible. Alas, there is nothing in there about the size and the funding of the EFSF,  which appear to us to be the far more important issues from the perspective of the markets.




Chart by: Bloomberg



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10 Responses to “The Euro Area Crisis May Be Coming To A Head”

  • zerobs:

    I love it: “Euro boosted on circumvention of democratic processes”.

    The only question is whether such “news” reduces or increases the chance for violence in Greece.

  • Andrew Judd:

    Thanks once again for bringing the blow by blow details of this incredible situation.

    However illiquid banks are not really much of a problem in the context of fiat. Lack of liquidity will be highly price deflationary.

    The main problem is a political one. Ie savers want to be saved. Bondholders want to be saved. Shareholders want to be saved. Plus there is a small army of people hoping to profit from collapse and price discovery. Everybody wants a bailout one way or another.

    • I agree. If one considers for instance the population’s resistance to things like bank bailouts more closely, it was something Angela Merkel herself once explained in her sometimes surprisingly frank manner.
      I’m paraphrasing here – when she was asked about the bank bailouts and why she had pursued this highly unpopular course, she replied: ‘It would have been even more unpopular not to do it; people say they don’t like the policy, but when confronted with what bank insolvencies could mean for them personally, they would rather have us bail out the banks.’
      She is right about that. We have lived in an inflationary system for so long, that the whole outlook of society is influenced by it. There is simply no longer any concrete experience with sound money and free banking.
      Many people may feel, deep down, that something is wrong with the current system, but they can not articulate what it is. They can also simply no longer imagine a world in which one’s income grows not by means of inflation, i.e. in nominal terms, but in real terms. The inflationary theories are so simplistic and seductive and sound economic theory so complex and difficult to understand (from the PoV of the common man) that the former are always an easier sell.

  • Floyd:

    The system became chaotic in the mathematical sense (i.e. having ALL edge conditions one could try to predict the outcome, alas in the absence of all edge conditions there is no one credible prediction).
    It is quite likely that the eurocrats will find a formula that sidelines the various parliaments, starting with Germany’s.
    At the same time, one cannot rule out that the eurocrats don’t understand how explosive the situation is (as suggested by Pater), coupled with the politician course (they only know how to do politics which is not conducive to solving real problems).

    • The people I call the ‘centralizers and harmonizers’ – incarnated in figures like Barroso, van Rompuy, Rehn, et al. – the supporters of the socialist superstate in short, are not interested in having democracy interfere with the ‘wise men’ (themselves) that are steering the EU. If they could, they would gladly eliminate national pariaments and subsidiarity altogether.
      However, this trend has luckily been circumscribed somewhat by recent decisions of the German constitutional court. There are now a few thresholds the German government can not (yet) cross.
      As to whether the eurocrats truly understand the ramifications of their actions here, I doubt it. They would act and talk differently if they did. Some people in the eurocracy know what the markets expect of them, but not all of them do, or perhaps don’t really care actually.
      The whole situation is complicated additionally by the vast gulf between short term thinking and outcomes and long term thinking and outcomes.

  • amun1:

    I wouldn’t count them out just yet. I think we’ve established that there’s a solid base of rumor, innuendo and allegations of printing sitting just below S&P 1200. If that should fail, then I’m sure we’ll see more monetization of something. But that probably won’t be necessary since the equity markets are firmly in control for the present.

    • I agree, we can not count them out. But the conflict between France and Germany over whether or not to print is a serious and central one to the whole way forward. If France prevails in this debate, the foundations for an enormous catastrophe will be laid – even though the markets will of course celebrate for a few weeks or months.
      If on the other hand Germany’s ‘hard line’ prevails, the markets are likely to express their disappointment pretty soon and violently – but in the long run it would of course be a somewhat better way forward.
      This must be tempered by the realization that not one party to the negotiations is truly pro free market, and that therefore the reforms that would really solve the problems at the root are as distant as ever.
      Besides, if market pressure increases, chances are good that the Germans will belatedly relent anyway.

      • RedQueenRace:

        Regardless which side prevails, the ensuing short-run market behavior will be spun by the Krugmans, Bernankes and others who believe in the power of the printing press to justify more counterfeiting on the US end.

        Big government and its supporters recognize the utility and flexibility of the markets as they use them as both whipping boy and crutch as needed.

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