Tuesday, November 15, 2011

Today's links

1-- Europe’s liquidity crisis, Felix Salmon, Reuters

Excerpt: Take out the nonexistent market following Lehman’s collapse, and spreads in Europe are right at their all-time highs.

We all know why this is, of course. European banks have lots of European sovereign debt. European sovereign debt is falling in value. Therefore European banks are insolvent. Therefore, they have greatly increased credit risk. Therefore, spreads are rising.

Except, this isn’t really true. Greek banks are insolvent, it’s true, if you mark their sovereign debt exposure to market. But to a first approximation, no other banks are. Mark French banks’ holdings of Italian sovereign debt down by say 10%, and they’re still fine; their capital drops, of course, as it would with any write-down, but certainly to nowhere near zero.

What is true is that Europe is in the middle of a textbook liquidity crisis. Banks are not lending to each other — and the ECB isn’t stepping in to solve the problem. This is a serious structural issue with the way that the European monetary system was constructed: the ECB is tasked only with guarding inflation, and not with ensuring the health of the banking system. Individual national central banks are meant to do that. But they can’t print money — only the ECB can. So when there’s a liquidity crisis, no one’s able to step in and solve it.....

the Exane analysts are convinced that talk of European bank recapitalizations is silly — essentially, it’s treating the wrong disease:

There is no reasonable amount of capital that can cure a liquidity shortage. The reason why people are refusing to lend to the banks is not primarily because they fear an underlying solvency problem (although some people do), but because they fear an obvious and immediate liquidity problem. It is rational not to lend to an institution that you believe to be illiquid.

The real problem here is simply that banks are hoarding their cash and not lending to each other. Look at the way that bank debt issuance has fallen off a cliff — even the issuance of covered bonds, which to a first approximation don’t have any credit risk....

And the way the banking sector works, banks have to be constantly lending to each other: in nearly every country in Europe, the amount of bank debt coming due every day is higher than the total amount of bank capital in the system. The overnight interbank market is the bloodstream of the European financial system, and the flow of blood is coming to a halt.

2--Cross-Border Banking in the Balance, Project Syndicate

Excerpt: The fact that Europe’s banks need massive amounts of new capital is by now generally accepted. Yet, despite valiant attempts by the new European Banking Authority to mandate and coordinate the measures that are needed, a European solution must take account of the network of foreign subsidiaries across Europe.

Mobilizing support for European banks will be hard; extending it to subsidiaries will be even harder. But, unlike the ill-advised exposure to sovereign debt across Europe, cross-border banking through foreign subsidiaries has been beneficial for investors, and for home and host countries alike – nowhere more so than in emerging Central and Eastern Europe, still the most important export market for the eurozone....

Even so, the threat to financial stability is possibly even graver today than it was in 2008, as the capacity of Western European governments to backstop banking systems is clearly reaching its limits. Allowing foreign banks’ subsidiaries to become orphaned amid a worsening crisis in home countries would undermine confidence in emerging Europe’s financial systems, which could trigger asset-price declines and precipitous contractions in credit. Ultimately, this would boomerang back on Western European banks, given their deep financial and real linkages with the region.

In 2008, such a catastrophic scenario was narrowly avoided, owing to policy intervention, including the coordination effort under the so-called Vienna Initiative (in which the European Bank for Reconstruction and Development, among others, was involved). A new pact to secure the achievements of financial integration is now urgently needed. Authorities from these banks’ home and host countries must sit down together...

3--Lenders' funding fears see LIBOR rocket to 1%, mortgage strategy

Excerpt: Three-month LIBOR last week rose to 1% for the first time since July 2009 as lenders’ funding and liquidity fears deepened on the back of the eurozone crisis...

Peter Williams, executive director of the Intermediary Mortgage Lenders Association, says the fact that the rate at which banks lend to each other has reached 1% reflects lenders’ fears on liquidity.

He says: “There are concerns about funding among all lenders at the moment and that is certainly affecting expectations for mortgage lending in 2012. There is no expectation that lending volumes will be higher than this year they may even be lower.”

Gary Styles, strategy, risk and economics director at Hometrack, says the spread between LIBOR and the base rate is well above normal, which will push up the pricing of tracker mortgages.

4--Was it the ECB, in the bond room, with the dagger?, Reuters

Excerpt: It turns out that it may have been the European Central Bank that finally finished Silvio Berlusconi off.

The central bank revealed on Monday that it severely reined in its government bond purchases last week, just at the crucial moment as markets were pushing Italy’s borrowing costs beyond the 6 percent pain threshold that finally forced Silvio to jump.

The ECB’s bond purchases have long been its torture method of choice. It turns them off when it wants more from its victims and opens taps when it gets what it wants.

This time it looks like it was Berlusconi’s head they were after. Maybe its not surprising his final outburst was a parting shot at the ECB calling for it to show some mercy and act as the lend of last resort for the euro zone.

5--An economic letter from the SF Fed: Future Recession Risks, calculated risk

Gathering storms across the Atlantic threaten a U.S. economy not yet recovered from the last recession. ... In the next few months, the odds of recession due to domestic factors appear reasonably contained. ...

