What happened on Tuesday in the euro area's sovereign debt and associated markets has probably set alarm bells ringing everywhere. Considering yet another day of widespread carnage in euro area sovereign debt, it was almost comical to see the US stock market rising following comments by the Fed's über-dove Charles Evans in a TV interview about his proclivity to vote for more money printing. This is 'news' why exactly?
Of course the crisis in the euro area isn't really news anymore either. Alas, a new, and potentially decisive (perhaps fatal) facet has made a speedy entrance over recent weeks and has become decidedly more manifest this week.
First we had reports that the EFSF could not even sell € 3 billion in bonds, after cutting down the originally planned offer size from € 5 billion when it became clear it couldn't possibly get bids for that much. Remember, that's supposed to be the euro area's 'bailout bazooka'. Right now it looks more like a water pistol. A small one.
The Telegraph reported that in order to cover up the failure of the auction, the EFSF bought its own bonds, something the bureaucrats overseeing the fund immediately denied. The problem with their denial is that there's no explanation how they actually moved the entire amount, since apparently there weren't bids for € 3 billion.
When the EFSF made its first bond sale over a year ago, it was ten times oversubscribed. At the time investors evidently still believed the bailout would work. These bonds have performed rather atrociously ever since, as opinions on the workability of the fund have slowly but surely changed. Right now there is a problem rearing its head that may well condemn the 'new enlarged' EFSF to the DOA status we have assigned to it right after it was born. The fund's AAA rating crucially depends on the ratings of its major backers, one of which is France. Unfortunately for France, its fate is tied at the hip with Italy's, due to the fact that French banks are actually the biggest holders of Italian debt. We have pointed this problem out before: it is likely not possible for France to retain its AAA rating if the government decides to backstop the big banks, as it may eventually feel forced to do. French banks in toto hold assets worth almost 400% of the country's GDP (a little less now, since they are busy shedding assets as fast as they can).
Considering Tuesday's moves in CDS on France and the move in OAT yields, the markets no longer think an AAA rating is appropriate for France (as an aside, if you were wondering what the acronym stand for, it is 'obligations assimilables du tresor', which denotes long term bonds). The spread of French over German yields has rocketed to a record high.
In fact, it appears as though Germany will soon be the last man standing in euro-land, as new highs have been recorded in CDS and yields all over the show. Even bonds that were heretofore somewhat mysteriously considered 'safe haven' bonds like those issued by Austria's government are beginning to crumble at astonishing speed. Austria's politicians were apparently alarmed enough by this development that they decided to bring forward legislation on a constitutional 'debt brake', including the demand that the 'Länder' (provinces) and municipalities run balanced budgets from 2017 onward (file under 'pipe dream').
We must reiterate on this occasion that we are not only finally seeing a crisis of the modern-day welfare states, but underlying it, a crisis of the fractionally reserved banking system. In spite of the fact that the ECB has now advanced almost € 1 trillion in 'emergency liquidity' to euro area banks, i.e., almost an entire enlarged EFSF worth of money from thin air, the banks continue to flounder.
Man overboard: the spread of French OATs over German bunds goes ballistic – click for higher resolution.
Euro Area Banks: Eurocracy Scores Own Goal
The euro area's biggest banks are facing a multifaceted problem. Not only are their holdings of euro-area sovereign bonds (ex Germany) losing value day after day, they are still lugging around gigantic amounts of toxic assets from the burst US real estate bubble (see our previous missive on this, scroll to the bottom of the post for the numbers), in addition to those that have been amassed in Europe's various housing bubbles, all of which have burst as well. If all of this stuff were marked to market – which it should be mentioned isn't even possible for the whole lot, since there simply is no longer a market for some of it – many of these banks would likely be insolvent.
Given the sudden realization a few weeks ago that euro area banks are short of capital and that the EBA's (European Banking Authority) previous 'stress tests' were largely a farce (the allegedly 'best capitalized bank in Europe' was Dexia according to the EBA – that's really all one needs to know about these tests), the EU has decided to apply more strict criteria to assess the health of banks and force them to raise far more capital than originally envisaged.
