Monday, December 19, 2011

Today's links

1--Treasuries Gain Most in Six Weeks as Crisis Exit Eludes Europe, Bloomberg

Excerpt: The euro slid for a second week as investors sought safety, dropping below $1.30 for the first time since January. Stocks dropped, with the Standard & Poor’s 500 Index down 2.8 percent....

The gap between what banks and the Treasury pay to borrow money for three months, known as the TED spread, was 57 basis points yesterday, the highest level since May 2009...

Fitch said yesterday a “comprehensive solution” to the euro-area crisis is “technically and politically beyond reach.” It changed its outlook on France to negative, while affirming its AAA rating. It also placed Spain, Italy, Belgium, Slovenia, Ireland and Cyprus on a “Rating Watch Negative” review, which it expects to complete by the end of January, according to a statement released in London.

Moody’s cut Belgium’s credit rating two levels to Aa3 yesterday, citing borrowing costs and slowing growth. The firm said earlier in the week the European summit offered few new measures and didn’t diminish the risk of rating revisions.

2--Censorship coming to the USA, Washington's blog, naked capitalism

Excerpt: Leading American Internet businessmen warn that the draconian copyright bill on the verge of being passed by Congress would let the US government use censorship techniques “similar to those used by China, Malaysia and Iran.”

If you want to know what the United States would look like after this bill is passed, just look at what’s been happening in Russia: The Russian government has been crushing dissent under the pretext of enforcing copyright law.

As the New York Times noted last year:

Across Russia, the security services have carried out dozens of similar raids against outspoken advocacy groups or opposition newspapers in recent years. Security officials say the inquiries reflect their concern about software piracy, which is rampant in Russia. Yet they rarely if ever carry out raids against advocacy groups or news organizations that back the government.

A review of these cases indicates that the security services often seize computers whether or not they contain illegal software. The police immediately filed reports saying they had discovered such programs, before even examining the computers in detail. The police claims have in numerous instances been successfully discredited by defendants when the cases go before judges....

Since the American copyright bills (SOPA and PIPA) target online activities, the same thing happening to Russian critics’ computers could happen to the websites of any Americans who criticize the government, the too big to fail banks, or any of the other powers-that-be.

Indeed, the American copyright bill is modeled after the Chinese system.

3--EA Infernal Devaluation Progressing, Economonitor

Excerpt: The EU answer to rebalancing portfolio and trade flows within the Euro area (EA) without currency devaluation is recession and deflation. They call this ‘internal devaluation’ – shifting relative prices by reducing domestic demand in the debtor countries, thereby shifting the terms of trade. Marshall Auerback calls it ‘infernal devaluation’. Marshall’s right.

Today we got more evidence that infernal devaluation is progressing. EA unit labor costs (ULC) – average cost of labour per hour workers – increased 0.2% in the third quarter, slowing the annual pace from 3.1% to 2.7%. While the slowdown was to be expected, given the deterioration of domestic demand, the elevated level of growth in ULC suggests that wages in Europe are stickier than what is needed to effectively drive the terms of trade via internal devaluation. Better put: downward pressure in European wages moves more like molasses than water; it will take severe recessions in some of the debtor countries to drive relative prices down sufficient enough to feasibly shift the terms of trade.

4--Draghi's diabolical plan, Interfluidity

Excerpt: Tyler Cowen has been emphasizing the possibility that the ECB will quietly fund sovereigns via the banking system. The ECB would lend to banks at very low rates, accepting sovereign debt as collateral. Banks would earn the spread between the yield on sovereign debt (which is currently distressed and very yieldy) and the sliver of interest demanded by the ECB. As a matter of mechanics, this plan could work. It’s the same as direct ECB lending to sovereigns, except ECB gets added security (in theory) by interposing banks as guarantors, and pays a fee for the privilege.

The Anglo-American punditosphere is unimpressed. After all, European banks are already in deep trouble because of their sovereign holdings. An article by Gareth Gore (ht Felix Salmon) quotes a senior banker:

“When investors are constantly asking what you have on your books and the board is asking you to reduce your exposure, it doesn’t really matter about the economics of the trade,” said the treasurer of one of Europe’s biggest banks. “Am I going to buy Italian bonds? No.”

That view echoes comments from UniCredit chief executive Federico Ghizzoni, who this week told reporters at a banking conference that using ECB money to buy government debt “wouldn’t be logical”. The bank had traditionally been one of the biggest buyers of Italian government bonds, with almost €50bn on its books....

European banks, especially in the troubled periphery, are mortally dependent upon the ECB for liquidity and finance. These banks will acquire whatever collateral the ECB prefers to lend against. It is not a matter of trying to profit from a spread. A spread would be nice for banks, a subsidy that will help them recapitalize over time. But holding collateral the ECB wants is a matter of life-or-death for them, every day. If the ECB wants Italian bonds, they will be supplied. If the ECB prefers that Italy “face market discipline”, it can quietly hint its concern and steepen the haircuts it imposes when the country’s bonds are offered as collateral. Banks will start to divest, replacing them with whatever the ECB favors.