However, the curve reflecting the international odds suggests more imminent danger to the economy, although this threat is harder to calibrate using historical data and only indirectly reflects the health of the European financial system. Recession odds based on international factors peak at about 45% toward the end of 2011 ... The combination of these two recession coins, shown in the combined risks line of Figure 2, is quite disconcerting. It indicates that the odds are greater than 50% that we will experience a recession sometime early in 2012. Because the international odds of recession are more imprecisely estimated, one must be careful with a strict interpretation of this result. But the message is clear. Prudence suggests that the fragile state of the U.S. economy would not easily withstand turbulence coming across the Atlantic.

Based on domestic data, I think a recession is unlikely. However the European crisis is definitely a significant downside risk to U.S. economic growth. The spillover from Europe depends on how the crisis unfolds ...

6--Why an EU Recession Could Quickly Infect the U.S., Fiscal Times

Excerpt: Even the growing fear of such a shock is already starting to show up in tighter global credit conditions. A composite of the fourth-quarter surveys of senior loan officers in the U.S., Eurozone, Japan, and Britain show that banks tightened their lending standards for the first time in two years. Also, a survey by the Institute of International Finance shows that emerging-market banks face increasing difficulty in accessing funds. Credit has been the jet fuel for emerging-market growth, which has been the main engine of global growth. “If something were to cut off the credit spigot, you could have a pretty abrupt shift in growth rates across the emerging world,” says J.P. Morgan’s Hensley.

A Eurozone recession will only intensify the credit strains. The Italian government’s borrowing cost for 10-year notes has soared to around 7 percent, compared with 1.7 percent for Germany and 2 percent for the U.S. Borrowing rates for Spain are 5.7 percent. “The surge in Italian and Spanish yields threatens to become explosive, particularly in the face of the impending fiscal austerity,” says Barclays Capital economist Julian Callow. Even for France, where rates have risen to 3.2 percent, the spread with Germany has widened to nearly a 20-year high, about three times greater than a year ago. As a percent of GDP, French banks are the most exposed to Italy’s debt, according to the Bank for International Settlements.

7--Bond Market Stares Down Technocrats as 10-Year Yields Climb in Italy and Spain; Technocratic Showdown in Greece with Troika Already?, Mish

Excerpt: The technocratic governments in Italy and Greece are not off to a smooth start judging from the action in the bond market. A quick glance at the 10-Year note in Italy shows the yield is up 25 basis points to 6.70% and the Spanish 10-year note is up 24 basis points, soaring through the 6% mark to 6.09%.

Meanwhile, Greek 1-year bonds are trading at a mere 250%. Any bets on when they exceed 300%?

8--Why we cannot keep trying to breath life into the euro corpse, Telegraph

Excerpt: The world economy is on the brink of recession because those countries which have a natural tendency to spend don't have the money, while those who do have the money don't want to spend it.

At the root of this dual disaster lie two fixed exchange rate systems.

The first is the informal system under which various emerging market currencies are managed against the American dollar. This links the world's biggest congenital spender and deficit country with a series of high growth, and relatively low-spending surplus countries led by China.

The exchange rate aspect is crucial because, if they were free, the currencies of the surplus bloc would rise. This would boost net exports for the US, thus increasing incomes and reducing deficits.

The opposite would occur in the surplus countries. But since they have relatively little debt, they would be able to offset the reduction in net exports by expanding domestic demand. The result would be stronger growth for the world economy overall and smaller deficits in the heavily indebted countries.

The second fixed exchange rate system is the euro, which links some formerly high spending, deficit countries, which are now hopelessly uncompetitive, with some ultra-competitive, high saving countries with relatively low debt, led by Germany.

For some reason, the whole western policy establishment, especially the US government, is signed up to the benefits of breaking the first fixed exchange rate system but not the second. Indeed, the British government has even said that it is in Britain's interest for the euro to hold together and for its members to form a fiscal union.

Is this view driven by the euro-wallahs at the Foreign Office, or by the Cabinet's own euro-fanatics, Chris Huhne and Nick Clegg?

9--What is global liquidity?, rivast.com

Excerpt: Mark Carney’s Drapers’ Hall speech has rightly been getting a lot of attention. It is about global liquidity. Carney starts with the context:

global liquidity has swung wildly from the exuberant surge that fed a cavalier “search for yield” during the Great Moderation to the severe retreat that prompted the desperate “rush for shelter” in the aftermath of Lehman

We all know broadly what he means by that – but what does he mean specifically? What is global liquidity?

Carney acknowledges that there is no agreed definition, and profers a sense of it:

liquidity represents the ease with which financial institutions, households and businesses can obtain financing…

To capture all the dimensions of global liquidity requires a combination of price and quantity measures. Price indicators, such as the general level of interest rates or credit spreads, provide information about the conditions under which liquidity is provided, while quantity measures, such as credit aggregates, show the degree to which such conditions translate into the build-up of risks.

10--All major economies headed for slowdowns: OECD, Reuters

Excerpt: None of the world's major economies will escape a slowdown, the Organization for Economic Co-operation and Development said on Monday, highlighting increasing signs that growth momentum is dwindling across the board.

The Paris-based organization's composite leading indicator (CLI) for its members fell for the seventh straight month to 100.4 in September, down from 100.9 in August and hitting the lowest reading since December 2009.

11--Pressure on the ECB grows as Mario Monti rides to rescue, Telegraph

Excerpt: Britain's Business Secretary, Vince Cable, echoed the calls for bolder action, blaming the ECB's passive stand for the dramatic escalation of the crisis last week that pushed Italy's €1.8 trillion to brink of meltdown and spread contagion to France.