As the same time the eurocracy has done everything it could to lose what credibility it once may have possessed by means of a string of rather strange interventions (such as the ban on 'naked CDS' trading enacted by the EU parliament this week) and by issuing promises it could not possibly keep. First and foremost among those promises were the ones related to the Greek debt situation.
Initially banks and other investors were told that there would be 'no haircuts' at all for Greek debt. The ECB specifically was vociferous in its insistence on this point. This was later revised to a '21% haircut' – but at the time it was also made clear that only private investors would be subjected to it. Public holders of claims against the Greek government, from the IMF to the ECB to the EFSF were and are exempted. The math on this never really worked, since by that time a lot of Greek debt had already made its way onto public balance sheets. So a few short months later, the haircut was increased to 50%.
We have always argued that those who made bad investments should bear responsibility for the losses incurred. However, creating two classes of creditors was a big mistake. It was an even bigger mistake to change the terms of the agreement twice in mid flight. To add insult to injury, these haircuts were deemed 'voluntary' in order to avoid a triggering of CDS contracts – with the entirely predictable consequence that some bond holders felt they could no longer properly hedge their risk and thus should better sell euro area sovereign bonds as quickly as possible.
Finally, the banks had no longer any reason to believe the latest string of promises issued by the eurocrats. The major promise of the most recent emergency summit was that Greece would be 'fire-walled' and that no other government debt in euro-land would be subjected to similar treatment. Not surprisingly, bank managers at this point are thinking 'Fool me once….'.
Moreover, the banks were told that the tough new capital rules should preferably be achieved by tapping the private sector. Should this not work, then banks would be eligible for government or EFSF bailouts, which would obviously come with a great many strings attached (one of which is 'no more bonuses', which has an effect on bankers that is the equivalent of sprinkling holy water on Beelzebub).
The reaction of the bankers was entirely predictable. More shareholder dilution at stock prices that have declined to multi-year lows? Forget it. Taking money from Papa State in exchange for being dictated to even more? No way. So what is left? Only one thing: shrink those bloated balance sheets by selling assets – those that can be sold that is. No-one's going to buy some CDO stuffed with US sub-prime debt or similar garbage. Oh, and remember, there's a sovereign debt crisis in euro-land, which has called forth a lone bidder in the markets in possession of unlimited funds – the ECB. The banks see this as a marvelous opportunity to de-risk and shrink their balance sheets: Sold to you, Mario!
One wonders what their asset quality will be like when all is said and done. The average euro-land bank will probably shrink back to its core of unsaleable crap plus a few pompous marbled buildings.
We conclude that the eurocracy has an unsurpassed capacity at shooting itself into the foot. It doesn't even need an adversary, it is perfectly capable of shredding the euro-area all by itself.
We are actually somewhat astonished to learn that the latest nutty idea of financial markets commissar Michel Barnier, namely to 'ban credit ratings' on wobbly sovereigns, has met with enough bureaucratic resistance yesterday to be torpedoed before it could become policy. As the , this time he was stopped by his fellow commissars, although the remainder of his plans was kept in place:
“PLANS TO ban sovereign credit ratings in “exceptional circumstances” have been shelved by Europe’s top financial regulator after he came under pressure to climb down on the controversial measure to rein in the agencies that issue the assessments of national financial strength.
Michel Barnier, the European internal market commissioner, admitted that he had to bow to objections from his fellow European Union commissioners but insisted the power to suspend ratings was never “the main measure” in his reform package.
Although Mr Barnier still unveiled proposals to aggressively transform the business model and methods of the big rating agencies, the last-minute decision to order more “technical work” on suspension represents a significant political blow.
Yet, despite the amendments, rating agencies remain deeply concerned by planned requirements for issuers of financial securities and bonds to rotate agencies, and rules that give regulators the power to “pre-approve” analysis methods.
“We strongly believe that the commission proposal is damaging for the credit markets,” said Michel Madelain, Moody’s chief operating officer.”
A bullet was dodged here: Barnier's wide-ranging plans to shoot any and all messengers he can find are already doing more than enough damage. Contrary to the beliefs apparently held by populist euro area politicians, the crisis is not the fault of 'speculators', it is the fault of the fiscally incontinent governments these politicians lead.
