Monday, November 28, 2011

Today's links

1--Options Dwindle for Euro Crisis, WSJ

Excerpt: The biggest question in Europe isn't what it was a few weeks ago. It is no longer just whether any of the 17 governments in the euro zone will default on its debts; increasingly it is whether the euro zone will survive in its current form at all....

concern over German bonds drove their yields up to near-convergence with the U.K.'s sovereign debt, which has no clear advantage beyond not being in euros. In recent weeks, borrowing costs for financially strong euro-zone governments such as the Netherlands and Finland have increased. Other high-rated European bonds—such as those for the European Financial Stability Facility—have struggled to find buyers.

If the first phase of the crisis saw investors fleeing from the periphery of the currency union to its core, the second has them fleeing the euro area altogether.

"This looks like an issue that is wider than just Germany. We think it is about the market attempting to price a breakup of the euro," wrote analysts Stephane Deo and Matteo Cominetta of UBS Investment Research Thursday. Investors they visited this week in Asia are questioning the willingness of governments to keep the euro zone together, they report: "As a result investors may seek to disinvest from Europe."...

Bond investors bought French government bonds knowing they would face interest-rate risk: Unless they hedged, they would lose money if interest rates rose. But it's only recently that it has dawned that French bonds expose them to another type of risk that conservative investors try to avoid: credit risk, the prospect that they may not be paid back in full and on time....

The reason this emerges with France, and not the equally indebted U.K., is because of uncertainty about the role of the ECB.

The central bank is resisting taking on the explicit role of lender of last resort for euro zone governments. Ms. Merkel, accompanied by the leaders of France and Italy, reiterated her support for its stance Thursday.

The ECB says it isn't a choice—it and many legal experts believe it would go beyond its charter to routinely buy national debt. It justifies its limited bond-buying as necessary for smooth workings of its monetary policy. Its consideration Thursday of longer-term loans to banks comes under a similar heading.

But without the promise of a central bank stepping in as a last resort, a government liquidity crisis is always at risk of turning into a solvency crisis. In the U.K., the Bank of England would step in as a buyer of government bonds.

Most investors have been assuming that the ECB has been, as Mr. Balls says, playing a "chicken strategy," waiting until the last minute to intervene decisively. First, the bank is presumed to want a cast-iron commitment on strict budgetary discipline by governments and the true integration of fiscal policies, including perhaps a common euro bond proposal as put forward by the European Commission this week.

2--Bond market hammers Italy, Spain ponders outside help, Reuters

Excerpt: Italy's borrowing costs soared to their highest levels since Rome joined the euro on Friday, piling pressure on the newly installed government of Mario Monti at the end of a week in which the euro zone crisis tainted even safe haven Germany.

A punishing bond sale, in which Italy was forced to pay a record 6.5 percent for six months paper, came after a disastrous German bond auction earlier in the week and the leaders of France, Germany and Italy failed to make headway in tackling the growing debt crisis.

Amid signs that the euro zone contagion is spreading, indications emerged in Madrid that the People's Party, getting ready to form a government in the coming weeks, may apply for international aid to shore up its finances.

After winning an election this month, the PP under Mariano Rajoy inherits an economy on the verge of recession, a tough 2012 public deficit target, financing costs driven to near unsustainable levels by nervous debt markets and a battered bank sector with billions of euros of troubled assets on its books.

3--Eurocarnage Continues: Things are only going from bad to worse in Europe, naked capitalism

Excerpt: German bond yields were also higher than they were after Wednesday’s terrible bunds auction. Stunningly, Belgian ten year yields have risen more than 1% this week, from 4.79% to 5.85%, with a downgrade of Belgium to AA by Standard & Poors no doubt contributing.

The Financial Times also reports that investors are fleeing Eurobank stocks:

Uninvestable is just about the worst word in a shareholders’ vocabulary.

The term – meaning that the market sees no point at all in investing in a certain asset – is being used increasingly when talking about European banks.

“It is an absolute disaster zone. I wouldn’t touch them. You couldn’t make me buy a bank,” says Paul Casson, director of pan-European equities at Henderson Global Equities.

