More Bailout Money Is Waiting in the Wings

Slightly panicky – interestingly just as euro area debt and stock markets are in a phase of recovery – EU ministers are plotting to increase the bail-out fund. Why would it need to be increased? The answer is probably that the notion forms part of the 'bazooka strategy' pioneered by John Paulson in 2008. Essentially it is saying 'if we wave a big enough gun in the market's face then the market will back down'. So far, the mere threat of that happening has indeed led to an improvement in the markets – but we distinctly remember that similar moves by the US government to contain the 2008 crisis also led to short term improvements in market sentiment. With the bigger questions of 'who shall ultimately bear the losses' and 'how big are the losses anyway'  remaining unsolved, the markets eventually crumbled even in the face of all these concerted interventions.

This is by the way how it always works historically. If the problem is big enough and intractable enough, then no amount of intervention can keep the contraction from happening and credit being withdrawn by fearful creditors and investors.



As reported by AP:


„Over the past week, calls to boost the eurozone's €750 billion ($1.3 billion) bailout fund by expanding its size and – perhaps more importantly – by giving it broader powers have grown louder.

French Finance Minister Christine Lagarde told journalists on Saturday that she and her counterparts were discussing giving the fund the power to buy government bonds on the open market – a move that would take pressure off countries that have seen bond prices fall and funding costs rise. Belgium's Finance Minister Didier Reynders, meanwhile, said the size of the fund should be doubled, to €1.5 trillion.

Jean Claude Trichet, the head of the European Central bank, and two top officials of the European Union's executive commission have also thrown their weight behind a new role for the bailout fund, which has so far been limited to providing rescue loans to cash-strapped countries.

The European Commission last week circulated a document among EU member states with some suggestions on how to broaden the scope of the fund beyond bailouts. But an EU official familiar with the document said talks were still at an early stage and that he didn't expect finance ministers to take any big decisions this week.

"The meeting will not achieve such a degree of detail," said the official, who was speaking on condition of anonymity because of the early stage of the discussions.

Most analysts say the eurozone's current strategy to deal with the crisis has failed.

That strategy sees countries bail out their struggling banks to then provide them with expensive rescue loans, conditioned on steep budget cuts, when they run out of money.

A €67.5 billion bailout of Ireland – necessary after massive capital injections for big banks pushed the country's budget deficit to almost one-third of economic output – didn't succeed in containing the crisis.

Greece, which received a €110 billion rescue loan, was on Saturday downgraded by another rating agency, reflecting concern about the country's ability to pay off its debt amid a shrinking economy and falling government revenue.

Most economists expect Portugal to also ask for help soon, while markets are worried about the financial health of much larger Spain.

Spain's economy makes up about 10 per cent of the eurozone's gross domestic product and bailing it out could easily overwhelm the existing facility.“


(our emphasis)

So we see it is the 'ghost of Spain' that is hovering over the proceedings. One thing is quite clear, Spain is in dire economic straits. Whether it can extricate itself in time from its problems remains very much open to question and should Portugal receive a bailout, then the question will become all the more urgent.

Note also who is pleading for 'doubling the fund's size' – none other than Belgium's minister of finance, who presumably is painfully aware of the troubles his own country is in.


Irish Monetary Escapades

Meanwhile it has also emerged that the Bank of Ireland is feeding emergency loans to Irish banks , which explains why direct ECB lending to the Irish banking system has slightly dropped. The amounts involved are staggering for this small nation. As reported by the Irish Independent:


„EMERGENCY lending from the ECB to banks in Ireland fell in December, the first decline since January 2010, but only because the Irish Central Bank stepped up its help to banks.

The Irish Independent learnt last night that the Central Bank of Ireland is financing €51bn of an emergency loan programme by printing its own money.

ECB lending to banks in Ireland fell from €136.4bn in November to €132bn at the end of December, according to the figures released by the Irish Central Bank yesterday.

At the same time, the bank increased its emergency lending by €6.4bn, bringing the total it is owed to €51bn.

The latest data does show a levelling off in demand for the loans. Emergency lending to banks shot up €16bn in November, but overall demand for the loans only increased by €2bn in December when ECB and Irish Central Bank figures are combined.

However, the figures also provide the latest evidence that responsibility for funding Ireland's broken banks is being pushed increasingly back on to Irish taxpayers. The loans are recorded by the Irish Central Bank under the heading "other assets".