Speculators are in fact doing us a great service by uncovering the system's fault-lines by means of reassessing the merits of dodgy debt and forcing governments to react. The correct reaction is not to 'ban speculation' as has just been done with CDS trading (the ban is supposed to become active in a year's time, but markets are forward looking with regards to that), the proper reaction is to make the debt less dodgy by cutting spending.
Readers may recall that we have discussed the problems arising from these interventions on several occasions. So has .
To Print or Not To Print …
We noted yesterday that recent personnel changes at the ECB and hints from Germany's politicians at the CDU congress indicate that a move to weaken the ECB's resistance to guaranteeing all government debt in the euro area may be underway(likely on a 'just in case' basis, but still).
However, we would point readers to the fact that the president of Germany's Bundesbank (BuBa) remains implacably opposed to this idea. An interesting portrait of Jens Weidmann has just appeared in Germany's news magazine Der Spiegel, an English language version of which can be seen here: 'Germany's Central Bank Against the World'.
If after reading this you are convinced Weidmann will never ever alter his stance, you are probably right. An interesting tidbit is that he is convinced that letting the ECB off the leash would actually do far more harm than good, as then the one institution that still has some credibility in the euro area will end up compromised, while the fiscal offender governments will lose the incentive they now have to adopt reforms.
Interestingly, Germany's public, its most prominent economists and its commercial banking establishment are all backing Weidmann's views.
So if there really is a 'plan B' regarding the disposition of the ECB's printing press, then it will have to happen over the dead body of Weidmann, metaphorically speaking.
Weidmann continues in the tradition of the BuBa, which was always marked by fierce independence and resistance to the wishes of the politicians of the day. Politicians are of course always in favor of easy money, an idea that is anathema to the BuBa.
Financial Quake Reaches Hungary
Below is a weekly chart of the euro against the Hungarian forint that kind of speaks for itself. You have to be in really deep trouble if your currency collapses against the euro of all things.
The forint has now plunged below its 2008/9 lows, which is quite a feat. Government bond yields are also rising sharply, but are still a good distance away from their GFC highs, when the ECB had to come to Hungary's aid with a liquidity injection and the IMF granted an emergency loan as well.
Forint per euro, weekly – click for higher resolution.
Unfortunately one of the euro-areas six AAA rated nations – namely Austria – is not only bordering Italy, but also Hungary and Slovenia (which we have previously noted is in grave trouble as well all of a sudden). A common border is per se not a reason for concern, but as one might imagine, Austria's commercial and banking ties to all these countries are strong. Hungary's government led by Victor Orban has become known for its capricious and dirigiste policies, one of which was to shift the losses from CHF denominated mortgage loans from borrowers to lenders – causing Austria's Erstebank to report a huge loss (we have chronicled the storied history of this loss and the resulting capital requirements in these pages not too long ago; as far as losses go, this one went on an astonishing growth trajectory in a very short time period).
Hungary's growing problems have now been noticed by the financial press. The :
“Hungary's central bank sounded the alarm on Tuesday as international investors continued to dump Hungarian assets amid concerns over the country's economic management and over the impact of the euro crisis on its banks and sovereign rating.
The National Bank of Hungary's monetary policy council warned that the drop in the country's currency, the forint, escalates the risk of inflation, and said official interest rates may have to be increased to reverse the trend. The central bank blamed the run on its currency on the threat of recession in the euro-zone and the effects that is having on neighboring countries that don't use the euro.
The official warning over capital flight extended the forint's sharp declines to near-record lows, as speculation grew that Hungary's strong banking ties with the euro zone made it most vulnerable among Eastern European economies.
Hungarian stocks tumbled and government borrowing costs soared as investors demanded higher premiums for Hungarian government bonds. Hungary paid a painfully high yield of 6.71% on Tuesday to sell 40 billion forints ($172.55 million) of three-month Treasury bills at auction. The cost of insuring against debt defaults continued to march higher.
Economists were reminded of Hungary's financial near-collapse in 2008, when only the arrival of emergency aid from the International Monetary Fund prevented its crisis from spreading to other emerging markets in the region.
"Hungary is once again at the epicenter of attention among emerging-market bond investors following a number of unorthodox and controversial policy choices made by the new administration," said Michail Diamantopoulos, an emerging-market portfolio manager at Investec Asset Management.