Even some bank chief executives seem to agree. “I’d be very interested to see the investor who is prepared to put more capital towards UK banks. All of them are thinking that’s a dumb place to put capital,” Stephen Hester, chief executive of RBS, the part-nationalised UK lender, said this week.

The fact that Portugal was downgraded to junk by Fitch was simply yet another bad bit of news, when months ago, it would have been seen as significant in its own right. Ditto the Moody’s downgrade of Hungary.

Perhaps I’m too far from the carnage to have an accurate reading, but the news reports seem more anesthetized than shellshocked. It seems almost as if the European leadership has successfully faked its way through so many past crunches that they are unable to perceive that the same old tricks are no longer working. And it is increasingly looking as if their dulled reaction times are so out of line with market events that even if they were to snap our of their stupor now, it would be too late

4--Dollar Funding Pressure at 3-Year High, WSJ

Excerpt: A closely watched money-market indicator of dollar-funding costs rose Friday to its highest level in more than three years, despite the continued availability of dollars in the global financial system.

The cost of swapping three-month euro funds into U.S. currency rose to its highest level since October 2008, in the wake of Lehman Brothers' bankruptcy, due to a wave of forward-selling of euros against the dollar.

"There's a very definitely a ramping in demand for dollars this morning," said ICAP strategist Chris Clark.

The so-called three-month euro-dollar cross-currency basis swap sank to as low as minus 161 basis points, around five times what it was in July, before settling back to minus 152.5 basis points, interdealer broker ICAP said.

The deepening of the euro-zone sovereign debt crisis and concerns over the creditworthiness of European banks due to their heavy sovereign-bond holdings means European banks are paying a growing premium to access dollars and dealers are being forced to lend euros at ever-lower interest rates in order to get dollars in return.

On Friday, they charged as much as 1.61 percentage points below the prevailing rate banks charge each other to lend euros over a three-month period. That rate, known as Euribor, was fixed at 1.475% Friday for three-month loans, up from 1.474% Thursday.

That means money-market participants are now willing to pay banks to borrow euros in order to receive dollars for the first time since the global financial crisis, ICAP's Mr. Clark said....

Major central banks also have dollar-swap facilities in place which dollar-starved banks can tap, although their punitive cost and worries over the potential loss of reputation has so far held back bank-use of these credit lines.

But the more costly it becomes for banks to borrow from each other, the more lucrative it may become for dollar-starved financial institutions to go to the European Central Bank.

5--ECB Considers Longer Bank Loans, WSJ

Excerpt: The European Central Bank is considering longer-term loans to commercial banks having trouble securing funding, as officials scramble to keep the region's government debt crisis from crippling the Continent's banking system.

Such a move would help banks shut out of the market for medium-term funds. But some analysts questioned whether more loans—even at longer maturities—would provide a lasting solution, given the root problem is the government debt of Greece, Italy and other struggling euro members that banks hold on their balance sheets

6--Poor German auction spells tough times for euro, Reuters

Excerpt: Weak demand at a German debt auction suggests investors are starting to shun even the euro zone's strongest economy, which could trigger more losses in the shared currency as many shift from euro-denominated assets to safe havens outside the region.

As Italian, Spanish and even French yield spreads have blown out to record levels in recent weeks, the trend has been for portfolio flows to switch into German Bunds, resulting in no foreign exchange outflows from the euro zone.

Those flows, combined with talk of repatriation of capital by euro zone banks desperate to shore up their balance sheets as money markets seize up, have been cited as reasons behind the euro's recent resilience around $1.34.

But that appears to be changing and on Thursday the euro slid to a 7-week low at $1.3316 on trading platform EBS.

Germany sold barely half the bonds it put up for auction on Wednesday, when a buyers' strike against the low yields on offer was fuelled by fears that Berlin could not remain immune from the crisis engulfing its heavily indebted euro partners.

In a sign that investors are cutting exposure to the euro zone as a whole, 10-year Bund yields converged with UK gilts for the first time in 2-1/2 years.

7--Another terrible day for Europe, UK Bubble

Excerpt: Can Europe survive another day like yesterday? The financial pages and the news wires carried an unrelenting series of bad news stories.

Portugal, from the BBC....