"The central bank has to have unlimited powers to intervene to support economies, and indeed banks, to prevent collapse," he told the BBC

"It's very clear that in addition to the disciplines that the southern Europeans are going to have to adopt, the Germans are going to have to play their role in supporting the eurozone. That's either directly or through the central bank, making absolutely sure that the big countries that are subject to speculative attack are properly supported with adequate liquidity."

The EU's €440bn rescue fund (EFSF) is supposed to take the baton from the ECB so it can step back, but the fund is not yet ready and is itself struggling to raise money at a viable cost....

Jens Weidmann, head of Germany's Bundesbank and a pivotal ECB governor, has further dug in his heels against any extension of bond purchases.

"We have a mandate and we have to stick to our mandate. Fixing an interest rate for a country is certainly not compatible with our mandate," he said over the weekend.

"The eurosystem must not be a lender of last resort for sovereigns because this would violate Article 123 of the EU treaty. I cannot see how you can ensure the stability of a monetary union by violating its legal provisions."

12--ECB buying Italian bonds as yields rise after auction, Reuters

Excerpt: The European Central bank began buying Italian government bonds in the secondary markets on Monday as yields rose in the wake of a five-year bond auction.

Yields at the 3 billion euro auction hit a euro-era high of 6.29 percent, dampening relief at the appointment of a new head of government in Italy as markets refocussed on the scale of the task facing policymakers trying to tackle the euro zone debt crisis.

One trader said the ECB was buying 2018 paper and another that they were looking at the 4-5 year sector of the curve.

Italian 5-year bond yields were 2 basis points higher at 6.55 percent after hitting a session high of around 6.63 percent

13--More bad news for eurozone as industrial sector shrinks, Telegraph

Excerpt: The eurozone's industrial sector shrank in September in the latest signal the troubled region is on course for another recession.

The region's woes intensified as official Eurostat figures showed industrial production fell 2pc, more than reversing a 1.4pc increase in August.

Portugal and Italy saw a particularly steep fall in output, at 5.8pc and 4.8pc respectively. Production fell by 2.9pc in Germany and 1.9pc in France.

"It is this increasingly widespread weakness of the manufacturing sector which adds to the near-certainty that the eurozone will slide back into recession, contracting in the fourth quarter and early next year," said Chris Williamson, chief economist at Markit.

The decline of industry in September dragged the annual growth rate of industrial production down to 2.2pc, the lowest level since late 2009. It was a sharp fall from the 6pc annual growth rate achieved in August.

14--The great euro Putsch rolls on as two democracies fall, Telegraph

Excerpt: Europe’s scorched-earth policies have begun in earnest. The inherent flaws of monetary union have created a crisis of such gravity that EU leaders now feel authorized to topple two elected governments.

As I long feared, the flood of cheap credit into Southern Europe and the slow death of Club Med industry by currency asphyxiation have together created such a dangerous situation for world finance that informed opinion is willing to turn a blind eye to EU sovereign trespass. Some even applaud.

The Greeks were ordered to drop their referendum on measures that reduce their country to a sort of Manchukuo, with EU commissars "on the ground", installed in each ministry, drawing up lists of state assets to be liquidated to pay foreign creditors.

Europe had the monetary and fiscal means to contain the EMU debt crisis long enough for Greeks to give or withhold their crucial assent to this ultimatum in December.

It chose - under German-Dutch pressure - not deploy those means. Instead it forced Greece to capitulate by cutting off an agreed loan payment.

In Italy, the European Central Bank has engineered the downfall of Silvio Berlusconi by playing the bond markets, switching purchases on and off to enforce compliance with its written dictates ("La Lettera"), and ultimately allowing 10-year yields to spike to 7.45pc to drive him out...

Italy’s youth are turning. Watch the footage of students chanting "democracy" and brandishing their "95 Theses" of Wittenberg revolt as poet Van Rompuy tried to speak in Fiesole.

"No to Austerity," starts the Luther List: "Troika out of Greece", "IMF and ECB out of Italy, Ireland, and Portugal", it goes on.

"The EU has become ever less accountable to the people of Europe. The undemocratic structures have infiltrated the very structures of the Union," they said.

Behold "the EU’s furious reaction to the Greek government’s effort to seek popular consent over the financial stranglehold imposed on the country. No longer are expressions of popular consent simply ignored, it is now impermissible to consult citizens."...

Italy’s four sets of pension reforms were held out as a shinging example. Finance minister Giulio Tremonti was feted in Brussels, lauded for his iron discipline and primary budget surplus.

And now these same EU bodies tell us that Italy’s failure to grasp the nettle of reform and tackle its debts is so egregious that Europe must step in to overthrow an elected government.

Let us end this EU lie - propagated by Berlin’s uber-bully Wolfgang Schauble - that Italy is suddenly guilty of economic crimes and debt debauchery.

What has changed is the industrial recession in Italy that began over the late summer and the likelihood of full-blown depression next year.

As you can see from this chart below, all three monetary aggregates in Italy have been collapsing for months, a lead indicator of Hell to come....

(see chart) The ECB could have prevented this monetary implosion in Italy. Instead it tightened further, without a squeak of protest from the governor of the Banca d‘Italia, then Mario Draghi.

Europe’s own policies of synchronized fiscal and monetary contraction are surely to blame for this sudden lurch downwards in Italy’s prospects...