Since it took the helm in spring 2010, the Hungarian government has introduced a number of one-time measures to fill holes in the budget while economic growth accelerates. Such steps include temporary "crisis" taxes imposed on the telecommunications, energy, retail and financial sectors; nationalization of the mandatory pension funds; and, this September, a plan that allows households to repay in a lump sum at discount rates mortgages denominated in foreign currencies.”
Let us say the budding crisis in Hungary is not entirely unexpected, but it sure comes at an inopportune moment.
Hungary's 10 year government bond yield, short term. About to overtake Ireland's as it were – click for higher resolution.
Hungary's 10 year government bond yield, long term. This shows that things are not yet as bad as they were at the height of the GFC in early 2009, but once these moves get going, they have a tendency to become 'non-linear' very quickly – click for higher resolution.
Euro Area Credit Market (Massacre) Charts
Below is our customary collection of CDS prices, bond yields, euro basis swaps and several other charts. Both charts and price scales are color coded. Prices are as of Tuesday's close.
It was an across-the-board massacre on Tuesday. It is no exaggeration to state that the debt crisis has never been closer to getting completely out of hand. A little over two weeks ago we thought that there was perhaps a small chance for things to calm down again for a while, but we were clearly mistaken.
Since then, things have gone from bad to worse in what seems an unseemly hurry. As the title of today's post indicates, the crisis is now eating away at the viability of the 'core', with only very few euro area sovereigns remaining above the market's suspicion.
Truth be told, not all of them deserve it, alas, the market has been quite diligent in winnowing the undeserving from the ranks.
5 year CDS on Portugal, Italy, Greece and Spain – CDS on Italy and Spain both have reached new highs once again – click for higher resolution.
5 year CDS on France, Belgium, Ireland and Japan – CDS on France and Belgium are now 'going vertical' – click for higher resolution.
A separate chart breaking out CDS on French debt. From an Elliott Wave standpoint we would guess that this is a third wave – the 'recognition wave'. What is being recognized is that France's credit rating is probably toast – click for higher resolution.
5 year CDS on Bulgaria, Croatia, Hungary and Austria – big one day jumps higher across the board once again, especially in CDS on Austria (up 20 basis points or roughly 10% on the day) – click for higher resolution.
5 year CDS on Latvia, Lithuania, Slovenia and Slovakia – also moving higher again, if at a somewhat slower pace – click for higher resolution.
5 year CDS on Romania, Poland, Slovakia and Estonia – Estonia is the best of these in absolute terms, but in relative terms it is now seeing the fastest rise of this quartet – click for higher resolution.
Three month, one year and five year euro basis swaps – these look like they will break support at any moment – click for higher resolution.
Our proprietary unweighted index of 5 year CDS on eight major European banks (BBVA, Banca Monte dei Paschi di Siena, Societe Generale, BNP Paribas, Deutsche Bank, UBS, Intesa Sanpaolo and Unicredito) – say hello to a new all time high in this index, on account of a huge one day jump of almost 30 basis points – click for higher resolution.
10 year government bond yields of Italy, Greece, Portugal and Spain – Italian yields back above 7%, Spanish yields at a new high – click for higher resolution.
10 year government bond yield of Austria, the 9 year government bond yield of Ireland, UK Gilts and the Greek 2 year note. The jump in Austrian bond yields has gone from 'remarkable' to 'striking' to 'scary' in the space of one week. Greek yields continue their bizarre journey toward absurdity – click for higher resolution.
5 year CDS on the two Austrian banks Erstebank and Raiffeisen continue to break higher with some vigor as well. These are indexed, absolute values are currently 344 basis points for Erstebank and 353 for Raiffeisen – click for higher resolution.
10 year government bond yield of Belgium – this is also beginning to look precarious – click for higher resolution.
10 year government bond yield of Belgium, weekly. Here it should be noted that in 2008, these yields reflected a 'price premium' or 'inflation premium'. Currently all they are reflecting is a 'risk premium', i.e. the market perception of growing default risk – click for higher resolution.
The 10 year bond yield of France. This looks pretty worrisome as well – click for higher resolution.