Portugal has had its debt rating cut by Fitch to so-called "junk" status, and warned it could be cut again.

Fitch made the downgrade because of its "large fiscal imbalances, high indebtedness across all sectors and adverse macroeconomic outlook".

Belgium, from Bloomberg...

Belgium’s credit rating was cut one step to AA by Standard & Poor’s, which said bank guarantees, lack of policy consensus and slowing growth will make it difficult to reduce the euro region’s fifth-highest debt load.

The rating was lowered from AA+, with a negative outlook, London-based S&P said yesterday in a statement. The action by S&P is the first downgrade for Belgium in almost 13 years and puts its credit ranking on a par with the S&P local-currency ratings of the Czech Republic, Kuwait and Chile.


The foreign- and local-currency bond ratings were cut one step to Ba1 from Baa3, the company said in a statement yesterday. Moody’s assigned a negative outlook. The country is rated the lowest investment grade at Standard & Poor’s and Fitch Ratings.

Hungary’s foreign-currency debt maturing next year will soar to 1.37 trillion forint ($5.8 billion), a 48 percent increase from this year. That will rise to 1.48 trillion forint in 2013 and peak at 1.65 trillion forint in 2014 as Hungary repays the 20 billion-euro ($26.5 billion) bailout. Hungary had $51.3 billion in foreign-exchange reserves at the end of September, according to Bloomberg data.

Italy, from the Telegraph...

Italy had to pay record rates in a €10bn bond sale, despite reports that the European Central Bank was buying Italian debt in the secondary market to try to support the auction.

The auction will be a blow to Mario Monti, the new Italian prime minister, who is battling to persuade markets that he can reduce the €1.9 trillion debt burden.

Italy sold six-month debt for a yield of 6.504pc - nearly double the 3.5pc yield demanded by investors at an auction at the end of October.

The auction will be a blow to Mario Monti, the new Italian prime minister, who is battling to persuade markets that he can reduce the €1.9 trillion debt burden of the eurozone's third largest economy.

Greece, from Reuters....

Greece's budget deficit will not fall below a key euro zone ceiling in 2014 as planned, if the debt-laden country fails to decide additional austerity measures in June, a set of updated forecasts revealed on Friday.

Assuming no more measures are taken, the budget gap will narrow to just 4.2 percent of gross domestic product in 2015 instead of the 1.1 percent assumed under a previous set of forecasts made in June, the finance ministry data showed.

8--Europe’s insoluble problems, Felix Salmon, Reuters

Excerpt: El-Erian is very good at explaining the problem which needs solving:

Europe must still stabilize its sovereign debt situation. But this is now far from sufficient. Policymakers must also move quickly to contain banking sector frailties, and do so using a more coherent approach to the trio of capital, asset quality and liquidity.

It seems to me, though, that sequencing matters here. Liquidity is — always — more important than capital/solvency. Give an insolvent bank enough liquidity, and it can live indefinitely. Remove liquidity from a bank, and it dies immediately, no matter how solvent it might be or how high its capital ratios are. And as for asset quality, we’re pretty much talking a zero-sum game here: when the banks’ dubious assets are the sovereign’s liabilities, the real solution is inflation, not nationalization.

And as for banks’ non-sovereign assets, good luck with selling those. The shadow banking sector knows exactly what happens to asset prices when sellers put €5 trillion of those assets on the market at once, and there’s literally no one out there who would dream of buying such things at or near par.

In every crisis there’s a point of no return — if you don’t do XYZ in time, it’s too late, and the crisis is certain to get out of anybody’s control. I’m increasingly convinced we’ve already passed that point of no return in Europe. The banks won’t lend to each other, the Germans won’t do Eurobonds, and the ECB won’t act as a lender of last resort. The confidence fairy has left the continent, and she isn’t about to return. Which means, as we used to say in 2008, that things are going to get worse before they get worse.

9--Fed Watch, Greece Again, economist's view

Excerpt: Greece is now taking a direct role in negotiations. Remember that the previous haircuts were "voluntary" and negotiated by Greece's European overlords to prevent triggering a credit event and CDS payouts. And one has to believe that "following the October agreement" implicitly means the Greeks will not upset the apple cart and trigger a credit event unilaterally. But if Greece is at the table forcing lenders to take massive haircuts, it will be virtually impossible to justify that this is not a technical default.