There is no possible way at this late stage to reconcile Italy’s needs for massive devaluation with Germany’s hard-money doctrines. One or the other must give.

15--ECB Cut Debt Purchases To A Trickle As Operation "Kick Silvio Out" Proceeded, zero hedge

Excerpt: Bond European Central Bank

As was just reported by the ECB, the amount of debt monetizations (sterilized supposedly, but when the banks exist purely due to ECB funding it is not really sterilization) in the past week was €4.5 billion. As explained previously, this does not include T+3 operations since Wednesday which have yet to settle, and which is where the kicker is as can be seen on the chart below as the move from 82 to 89 on the 4.75% of 2021 occurred on Thursday and Friday. The week's number is notable because in the week before €9.5 billion was monetized (bringing the total purchases under the SMP to €192.5 billion). Of course, by Thursday Silvio was out. And that's when the buying really started. Expect to see a surge in the next week's reported ECB purchases even as the Italian bond market once again begins selling off.

Bond purchases by the SMP:(chart)

16--Superfraud, Paul Krugman, NY Times

Excerpt: It’s a bird! It’s a plane! It’s a turkey!

I thought I had worked out all the worst-case scenarios for the supercommittee (there was never a best-case). But this is even worse than my worst imagining: a deal to undermine key social insurance programs in return for a promise that Congress will come up with a plan for raising revenue at some future date. If you think that promise has any credibility whatsoever – if you have any doubts that the end result would be to gut Social Security and actually cut taxes for the wealthy – I have this Nigerian bank account that can be yours if you send me $100,000 in expenses.

The worst of it is that Democrats might actually go for it.

17--Europe’s Woes Pose New Peril to Recovery in the U.S, NY Times

Excerpt: Even with the recent moves, the United States financial system still has billions at risk to European institutions.

In an extensive report to lawmakers in September, the Congressional Research Service estimated that the exposure of banks to Greece, Ireland, Italy, Portugal, and Spain — some of the most heavily indebted euro zone economies — amounted to $641 billion. It added, “a collapse of a major European bank could produce similar problems in U.S. institutions.”

It further estimated American banks’ exposure to German and French banks at in “excess of” $1.2 trillion, equivalent to about 10 percent of total commercial banking assets in the United States. Similarly, the Bank for International Settlements reports that at midyear banks in the United States had $757 billion in derivatives contracts and $650 billion in credit commitments from European banks.

“Europe is very clearly in a Bear Stearns environment,” said Stephen Wood, chief market strategist at Russell Investments, referring to the investment bank that collapsed in early 2008 without setting off broader financial panic.

“The question is: ‘Do they get to a Lehman environment?’ They’re not there yet, but the dark clouds are beginning to gather. Right now, we’re seeing the U.S. dollar and U.S. markets benefiting, relatively, as safe havens,” Mr. Wood said. “But that wild card, that sword of Damocles, is going to be what the capital market implications are if there is a major credit event in Europe.”

18---IMF warns of double dip, zero hedge

Excerpt: The IMF has released the report it prepared for last week's futile G-20 session, which incidentally saw the IMF being shut out of bailing out the Eurozone: a development which was adverse at the time but now is largely irrelevant: after all Greece has a new parliament, if still no ink to print tax forms. So what did the IMF say? Here are some key soundbites.

On the future:

Recovery remains in low gear in major advanced economies with elevated risk of falling back into recession. Policy paralysis and incoherence have contributed to exacerbating uncertainty, a loss of confidence, and heightened financial market stress—all of which are inimical to demand rebalancing and global growth prospects.

Thus, understanding large imbalances within and across countries has taken on renewed importance. Policy makers need to move with a greater sense of urgency on reaching an agreement on policies that will reduce imbalances and lay the foundation for restoring the global economy to health.

19--Why Italian fiscal austerity won’t work, Marginal Revolution

Excerpt: The financial crisis, now exacerbated by a revenue shortage, destroys the economy before the potential gains from the expenditure-switching have a chance to kick in. Furthermore, if the broader economy is dysfunctional, the gains from expenditure-switching to the private sector may not show up even in the medium run. Growth-enhancing reforms can take many years to pay off, as we see from the histories of New Zealand, Chile, or the ex-communist countries. Yet even the Italian two-year note shows default risk, yielding twice as much or more as the American 30-year bond.

That said, more government spending probably won’t work either, unless you think that spending is extremely effective in targeting unemployed resources, which in Italy I believe it is not. Neither contractionary nor expansionary fiscal policy will succeed.

The only answer, if that is the right word, is a central bank. Right now central banks need to be doing everything they can to avoid a second Great Depression. I talk to many smart people, and I am continually surprised how many of them do not realize the urgency of the current situation.

20--Here's what traders are saying about ECB intervention, Credit Writedowns

Excerpt: Here’s what I hear some traders in Europe a friend recently spoke to believe. They expect the ECB or an ECB-funded EFSF to become the buyer of last resort of all euro-denominated government bonds, and to eliminate the spreads. The question is when. They say the worst case scenario is that the ECB moves only when a full-fledged bank run is about to begin. The best case scenario is that they move when ECB-approved PMs rule both Greece and Italy.

They also see that the quid pro quo will mean an inevitable reduction of sovereignty, but they understand that austerity alone will lead to disaster. There is a (small) signal of increased support for a change in European rules is possible to allow this. But these traders say that more likely Draghi will preside over the collapse of the currency which he is tasked to manage for the next 8 years.