10 year bond yield of France, long term. If it is to come down again, now's the time. Should this trendline break, a move to the next level of lateral resistance becomes highly likely – click for higher resolution.
Italy's 10/2 year spread, long term. Once again approaching inversion – click for higher resolution.
Portugal's 10/2 inversion once again widens a little – click for higher resolution.
Inflation adjusted yields show that inflation expectations are now falling faster in the euro area than in the US – click for higher resolution.
5 year CDS on Australia's 'Big Four' banks – bouncing again – click for higher resolution.
The structure of the decision making bodies of the ECB. Jürgen Stark is about to be replaced by Jörg Asmussen (the chief economist is traditionally a German), the replacement for Lorenzo Bini Smaghi (who is leaving due to the new president being an Italian as well) has yet to be determined, but will most likely be a Frenchman – click for higher resolution.
Regarding Belgium, here is a famous (in Belgium, anyway) song from better, more lighthearted times:
Potverdekke! by Mr. John.
Jens Weidmann's name meanwhile reminds one of the German archaic term for 'hunter', which is 'Waidmann'. Even today, hunters greet each other by saying 'Waidmann's Heil!'
Ironically, there is a song called Waidmann's Heil by the German metal band Rammstein, the chorus of which goes 'Die Kreatur Muss Sterben' ('the creature must die'). This is probably what every politician below 47 degrees North latitude in Europe is currently secretly thinking when contemplating Weidmann.
We doubt he will do them the favor, but he may eventually be outvoted.
Rammstein, Waidmann's Heil (sounds appropriately apocalyptic as well).
Lastly, here is another Spiegel article we would recommend to our readers, dealing with the German government's plans to transfer more power to Brussels (as discussed yesterday), which will necessitate that the German constitution be altered – which in turn will likely require a referendum.
Charts by: Bloomberg, M&G Investments, Portfolio.hu, Der Spiegel
You may have noticed that our so-called “semiannual” funding drive, which started sometime in the summer if memory serves, has seamlessly segued into the winter. In fact, the year is almost over! We assure you this is not merely evidence of our chutzpa; rather, it is indicative of the fact that ad income still needs to be supplemented in order to support upkeep of the site. Naturally, the traditional benefits that can be spontaneously triggered by donations to this site remain operative regardless of the season - ranging from a boost to general well-being/happiness (inter alia featuring improved sleep & appetite), children including you in their songs, up to the likely allotment of privileges in the afterlife, etc., etc., but the Christmas season is probably an especially propitious time to cross our palms with silver. A special thank you to all readers who have already chipped in, your generosity is greatly appreciated. Regardless of that, we are honored by everybody's readership and hope we have managed to add a little value to your life.
Bitcoin address: 1DRkVzUmkGaz9xAP81us86zzxh5VMEhNke
6 Responses to “The Crisis Eats Its Way Into The Core”
Most read in the last 20 days:
- Modi’s Great Leap Forward
India’s Currency Ban – Part VIII India’s Prime Minister, Narendra Modi, announced on 8th November 2016 that Rs 500 (~$7.50) and Rs 1,000 (~$15) banknotes would no longer be legal tender. Linked are Part-I, Part-II, Part-III, Part-IV, Part-V, Part-VI and Part-VII, which provide updates on the demonetization saga and how Modi is acting as a catalyst to hasten the rapid degradation of India and what remains of its institutions. India’s Pride and Joy Indians are...
- US Financial Markets – Alarm Bells are Ringing
A Shift in Expectations When discussing the outlook for so-called “risk assets”, i.e., mainly stocks and corporate bonds (particularly low-grade bonds) and their counterparts on the “safe haven” end of the spectrum (such as gold and government bonds with strong ratings), one has to consider different time frames and the indicators applicable to these time frames. Since Donald Trump's election victory, there have been sizable moves in stocks, gold and treasury bonds, as the election...
- Global Recession and Other Visions for 2017
Conjuring Up Visions Today’s a day for considering new hopes, new dreams, and new hallucinations. The New Year is here, after all. Now is the time to turn over a new leaf and start afresh. Naturally, 2017 will be the year you get exactly what’s coming to you. Both good and bad. But what else will happen? Image of a recently discarded vision... Image by Michael Del Mundo Here we begin by closing our eyes and slowing our breath. We let our mind...