This is shaping up to be the final test of the credibility of the sovereign CDS market - either exposure is hedged or it is not. Interestingly, either outcome is potentially catastrophic, with the end result being either the unknown outcomes of triggering CDS payouts or a complete flight from European sovereign debt. Maybe both.

I really hope somebody at the ECB is sticking around to work this weekend.

10--Mysterious Europe, Paul Krugman, NY Times

Excerpt: ...the underlying eurozone story is pretty clear and simple. After the creation of the euro, investors developed a false sense of security about lending to peripheral economies; this led to large capital flows from the core to the periphery, and corresponding current account imbalances: (chart)

These capital inflows also caused a boom in the periphery that raised costs and prices dramatically compared with the core: chart

Now all of that has to be unwound. So how is that supposed to happen?

It seems obvious that spending cuts in the periphery have to be offset by spending increases in the core, and also that a way has to be found to make the required real depreciation in the periphery feasible. But eurozone policy is for austerity everywhere, and a low inflation target for the area as a whole, which means crippling deflation in the periphery.

So where is the story about how this is supposed to work?

As far as I can tell, European policy makers aren’t even thinking about scenarios. They’re just repeating the old slogans about stable prices and fiscal responsibility, with no narrative at all about how pursuing those virtues can be consistent with European recovery.

Even a few months ago I regarded a complete euro crackup as highly implausible. Now I’m having trouble finding a plausible story about how the thing survives.

11--More on the Big Lie, The Big Picture

Excerpt: Nonbank mortgage underwriting exploded from 2001 to 2007, along with the private label securitization market, which eclipsed Fannie and Freddie during the boom.

Check the mortgage origination data: The vast majority of subprime mortgages — the loans at the heart of the global crisis — were underwritten by unregulated private firms. These were lenders who sold the bulk of their mortgages to Wall Street, not to Fannie or Freddie. Indeed, these firms had no deposits, so they were not under the jurisdiction of the Federal Deposit Insurance Corp or the Office of Thrift Supervision. The relative market share of Fannie Mae and Freddie Mac dropped from a high of 57 percent of all new mortgage originations in 2003, down to 37 percent as the bubble was developing in 2005-06.

Private lenders not subject to congressional regulations collapsed lending standards. Taking up that extra share were nonbanks selling mortgages elsewhere, not to the GSEs. Conforming mortgages had rules that were less profitable than the newfangled loans. Private securitizers — competitors of Fannie and Freddie — grew from 10 percent of the market in 2002 to nearly 40 percent in 2006. As a percentage of all mortgage-backed securities, private securitization grew from 23 percent in 2003 to 56 percent in 2006.

Only one of the top 25 subprime lenders in 2006 was directly subject to the housing laws overseen by either Fannie Mae, Freddie Mac or the Community Reinvestment Act — Source: McClatchy


These firms had business models that could be called “Lend-in-order-to-sell-to-Wall-Street-securitizers.” They offered all manner of nontraditional mortgages — the 2/28 adjustable rate mortgages, piggy-back loans, negative amortization loans. These defaulted in huge numbers, far more than the regulated mortgage writers did.

Consider a study by McClatchy: It found that more than 84 percent of the subprime mortgages in 2006 were issued by private lending. These private firms made nearly 83 percent of the subprime loans to low- and moderate-income borrowers that year. And McClatchy found that out of the top 25 subprime lenders in 2006, only one was subject to the usual mortgage laws and regulations.

A 2008 analysis found that the nonbank underwriters made more than 12 million subprime mortgages with a value of nearly $2 trillion. The lenders who made these were exempt from federal regulations.

A study by the Federal Reserve shows that more than 84 percent of the subprime mortgages in 2006 were issued by private lending institutions. The study found that the government-sponsored enterprises were concerned with the loss of market share to these private lenders — Fannie and Freddie were chasing profits, not trying to meet low-income lending goals.