That’s close to a verbatim report I got from Italy. Thanks for the update, Andrea. This is all very much in line with what I have been telling you for one year now. And I still think it will happen this way. But clearly the risk to asset prices is all to the downside and that means risk off.

21--The crisis in the eurozone: The continent is destroying the weak to protect the strong. But will that be enough?, James Galbraith, Salon

Excerpt: The eurozone crisis is a bank crisis posing as a series of national debt crises and complicated by reactionary economic ideas, a defective financial architecture and a toxic political environment, especially in Germany, in France, in Italy and in Greece.

Like our own, the European banking crisis is the product of over-lending to weak borrowers, including for housing in Spain, commercial real estate in Ireland and the public sector (partly for infrastructure) in Greece. The European banks leveraged up to buy toxic American mortgages and when those collapsed they started dumping their weak sovereign bonds to buy strong ones, driving up yields and eventually forcing the whole European periphery into crisis. Greece was merely the first domino in the line.

In all such crises the banks’ first defense is to plead surprise – “no one could have known!” – and to blame their clients for recklessness and cheating. This is true but it obscures the fact that the bankers pushed the loans very hard while the fees were fat....

Underpinning banker power in Creditor Europe is a Calvinist sensibility that has turned surpluses into a sign of virtue and deficits into a mark of vice, while fetishizing deregulation, privatization and market-driven adjustment. The North Europeans have forgotten that economic integration always concentrates industry (and even agriculture) in the richer regions.

As this process unfolds the Germans reap the rents and lecture their newly indebted customers to cut wages, sell off assets, and give up their pensions, schools, universities, healthcare – much of which were second-rate to begin with. Recently the lectures have become orders, delivered by the IMF and ECB, demonstrating to Europe’s new debt peons that they no longer live in democratic states.

The U.S. advantage

The eurozone’s architecture makes things worse in two major ways. While the EU has long paid some compensation to its poorer regions, these structural funds were never adequate and are now blocked by unmeetable co-pay requirements. And the zone lacks the inter-regional redistribution channels to households that the U.S. has developed in Social Security, Medicare, Medicaid, federal government payrolls and military contracting among other things. Nor do German retirees settle in Greece or Portugal in large numbers as New Yorkers do in Florida or Michiganders in Texas.

Second, the ECB refuses to solve the crisis at a stroke, which it could do by buying up the weak countries’ bonds and refinancing them. The argument against this is called “moral hazard,” buttressed by old-fashioned inflation fears, but the real issue is that to do so would admit loss of control by creditors over the central bank. Actions parallel to those taken by the Federal Reserve – nationalizing the entire commercial paper market, for instance – would repel the ECB, even though it does buy up sovereign bonds when it has to. So instead the zone has gone about creating a gigantic toxic CDO called the European Financial Stability Fund, which may shortly be turned into an even more gigantic toxic CDS (like AIG, they will call it “insurance”). This may defer panic at most for a little while....

These are the best ideas and none of them will happen. Europe’s political classes exist these days in a vise forged by desperate bankers and angry voters, no less in Germany and France than in Greece or Italy. Discourse is sealed off from fresh ideas and political survival depends on kicking cans down roads so that the fact that this is a banking crisis does not have to be faced. The fate of the weak is at best incidental. Thus every meeting of finance ministers and prime ministers yields treacherous half-measures and legal evasions....

The latest example was the pretzel-logic that declared a 50 percent haircut on Greek debt to be “voluntary” so that it would not trigger default clauses on the CDS to which some American banks, in particular, might be exposed. When Timothy Geithner warned the Europeans of potential “catastrophe” last month one may reasonably infer he had this risk – and not the minor effect on our already disastrous jobs picture – in mind. But of course if the haircut can be declared voluntary, then CDS are not worth the storage space they occupy in bankers’ computers, and another prop to the rapidly failing market in sovereign debts falls to the ground.

Political fragility also explains the fury in France and Germany when George Papandreou [the calmest man in Europe, by the way, having been born and raised in Minnesota] sought to cut the knot of his rebellious ministers, irresponsible opposition and angry public by putting the latest austerity package to a vote. God help the bankers! The move was fatal to Papandreou in short order, and Greece will now be turned over to a junta of creditors’ deputies if such can be found willing to take the job. It won’t be anyone who wants to continue to live in Greece afterward.

Greece and Ireland are being destroyed. Portugal and Spain are in limbo, and the crisis shifts to Italy – truly too big to fail – which is being put into an IMF-dictated receivership as I write. Meanwhile France struggles to delay the (inevitable) downgrade of its AAA rating by cutting every social and investment program.

If there were an easy exit from the Euro, Greece would be gone already. But Greece is not Argentina with soybeans and oil for the Chinese market, and legally exit from the Euro means leaving the European Union. It’s a choice only Germany can make. For the others, the choice is between cancer and heart attack, barring a transformation in Northern Europe that not even Socialist victories in the next round of French and German elections would bring.

So the cauldrons bubble. Debtor Europe is sliding toward social breakdown, financial panic and ultimately to emigration, once again, as the way out, for some. Yet – and here is another difference with the United States – people there have not entirely forgotten how to fight back. Marches, demonstrations, strikes and general strikes are on the rise. We are at the point where political structures offer no hope, and the baton stands to pass, quite soon, to the hand of resistance. It may not be capable of much – but we shall see.