- The Great El Monte Public Pension Swindle
Nowhere City California There are places in Southern California where, although the sun always shines, they haven’t seen a ray of light for over 50-years. There’s a no man’s land of urban blight along Interstate 10, from East Los Angeles through the San Gabriel Valley, where cities you’ve never heard of and would never go to, are jumbled together like shipping containers on Terminal Island. El Monte, California, is one of those places. Advice dispensed on Interstate...
- A Trade Deal Trump Cannot Improve
Worst in Class BALTIMORE – People can believe whatever they want. But sooner or later, real life intervenes. We just like to see the looks on their faces when it does. By that measure, 2017 may be our best year ever. Rarely have so many people believed so many impossible things. Alice laughed. "There's no use trying," she said: "one can't believe impossible things." "I daresay you haven't had much practice," said the Queen. "When I was your age, I always did it for...
- Pope Francis Now International Monetary Guru
Neo-Marxist Pope Francis Argues for Global Central Bank As the new year dawns, it seems the current occupant of St. Peter’s Chair will take on a new function which is outside the purview of the office that the Divine Founder of his institution had clearly mandated. Neo-Papist transmogrification. We highly recommend the economic thought of one of Francis' storied predecessors, John Paul II, which we have written about on previous occasions. In “A Tale of Two Popes” and...
- Where’s the Outrage?
Blind to Crony Socialism Whenever a failed CEO is fired with a cushy payoff, the outrage is swift and voluminous. The liberal press usually misrepresents this as a hypocritical “jobs for the boys” program within the capitalist class. In reality, the payoffs are almost always contractual obligations, often for deferred compensation, that the companies vigorously try to avoid. Believe me. I’ve been on both sides of this kind of dispute (except, of course, for the “failed”...
- Trump’s Trade Catastrophe?
“Trade Cheaters” It is worse than “voodoo economics,” says former Treasury Secretary Larry Summers. It is the “economic equivalent of creationism.” Wait a minute - Larry Summers is wrong about almost everything. Could he be right about this? Larry Summers, the man who is usually wrong about almost everything. As we have always argued, the economy is much safer when he sleeps, so his tendency to fall asleep on all sorts of occasions should definitely be welcomed....
- Trump’s Plan to Close the Trade Deficit with China
Rags to Riches Jack Ma is an amiable fellow. Back in 1994, while visiting the United States he decided to give that newfangled internet thing a whirl. At a moment of peak inspiration, he executed his first search engine request by typing in the word beer. Jack Ma, founder and CEO of Alibaba, China's largest e-commerce firm. Once he was a school teacher, but it turned out that he had enormous entrepreneurial talent and that the world of wheelers, dealers, movers and...
- Money Creation and the Boom-Bust Cycle
A Difference of Opinions In his various writings, Murray Rothbard argued that in a free market economy that operates on a gold standard, the creation of credit that is not fully backed up by gold (fractional-reserve banking) sets in motion the menace of the boom-bust cycle. In his The Case for 100 Percent Gold Dollar Rothbard wrote: I therefore advocate as the soundest monetary system and the only one fully compatible with the free market and with the absence of force or fraud...
- Side Notes, January 14 - Red Flags Over Goldman Sachs
Red Flags Over Goldman Sachs Just to prove that I am an even-handed insulter, here is a rant about my former employer, Goldman Sachs. The scandal at 1MDB, the Malaysian sovereign wealth fund from which it appears that billions were stolen by politicians all the way up to the Prime Minister, continues to unfold. The main players in the 1MDB scandal. Irony alert: apparently money siphoned off from 1MDB was used to inter alia finance Martin Scorcese's movie “The Wolf of...
- Silver’s Got Fundamentals - Precious Metals Supply-Demand Report
Supply-Demand Fundamentals Improve Noticeably Last week was another short week, due to the New Year holiday. We look forward to getting back to our regularly scheduled market action. Photo via thedailycoin.org The prices of both metals moved up again this week. Something very noticeable is occurring in the supply and demand fundamentals. We will give an update on that, but first, here’s the graph of the metals’ prices. Prices of gold and silver...