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enough and intractable enough, then no amount of intervention can keep the contraction from happening and credit being withdrawn by fearful creditors and investors.
„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.“
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 :
„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.
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 sentimentrader.com, 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.
Dear Readers! We are happy to report that we have reached our turn-of-the-year funding goal and want to extend a special thank you to all of you who have chipped in. We are very grateful for your support! As a general remark, according to usually well informed circles, exercising the donation button in between funding drives is definitely legal and highly appreciated as well.
Bitcoin address: 1DRkVzUmkGaz9xAP81us86zzxh5VMEhNke
5 Responses to “Market Update , January 19”
Most read in the last 20 days:
- How the Welfare State Dies
Hollande Threatens to Ban Protests Brexit has diverted attention from another little drama playing out in Europe. As of the time of writing, if you Google “Hollande threatens to ban protests” or variations thereof, you will find Russian, South African and even Iranian press reports on the topic. Otherwise, it's basically crickets (sole exception: Politico). Gee, we wonder why? They don't like him anymore: 120.000 protesters recently turned Paris into a war zone. All...
- Free Speech Under Attack
Offending People Left and Right Bill Bonner, whose Diaries we republish here, is well-known for being an equal opportunity offender - meaning that political affiliation, gender, age, or any other defining characteristics won't save worthy targets from getting offended. As far as we are concerned, we generally try not to be unnecessarily rude to people, but occasionally giving offense is not exactly beneath us either. The motto of the equal opportunity...
- Toward Freedom: Will The UK Write History?
Mutating Promises We are less than one week away from the EU referendum, the moment when the British people will be called upon to make a historic decision – will they vote to “Brexit” or to “Bremain”? Both camps have been going at each other with fierce campaigns to tilt the vote in their direction, but according to the latest polls, with the “Leave” camp’s latest surge still within the margin of error, the outcome is too close to call. The battle lines are...
- A Market Ready to Blow and the Flag of the Conquerors
Bold Prediction MICHAELS, Maryland – The flag in front of our hotel flies at half-mast. The little town of St. Michaels is a tourist and conference destination on the Chesapeake Bay. It is far from Orlando, and even farther from Daesh (a.k.a. ISIL) and the Mideast. St. Michaels, Maryland – the town that fooled the British (they say, today). Photo credit: Fletcher6 Out on the river, a sleek sailboat, with lacquered wood trim, glides by, making hardly a...
- Going... Going... Gone! The EU Begins to Splinter
Dark Social Mood Tsunami Washes Ashore Early this morning one might have been forgiven for thinking that Japan had probably just been hit by another tsunami. The Nikkei was down 1,300 points, the yen briefly soared above par. Gold had intermittently gained 100 smackers – if memory serves, the biggest nominal intra-day gain ever recorded (with the possible exception of one or two days in early 1980). Here is a picture of Haruhiko Kuroda in front of his Bloomberg monitor this...
- Rule Britannia
A Glorious Day What a glorious day for Britain and anyone among you who continues to believe in the ideas of liberty, freedom, and sovereign democratic rule. The British people have cast their vote and I have never ever felt so relieved about having been wrong. Against all expectations, the leave camp somehow managed to push the referendum across the center line, with 51.9% of voters counted electing to leave the European Union. Waving good-bye to...
- What Could Possibly Go Wrong?
A Convocation Of Gamblers The Wall Street Journal and BloombergView have just run articles on the shadow banking system in China. This has put me in a nostalgic mood. About 35 years ago when I was living in Japan, I made a side trip to Hong Kong. Asia's Sin City, Macau Photo credit: Nattee Chalermtiragool I took the hydrofoil to Macau one afternoon and the same service back early the next morning. On the morning trip, I am sure that I saw many of the...
- The Problem with Corporate Debt
Taking Off Like a Rocket There are actually two problems with corporate debt. One is that there is too much of it... the other is that a lot of it appears to be going sour. Harvey had a good time in recent years...well, not so much between mid 2014 and early 2016, but happy days are here again! Cartoon by Frank Modell As a brief report at Marketwatch last week (widely ignored as far as we are aware) informs us: “Businesses racked up debt in the...
- A Darwin Award for Capital Allocation
Beyond Human Capacity Distilling down and projecting out the economy’s limitless spectrum of interrelationships is near impossible to do with any regular accuracy. The inputs are too vast. The relationships are too erratic. The economy - complex and ever-changing interrelations. Image credit: Andrea Dionne Quite frankly, keeping tabs on it all is beyond human capacity. This also goes for the federal government. Even with all their data gatherers and...
- Janet Yellen’s $200-Trillion Debt Problem
Blame “Brexit” BALTIMORE – The U.S. stock market broke its losing streak on Thursday [and even more so on Monday, ed.]. After five straight losing sessions, the Dow eked out a 92-point gain. The financial media didn’t know what to say about it. So, we ended up with the typical inanities, myths, and claptrap. “Investors” are pushing the DJIA back up again..apparently any excuse will do at the moment. The idea may backfire though, as exactly the same thing happened...
- Gold and Brexit
Going Up for the Wrong Reason Gold is soaring. It should—and a lot—but in my view not for the reason it is. Indeed gold is insurance for uncertain times, a time that Brexit seems to represent. But insurance is an administrative cost — one must minimize its use. August gold contract, daily – gold has been strong of late, but this seems to be driven by “Brexit” fears - click to enlarge. Moreover, insuring against Brexit might ironically be equivalent...
- The Fed’s Doomsday Device
Bezzle BALTIMORE – Barron’s, in a lather, says the market is facing the “Two Horsemen of the Apocalypse.” Huh? Only two? There were four last time! Supposedly, the so-called Brexit – the vote in Britain this Thursday on whether to leave or remain in the European Union (EU) – and uncertainty over where the Fed will take U.S. interest rates are cutting down stocks faster than a Z-turn mower. But Brexit is a side show. As our contacts in London...