22--Financing Markets Tighten Spigots, Wall Street Journal

Excerpt: Worries over the fate of European nations are gumming up the intricate gears of the financial system.

European banks are placing their money with the region's central bank instead of lending it out. And in the U.S., money-market funds are again ratcheting back the amount of money they lend to European banks. That is raising the cost of short-term cash and sending some lending indicators to their highest levels since the European crisis escalated 18 months ago.

The rising cost of borrowing demonstrates the lack of faith investors hold in European leaders to resolve the region's debt crisis. It also suggests that the region's banks remain under stress, despite officials' efforts to restore confidence. Taken as a whole, the markets show that private money is flowing only in fits and starts to select few European financial recipients.

"The funding market is not working properly," said Giuseppe Maraffino, a European money-market strategist at Barclays Capital, adding that ease of funding is differentiated between various types of banks based on geography and reputation.

The latest sign came on Monday, when the European Central Bank reported that money going into its low-interest-rate overnight-deposit facility has been surging, effectively pulling money out of the banking system. Last week, euro-zone banks' overnight deposits with the ECB hit €288.43 billion ($397.8 billion), the highest level since the debt crisis first erupted last year.

"When the market is stressed and banks don't necessarily want to face off against other banks, they can put money basically risk free in the deposit facility," said Alex Roever, money-market strategist at J.P. Morgan Chase & Co. in New York.

And in the Federal Reserve's quarterly senior loan officer survey released Monday, about two-thirds of banks that make loans to European banks had tightened standards in the third quarter.

Meanwhile, the market for short-term debt issued by foreign financial entities is shrinking as U.S. money funds continue to cut lending to European banks. Foreign financial paper outstanding in the U.S. has declined 22%, or roughly $53 billion, since the end of May.

Investors are making Italian banks pay more than their French counterparts, said Neela Gollapudi, interest-rate strategist at Citigroup in New York.

And some French banks also are paying more than they usually do: They have to pay an additional 0.45 percentage point to 0.70 percentage point a day for funding, Mr. Gollapudi said. By comparison, high-quality U.S. banks typically are funding at about 0.15 percentage point more than what they would pay for overnight debt. The highest-rated financial firms were able to borrow money for seven days using commercial paper at an average rate of 0.08 percentage point last week, according to data from the Federal Reserve.

"Money-fund managers are on the defensive given questions about the endgame in Europe and withdrawals by investors in prime funds. This has led to strong demand for Treasury bills—even at zero yields—and less interest in bank [commercial paper] or CDs," said Brian Smedley, an interest-rate strategist with Bank of America Merrill Lynch, in an email.

That demand has helped push up the TED spread, which measures the gap between three-month Treasury bill yields and interbank lending rates. The TED spread has moved steadily higher and on Monday was at 0.43 percentage point, according to FactSet data, flirting with highs unseen since the Greek crisis first flared up in the middle of 2010. And the three-month U.S. dollar London interbank offered rate, or Libor, continues to edge up, rising to 0.44139%.

Still, many of these measures remain a far cry from where they were during the financial crisis. Back then, the short-term markets virtually ground to a halt. The TED spread soared above 4.50 percentage points and Libor was about 4.82%. And measures put in place during the crisis, such as the ECB being prepared to lend to banks, have helped ease the crunch.

That ability helps "offset the risk of a funding-led crisis," said Mr. Roever of J.P. Morgan

23--The ECB to the rescue, Pragmatic Capitalism

Excerpt: The big rumor driving markets in the last 24 hours is the idea that the ECB will step in as the lender of last resort in Italy once the austerity bill is officially passed. It’s a hilarious quid pro quo – you crush your economy through austerity and we’ll buy a few bonds to ease market fears. Danske Bank has some details on the timeline here:

“The development in Italy will continue to be focal in the coming week. It is key that the austerity bill (EUR60bn) will pass in the lower house. The vote is set to take place on Sunday. We expect the ECB to step up its buying on Monday, once Italy has done its part. It is possible that the ECB will send out a statement on Sunday evening in which it recognises Italy’s last move, as was also the case in August. Back then, when Italy and Spain were included in the Securities Markets Programme (SMP), the ECB successfully pushed 10-year yields from around 6.5% to under 5%. The purchases were massive in the first 7-day period (EUR22.5bn). However, this time the purchases are likely to be even bigger, say +EUR30bn in the first 7-day period. It is essential that the ECB sends a clear signal that it is committed, as it will be tested by the market repeatedly. PM Berlusconi is expected to step down once the bill has passed. We still don’t know whether Italy will go for a general election or whether a national unity government will be formed. This week President Napolitano announced that Mario Monti (former EU commissioner) has been named senator for life, which would make it easier for him to lead a “technocrat” unity government. If this gets broad support it would be the ideal solution from a market point of view.”

Will this work? It depends. If the ECB came out and said: “we are a buyer of Italian bonds at 6%”, then yes, this will work. But they won’t do that. Instead, they’ll likely repeat what they did in August where they buy EUR20B+ bonds, yields sink and then EMU leaders crawl back into their corner where they can watch everything start to meltdown again. As we now know, austerity and tepid bond buying is not the fix. Austerity without growth improvements leads to a worsening budget situation. Have we learned nothing from recent experience? And Italy’s growth prospects are particularly atrocious (see here). The odds of them growing their way out of this catastrophe is practically nil. So, the only real fix here is for the ECB to step in as THE buyer. That or a Euro bond/central treasury solution. In other words, you have to eliminate the solvency issue in Italy. I don’t think the Germans are willing to unleash the bazooka that is required here. Jurgen Stark made that VERY clear earlier this week. Their long standing fears of inflation override all of this.