A spokesman for the ECB said the Irish Central Bank is itself creating the money it is lending to banks, not borrowing cash from the ECB to fund the payments. The ECB spokesman said the Irish Central Bank can create its own funds if it deems it appropriate, as long as the ECB is notified.

News that money is being created in Ireland will feed fears already voiced this week by ECB president Jean-Claude Trichet that inflation is a potential concern for the eurozone.

However, a source at the ECB said the European bank is comfortable that the amounts involved are small enough not to be systemically significant. The ECB has been lending money to banks in Ireland at just 1pc, as long as the banks can put up acceptable collateral.

The volume of those loans surged from €95bn in August 2010 to €136.4bn in November, as Irish banks repaid their bondholders without being able to refinance in the private sector. The ECB loans prevented banks that could not raise funds from the private sector running out of cash after repaying their own lenders and meeting deposit withdrawals.


Leaving aside for the moment the surprising revelation that a national central bank that is part of the euro-system is apparently able to print money all by itself just as long as it 'notifies the ECB', we find it absolutely astounding that the ECB is lending to Irish banks at just 100 basis points. This is exactly the kind of thing that would never happen in a free market and illustrates the perverse incentives our centrally planned monetary system creates. By rights the Irish banks at the receiving end of these loans should have been wound up due to their insolvency long ago, and that would have ended the matter. Ireland would have gone through a wrenching period of economic adjustment – something it was unable to avoid anyway – but in the end it could have started with a clean slate. Instead the Irish tax payers are now going to pay for bank bailout 'legacy costs' until they are blue in the face (or perhaps in Ireland their faces will turn green). Interestingly, the rebound in euro area CDS spreads has sort of by-passed Ireland somewhat this past week. In Iceland, where the big banks were allowed to go under, an economic revival looks far more likely nowadays than in Ireland – QED.

Note also, the central bank of Ireland simply records emergency loans as 'other assets' on its books and apparently is not even receiving collateral for them. They appear to be completely unbacked loans, financed solely by the printing press. Given that the Irish banks are unlikely to lend money out on the basis of these emergency funds, the inflationary effect should be muted, as € 50 billion isn't all that much in the bigger scheme of things, but the principle as such should be disconcerting, to say the least. Consider for instance what will happen if the banks fail to pay the emergency loans back. In that case, euro area money supply would increase by € 50 billion forever – and this money came literally from thin air. Since the central bank has no collateral on its books in exchange for the loans, it would be in no position to drain these funds from the economy.

On to the charts – we present our collection of usual suspects plus a few charts illustrating the big short squeeze that occurred in some of the European exchanges this past week.


1.    CDS – prices in basis points, color coded


5 year CDS spreads on Portugal, Italy, Greece and Spain – all still in retreat, but approaching short term support levels now – click for higher resolution.



5 year CDS spreads on Ireland, the senior debt of Bank of Ireland, France and Japan. Irish spreads haven't come in much and are already bouncing again. There has been an amazing rocket ride higher in Japan's CDS spreads. Is there finally trouble on the horizon in Japan? 86.49 basis points is not much in absolute terms, but for a major industrialized nation this is a level where concerns should increase quite a bit – click for higher resolution.



5 year CDS spreads on Romania, Austria, Hungary and Belgium. All following the PIIGS spreads lower this past week – click for higher resolution.



The Markit SovX index of CDS on 19 Western European sovereigns – a pullback as well over the past week, but this remains a bullish chart nonetheless – click for higher resolution.



2.    Euro Basis Swaps

EBS continue to recover, indicating that potential dollar funding problems in the euro area are still on the retreat. This tends to be short term dollar bearish/ euro bullish per experience.



3 month euro basis swap – a big bounce, but minus 40.75 basis points is of course still a worrisome level historically – click for higher resolution.



1 year euro basis swap –  recovering to minus 37.645 basis points – click for higher resolution.




3.    Other Charts


5 year CDS spreads on the 'big Four' Australian banks – still retreating from their big spike earlier in the year. We believe we will eventually see these spreads at much higher levels in the course of 2011 – click for higher resolution.



The SPX, T.R.'s proprietary VIX-based volatility indicator and the gold-silver and gold-commodities ratios. No major divergences at the moment, but all of this continues to look extremely stretched – click for higher resolution.