12--When Credit Bites Back: Leverage, Business Cycles, and Crises, SF Fed

Excerpt: Abstract:

This paper studies the role of leverage in the business cycle. Based on a study of nearly 200 recession episodes in 14 advanced countries between 1870 and 2008, we document a new stylized fact of the modern business cycle: more credit-intensive booms tend to be followed by deeper recessions and slower recoveries.

We nd a close relationship between the rate of credit growth relative to GDP in the expansion phase and the severity of the subsequent recession. We use local projection methods to study how leverage impacts

the behavior of key macroeconomic variables such as investment, lending, interest rates, and inflation.

The effects of leverage are particularly pronounced in recessions that coincide with nancial crises, but are also distinctly present in normal cycles. The stylized facts we uncover lend support to the idea that

nancial factors play an important role in the modern business cycle.

13--Europe's IMF End-Run, WSJ

Excerpt: German Chancellor Angela Merkel attracted scorn this week for rejecting another idea from the self-appointed committee to save the euro. That would be the proposal for the European Central Bank to lend to the International Monetary Fund, so that the Fund in turn can lend even greater amounts to troubled euro-zone economies.

The IMF has already committed €78.5 billion to the Greek, Irish and Portuguese bailouts, or roughly a third of the total. (The EU put in the rest.) An Italian or Spanish collapse would need a bigger backstop, though, and the ECB is the only institution in Europe with the power to print the money that an Italy or Spain would need.

The central bank and its printing press might already be doing more in this crisis but for that pesky thing called EU law, which forbids the ECB from directly financing euro-zone governments. That's where the IMF steps in to play the bag man. Since it's perfectly lawful for the central bank to transact with the IMF, that loophole has some officials in Brussels and at the Fund salivating. The word is that EU policy makers are looking to have a lending agreement ready in time for their next summit, on Dec. 9.

For European leaders, laundering ECB lending through the IMF has one big additional advantage, on top of being an end-run around EU law. When the EU lends to periphery economies, only EU taxpayers carry the risk of loss in the event of sovereign default. But when the IMF lends, taxpayers around the world share the risk, with Americans taking the largest helping...

The problem here is as much with the proper role of the central bank as it is about global taxpayer exposure to the euro mess. The ECB is already in dubious legal territory for the €187 billion it's holding in euro-zone sovereign debt. Making it an IMF creditor would thrust it deeper into the political and fiscal arenas, in abnegation of the central bank's monetary independence.

14--Germany, France plan quick new Stability Pact, Reuters

Excerpt: German Chancellor Angela Merkel and French President Nicolas Sarkozy are planning more drastic means - including a quick new Stability Pact - to fight the euro zone sovereign debt crisis, Welt am Sonntag reported on Sunday.

The Sunday newspaper reported in an advance before publication that if necessary Germany and France were ready to join a number of countries in agreeing to tough budget discipline.

The report, which echoed a Reuters report on Friday from Brussels, quoted German government sources as saying that the crisis fighting plan could possibly be announced by Merkel and Sarkozy in the coming week.

The report said that because it would take too long to change existing European Union treaties, euro zone countries should avoid such delays be agreeing to a new Stability Pact among themselves - possibly implemented at the start of 2012.

Based upon these measures, there should be a majority within the ECB for a stronger intervention in capital markets," Welt am Sonntag said. It quotes a central banker as saying: "If the politicians can agree to a comprehensive step, the ECB will jump in and help."

In Brussels on Friday, euro zone officials said a push by euro zone countries towards very close fiscal integration could give the ECB the necessary room for manoeuvre to scale up euro zone bond purchases and stabilise markets.

The ECB, which cannot directly finance governments, has been buying Italian and Spanish bonds on the secondary market since August to try to keep down borrowing costs for the euro zone's third and fourth largest economies and contain the spreading of Europe's sovereign debt problem.

Such tight fiscal integration is being considered by France and Germany, the officials said, with Berlin pushing to change the European Union treaty so that a country could be sued for breach of EU budget rules in the European Court of Justice.

The European Commission, the EU executive arm, put forward proposals on Wednesday to grant it intrusive powers of approval of euro zone budgets before they are submitted to national parliaments, which, if approved, would effectively mean ceding some national sovereignty over budgets.

This could lead to joint debt issuance for the euro zone, where countries would be liable for each others' debts.

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