So, we’ll wait and see what happens in the coming week, but I am fairly certain that nothing has been resolved and nothing will be resolved. The Europeans are in denial over what is required here and their inability to work together is now on full display for the world to see. I believe they should move towards fiscal union, but I don’t for a second underestimate the potential risk of a dissolution of some sort. At times I claim to be able to predict the madness of crowds, but I would never pretend to be able to predict the madness of politicians.

24--Down with the eurozone, Nouriel Roubini, Project Syndicate

Excerpt: The eurozone crisis seems to be reaching its climax, with Greece on the verge of default and an inglorious exit from the monetary union, and now Italy on the verge of losing market access. But the eurozone's problems are much deeper. They are structural, and they severely affect at least four other economies: Ireland, Portugal, Cyprus, and Spain.

For the last decade, the PIIGS (Portugal, Ireland, Italy, Greece, and Spain) were the eurozone's consumers of first and last resort, spending more than their income and running ever-larger current-account deficits. Meanwhile, the eurozone core (Germany, the Netherlands, Austria, and France) comprised the producers of first and last resort, spending below their incomes and running ever-larger current-account surpluses.

These external imbalances were also driven by the euro’s strength since 2002, and by the divergence in real exchange rates and competitiveness within the eurozone. Unit labor costs fell in Germany and other parts of the core (as wage growth lagged that of productivity), leading to a real depreciation and rising current-account surpluses, while the reverse occurred in the PIIGS (and Cyprus), leading to real appreciation and widening current-account deficits. In Ireland and Spain, private savings collapsed, and a housing bubble fueled excessive consumption, while in Greece, Portugal, Cyprus, and Italy, it was excessive fiscal deficits that exacerbated external imbalances....

Symmetrical reflation is the best option for restoring growth and competitiveness on the eurozone's periphery while undertaking necessary austerity measures and structural reforms. This implies significant easing of monetary policy by the European Central Bank; provision of unlimited lender-of-last-resort support to illiquid but potentially solvent economies; a sharp depreciation of the euro, which would turn current-account deficits into surpluses; and fiscal stimulus in the core if the periphery is forced into austerity.

Unfortunately, Germany and the ECB oppose this option, owing to the prospect of a temporary dose of modestly higher inflation in the core relative to the periphery.

The bitter medicine that Germany and the ECB want to impose on the periphery – the second option – is recessionary deflation: fiscal austerity, structural reforms to boost productivity growth and reduce unit labor costs, and real depreciation via price adjustment, as opposed to nominal exchange-rate adjustment.

The problems with this option are many. Fiscal austerity, while necessary, means a deeper recession in the short term. Even structural reform reduces output in the short run, because it requires firing workers, shutting down money-losing firms, and gradually reallocating labor and capital to emerging new industries. So, to prevent a spiral of ever-deepening recession, the periphery needs real depreciation to improve its external deficit. But even if prices and wages were to fall by 30% over the next few years (which would most likely be socially and politically unsustainable), the real value of debt would increase sharply, worsening the insolvency of governments and private debtors....

Of course, such a disorderly eurozone break-up would be as severe a shock as the collapse of Lehman Brothers in 2008, if not worse. Avoiding it would compel the eurozone's core economies to embrace the fourth and final option: bribing the periphery to remain in a low-growth uncompetitive state. This would require accepting massive losses on public and private debt, as well as enormous transfer payments that boost the periphery’s income while its output stagnates.

Italy has done something similar for decades, with its northern regions subsidizing the poorer Mezzogiorno. But such permanent fiscal transfers are politically impossible in the eurozone, where Germans are Germans and Greeks are Greeks.

That also means that Germany and the ECB have less power than they seem to believe. Unless they abandon asymmetric adjustment (recessionary deflation), which concentrates all of the pain in the periphery, in favor of a more symmetrical approach (austerity and structural reforms on the periphery, combined with eurozone-wide reflation), the monetary union's slow-developing train wreck will accelerate as peripheral countries default and exit.

The recent chaos in Greece and Italy may be the first step in this process. Clearly, the eurozone’s muddle-through approach no longer works. Unless the eurozone moves toward greater economic, fiscal, and political integration (on a path consistent with short-term restoration of growth, competitiveness, and debt sustainability, which are needed to resolve unsustainable debt and reduce chronic fiscal and external deficits), recessionary deflation will certainly lead to a disorderly break-up.

With Italy too big to fail, too big to save, and now at the point of no return, the endgame for the eurozone has begun. Sequential, coercive restructurings of debt will come first, and then exits from the monetary union that will eventually lead to the eurozone’s disintegration.

25--Pan-Labyrinth, FT Alphaville

Excerpt: markets will remain largely range-bound for a while. But the risks are tilted to the downside as the eurozone saga will no doubt intensify further, Dow said. In short, “path uncertain, destination ugly”, he says.