The SPX vs. the AUD-JPY cross. Here we continue to see a major divergence – click for higher resolution.



The spread between the OEX put-call and the equity only put-call ratios. This spread is giving its third bearish signal in a row and should be of major concern to stock market bulls. Via, a service we highly recommend – click for higher resolution.



MUB – the National Municipal Bond Fund ETF – a slight pause in the crash via a big bounce on Tuesday, but the recent move still strikes us as part of the third wave down. We doubt it is over, mainly due to the EW count we're applying to this, but there are a few positive divergences with RSI now, so perhaps a short term recovery is in the cards – click for higher resolution.



Spain's IBEX stock index – a big short covering bounce over the last week, driven especially by bank stocks – click for higher resolution.



The Dow Jones Portugal stock index – also a strong bounce, though not quite as enthusiastic as in Spain's market – click for higher resolution.



In closing we want to reiterate what we have been saying for a while now: although the stock market continues to levitate on the fumes of QE2, risk is extraordinarily high and it is getting more so by the day. Market sentiment is well beyond complacent by now. Proceed with great care.


Charts by: Bloomberg, &







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5 Responses to “Market Update , January 19”

  • White eagle:

    In Yugoslavia final collapse started when one of the republics(there were 6)just printed needed amount of Dinars when she didn’t see any other way out of trouble.Other republics were not happy,to put it mildly.That broke the political will to stay together and do some serious reforms(privatization…). Soon wars started…
    Could you tell me who can refrain Greeks from printing 300 billion euros and solve their problems,now after this Irish/Trichet move.What will Germans and Dutch do?
    Is this the beginning of the end? War?
    Nomen est omen.Root of Trichet family name is ¨to cheat¨ in French!
    What would do other States in USA if California printed billions of dollars to solve her problems?

    • As I understand the situation, it is currently assumed (although I can not really find independent corroboration of this) that if the ’emergency loans’ the Bank of Ireland has extended are not paid back, then the Irish government would have to take over the liability. In practice I think this verges on the impossible.
      It would certainly be interesting to find out if other euro area system central banks have also engaged in similar shenanigans, but so far I haven’t heard anything. In my opinion the biggest danger in this context is that the best laid plans are bound to misfire, stranding the economy with a vastly expanded money supply that can no longer be drained because either the assets that were bought in originally providing it have lost too much value or , as is the case here, no such corresponding assets exist at all and the borrowers fail to return the funds. No-one has ever set out on a deliberate course to destroy a currency – not even Yugoslavia. I remember the big inflation of Yugoslavia well, it kind of ‘just happened’. At first, it was thought that covering deficits with money printing would only be a ‘temporary measure’. However, soon it all spiraled out of control.

      • White eagle:

        It is clear that everybody in Ireland is broke – government,banks,central bank,borrowers,depositors,companies connected to real estate or state subsidies…This rescue charade and printing was allowed to give French,German and British bondholders some air.There is no way to grow out of this-we just had historical bubble recently.All this is just kicking the can down the road-for Japan it worked for 20 years thanks to exports and nationalistic pension funds.They are finished now.Europe will not have 20 years of time!
        Sadly,hyperinflations are still considered like earthquakes or tsunamis by mainstream and our leaders,not man made.Same goes for bubbles and their busts.

  • I find that JYB default rate very interesting in light of the rate paid on Japanese bonds. I don’t believe I would be holding those handgernades with the pins out very much longer. A few months ago, Kyle Bass of Hayman Capital was talking about putting on a short on Japanese debt. Here we have almost 1% risk in debt yielding less than 2%. A 1% move in the rate on Japanese debt wipes out 10% of the income of the Japanese government. Up in smoke could come suddenly. To think the Chinese chose Japanese bonds to rotate out of US debt? What are they up to?

    • In fact, when I posted this chart, the CDS spread was already higher than the corresponding JGB yield. 5 year JGB’s only yielded 0.54% on this day. So if a holder of the bonds bought insurance, then this would already have cost more than the bond produced in income, generating a negative carry. This makes this recent rise in CDS on JGBs all the more worrisome. Clearly Japan’s fiscal situation is an accident waiting to happen…or perhaps we should rather say a powder keg in search of a spark.

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