A lot of commentators have derided Europe’s “policy breakthrough” as just a restatement of the old stability and growth pact with some institutional changes at the margin. Talk of automatic consequences and qualified majorities may just be blah blah blah. But if European states become dependent on bank finance, they become dependent on ECB finance. The ECB would have the power to manufacture fiscal crises for a misbehaving state at will, and with marvelous deniability. Laundered through banks and then through capital markets, ECB actions would be attributed to nameless bond vigilantes rather than unelected technocrats. ECB haircuts would very quickly be self-justifying, and disentangling cause from effect would be nearly impossible as officials might privately telegraph changes before anything is put in writing. Control would be hidden as a market outcome, a fact of nature.

Operationally, I don’t see why the plan can’t work. I dislike it, both because I dislike the policies I suspect ECB would enforce (austerity and internal devaluation) and because it is profoundly undemocratic. Democracy is really the main obstacle, though the plan gains some immunity from the fact that politicians who try to call it out would quickly be labeled conspiracy nuts.

5--Fannie and Freddie were not responsible for the Housing Bubble, CEPR

Excerpt: The Post article at one point commented that:

"Fannie Mae and Freddie Mac, which came to symbolize the housing bubble and its painful aftermath."

In fact, the charges described in the article describe a situation in which the top executives at these institutions bought up stakes in non-prime loans and subprime backed securities just as the market was collapsing. The purchases began in late 2006 and accelerated in 2007 and 2008.

The housing bubble had peaked in the middle of 2006 and subprime issuance plummeted in the second half of the year. It had virtually ceased altogether by 2007. In other words, Fannie and Freddie purchases at this point could have played no role in the splurge of subprime junk loans because the splurge had already stopped.

The purchases of securities backed by subprime and Alt-A loans was simply reducing the explosure of the private investment banks that had issued these securities (e.g. Goldman Sachs and Lehman) or issuers that still had some loans on their books (e.g. Countrywide or Ameriquest). This would have transferred bad debt from the private sector to the government sponsored enterprises, but the economic damage caused by the issuance of these loans had already been done.

6--Fitch: comprehensive euro zone deal "beyond reach", Reuters

Excerpt: The credit rating agency Fitch has told euro zone countries it believes a comprehensive solution to their debt crisis is beyond reach, putting six euro zone economies including Italy on watch for potential downgrades in the near future....

"Of particular concern is the absence of a credible financial backstop," it said. "In Fitch's opinion this requires more active and explicit commitment from the ECB to mitigate the risk of self-fulfilling liquidity crises for potentially illiquid but solvent Euro Area Member States."...

"The systemic nature of the euro zone crisis is having a profoundly adverse effect on economic and financial stability across the region," Fitch said....


Merkel - under pressure from the revered Bundesbank to force debt-saddled euro zone countries to reform and save their way out of crisis with austerity measures - has led a push for automatic sanctions for deficit "sinners" in the bloc.

This has fed concerns that excessive belt-tightening in southern countries could send their economies into a negative spiral with no prospect of growing out of crisis, while feeding resentment in the prosperous north...

Euro zone governments need to sell almost 80 billion euros of fresh debt in January alone, and the stand-off between policymakers and banks could turn the slow-burning debt crisis into a conflagration in the New Year.

7--Alexander Cockburn on the euro crisis, counterpunch

Excerpt: As Serge Halimi, the director of Le Monde diplomatique, put it recently, “In the current political and social situation, a federal Europe would strengthen the already stifling neoliberal mechanisms and reduce the sovereign power of the people by handing it over to shadowy technocratic bodies.”

8--Now That European Banks Have Money, Lots Of People Have Ideas For What They Should Do With It, Dealbreaker

Excerpt: So Europe’s all better now, or something. The banks are anyway. They have had the money flung at them, in the form of the European Central Bank advancing them tons of medium-term funding at attractive rates and with pretty chill collateral requirements, and now they just have to sit back and be awesome.

Since they’re now all flush and awesome, various people have come out of the woodwork to help them spend their money. (I’m happy to help too! Call me!) One possible answer is “bail out your reprobate governments,” which FT Alphaville have dubbed the “Sarko trade” after a guy who said this:

French President Nicolas Sarkozy said the ECB’s increased provision of funds meant governments in countries like Italy and Spain could look to their countries’ banks to buy their bonds. “This means that each state can turn to its banks, which will have liquidity at their disposal,” Sarkozy told reporters at the summit in Brussels...

Mario Draghi, president of the European Central Bank, has urged commercial banks to exploit radical new measures taken by the ECB to increase liquidity in the European banking system, in order to maintain lending to the real economy and prevent a renewed credit crunch. “We want to make it absolutely clear that in the present conditions, where systemic risk is seriously hampering the functioning of the economy, we see no stigma attached to the use of central banking credit provisions,” he told an audience in Berlin in his first public speech at the head of the ECB. “Our facilities are there to be used.”

Someone else who likes this idea is Goldman Sachs, where Draghi used to work, which, COINCIDENCE? Yesterday FT Alphaville wrote about Goldman’s equity research note from Tuesday on European banks. And as Alphaville points out, the ECB’s willingness to take commercial loans as collateral should make commercial lending more attractive than it used to be.