Here’s an excerpt from our conversation where he also waxes lyrical about the vexed art of positioning:

Remarks on eurozone bonds:

Asset allocators have made a decision to reduce eurozone bond exposure many months ago. So you will see yields impervious to the newsflow. These bonds were viewed as risk free but forget about issues such as interest rate risk or convexity now, it’s a credit product now. There is an important shift in the pattern of demand. When good news happens, spreads will continue to widen – due to structural shift in the investor base. In short, there is a discontinuity in the investor base as asset allocators don’t want to buy at such high spreads [given risk-aversion triggered by panic level spreads].

Investment strategy:

So Europe is in big big trouble. I am waiting for the right time to express a bearish view. We [investment team] have a wrestling match about when that time will come but I don’t rule out the prospect that positive technicals will boost risky assets for now. At the end of season, investors tend to take risk with flows that they have and October to December tends to be a good period for this. So I am respectful of the positive technicals and the seasonality.

But more fundamentally, deteriorating global economic fundamentals are not reflected in many asset classes, from US high yield to currencies. It’s hard to get into bonds given their low yields. There is not enough certainty to take conviction trades in currencies. And stocks are sensitive to growth. If there is financial Armageddon, stocks will price in this threat of recession – and markets are good at belated over-reaction.

There are various options involved in expressing a bearish opinion and this can involve buying Treasuries, increasing cash positions or shorting a certain credit or equity index. But for now, you have to be tactical rather than strategic.

26--The pain in Spain, FT Alphaville

Excerpt: The pain in Spain…

Chew over this morsel of bad news, from ING: (Emphasis ours)

The economic recovery in Spain has ground to a complete halt. According to first estimates by INE, Spanish real GDP was unchanged in the third quarter (0.8% YoY), after growing a modest 0.2% QoQ in the second quarter. The outcome was less bad than had been suggested by lead indicators such as the purchasing managers’ indices, but bang in line with the initial estimate of the Bank of Spain. No expenditure breakdown is available at this stage, but we suspect that a positive contribution from net exports was offset by a further contraction in domestic demand.

A Spanish economic siesta recession should now be priced in, reckons ING:

Looking ahead, we fear that the Spanish economy might slip into recession soon – perhaps as soon as the current fourth quarter. Our base case scenario envisages no economic growth in 2012. The worsening economic outlook poses significant risks to Spain’s fiscal consolidation efforts.

27--"Sold To You": European Banks Quietly Dumping €300 Billion In Italian Debt, zero hedge

Excerpt: While the market is ripping today on absolutely nothing (earlier we noted the rotation of muppet X with muppet Y - this changes nothing but who cares), BTPs are soaring, and confusion is prevalent, one thing is certain: we now know who is not buying Italian bonds. As IFR reports, "European banks are planning to dump more of the €300bn they own in Italian government debt, as they seek to pre-empt a worsening of the region’s debt crisis and avoid crippling writedowns – a move that could scupper the European Central Bank’s efforts to bring down soaring yields. Still reeling from heavy losses on money they lent to Greece, lenders are keen not to make the same mistake twice.Then, under the pressure of governments and a hope that credit default swaps would protect them against heavy losses, they held on until it was too late to sell." And for our European readers who may be wondering who the dumb money will be as this tsellnami unleashes, we have one word: you. "With the ECB providing a bid for Italian bonds that might not otherwise exist, board members at some of Europe’s largest bank say now is the time to accelerate disposals. Many are also reversing long-standing policies of buying into new Italian bond issues, denying Rome an important base of support." And there you have your explanation for today's action - yet another headfake to get the idiot money foaming at the mouths while the insolvent banks quietly dump everything, sending the EURUSD once again higher as EUR repatriation resumes, this time with feeling.

IFR continues: "As a reminder, Germany has made it an explicit condition of its participation in the now irrelevant EFSF that the SMP program which is the only program currently functioning to provide secondary market support, be unwound shortly. The SMP currently has just under €200 billion in total bond holdings. Does anyone really think Germany will allow the monetization fund to increase by 150% before Merkel says something? We doubt it.

28--Euro zone flaws were clear before its launch: Reuters polls, Reuters

Excerpt: More than a dozen years ago when the single European currency was born, Reuters polls of economists show they were well aware of many of the flaws that threaten the euro today.

While no-one in the late 1990s anticipated a sovereign debt crisis quite like the one now raging from Athens to Rome, Reuters polls from that era showed the euro zone's existential plight has deep roots....

"I was aware of the problem that you have a monetary union without a fiscal union, and I wrote about the issues that low interest rates for the periphery will likely get them into a boom, but what happens when the boom goes bust?"

Economists picked three scenarios as most likely to threaten the existence of the euro zone: a decision to withdraw by one of its members; national resistance toward greater political union; and the danger that a one-size-fits-all monetary policy creates economic havoc....


The euro zone periphery's budgets were a worry well before the single currency was launched.

A July 1998 Reuters poll showed 34 out of 42 economists backing the presidents of the European Central Bank and Bundesbank in their belief that the fiscal policies of some countries were too loose before euro adoption.

Respondents were also asked to name the countries they thought had fiscal policies that were too lax in the run-up to the euro's launch.

Topping the list were Ireland, Spain and Italy.

"I don't think anyone thought it was going to be plain sailing," said Trevor Williams, chief economist at Lloyds Banking Group, a contributor to the survey, looking back on how economists thought the euro would fare.

"There was optimism that the currency would reduce transaction costs in a single market, and would economically benefit those members, particularly the smaller ones."

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