So that’s nice...

GS is more willing to see dollar signs, and even the numbers that come after them:

Finally, the overall P&L impact of new ECB bank funding arrangements is difficult to gauge. Below, we have simplistically assumed that the use of the facility carries a funding cost relief of between 100-400bp. The latter is the difference between current market rates for sovereigns (or current customer deposit rates) compared to the 1% rate at the ECB. Commercially, the ECB facility is attractively priced and has the capacity to impact current (low) levels of overall bank profitability meaningfully. The effect will clearly differ among individual banks...

But it’s worth keeping that reaction in mind when you think about the ECB funding facility because the best imaginable outcome here goes something like this:

(1) ECB funds European banks;

(2) European banks fund their deadbeat governments, solving their liquidity crises;

(3) European banks also fund European businesses, minimizing the effects of fiscal austerity and leading to growth in the eurozone economy and tax base, solving Europe’s solvency crisis;

(4) everybody is thrilled; and

(5) particularly thrilled are the banks, who both avoid systemic meltdown and have higher revenues and cheaper funding. For the layman, that means that someone comes to their offices and hands them sacks with dollar euro signs on them.

And that process looks a little familiar. Well, not steps (2), or (3), or (4). But lender-of-last-resort-funds-banks-which-then-survive-and-make-money is a familiar story and it pisses people off. It drives some people insane, leading them to do things like somewhat seriously claim that the Fed loaned banks $29 trillion dollars. (Not everyone agrees.)

9--Banks resist European pressure to buy government debt, IFR (international Finance Review)

Excerpt: Banks are unlikely to come to the aid of debt-ridden eurozone countries, with many planning to ignore political pressure to use cheap money from the European Central Bank to fund purchases of sovereign bonds.

With eurozone governments needing to sell almost €80bn of fresh debt in January alone and bond yields rising by the day, the stand-off between policymakers and banks could turn Europe’s slow-burning debt crisis into a full-scale conflagration in the New Year.

Burned by Greek losses, and under the scrutiny of shareholders, banks have slashed their exposure to weaker European sovereigns over recent months. Senior bankers say they will cut further, despite pressure to use newly available, longer-term ECB loans to buy government debt as part of an officially-sanctioned carry trade.

“When investors are constantly asking what you have on your books and the board is asking you to reduce your exposure, it doesn’t really matter about the economics of the trade,” said the treasurer of one of Europe’s biggest banks. “Am I going to buy Italian bonds? No.”

That view echoes comments from UniCredit chief executive Federico Ghizzoni, who this week told reporters at a banking conference that using ECB money to buy government debt “wouldn’t be logical”. The bank had traditionally been one of the biggest buyers of Italian government bonds, with almost €50bn on its books.

Such attitudes will come as a major blow to European policymakers, who had been hoping banks would use ECB money to profit from the carry trade, helping governments in the process. “Each state can turn to its banks, which will have liquidity at their disposal,” French President Nicolas Sarkozy said after last week’s summit of leaders.

Under the ECB’s new long-term refinancing operations starting on December 21, banks will be allowed to borrow money against certain assets on a three-year basis, paying just 1% per annum. They could then buy Italian 10-year bonds yielding more than 7%, and pocket the difference.

Debts come due

But rather than use money raised via the ECB to buy government bonds, bankers say that they are more likely to use the funds to pay off their own debts.

“I can’t think for a moment why anyone would want to [buy eurozone government debt],” said the head of capital markets at one European bank that is also reducing its exposure to eurozone sovereign bonds. “Everyone is trying to protect capital. It’s counter-intuitive. It would be digging a deeper hole for yourself.”

Indeed, the European banking industry collectively needs to pay back or refinance about €650bn of liabilities next year – Lloyds, UniCredit, BNP Paribas, RBS and HSBC face the most, each having €30bn or more of instruments maturing, according to estimates from Nomura.

With bank debts coming due and most firms unable to raise fresh funds in bond markets – which remain largely closed – bankers say it is much more prudent to use ECB loans to pay off their own creditors rather than speculate that European governments pay back all their debt.

“Banks need this liquidity to get them through the wall of refinancing they are facing next year,” said the capital markets head. “That’s where the money is going to go. Banks need to deleverage rather than re-leverage. It’s just wishful thinking that they will pile back into government bonds.”...

Bond sales in the New Year will be a big test of whether the strategy will work. In the first quarter alone, Italy plans to sell around €50bn in fresh debt and Spain €21bn. If Rome is unable to find buyers for its debt, that could jeopardise the payment of €28bn of maturing debt on February 1 and a further €16bn on March 1. Spain doesn’t have any major redemptions in the first quarter.

“It’s potentially going to be very very challenging,” added one debt banker who is involved in the New Year sovereign debt sales.

10--How big could the Sarko trade go?, FT. Alphaville

Excerpt: Via Reuters:

French President Nicolas Sarkozy said the ECB’s increased provision of funds meant governments in countries like Italy and Spain could look to their countries’ banks to buy their bonds. “This means that each state can turn to its banks, which will have liquidity at their disposal,” Sarkozy told reporters at the summit in Brussels....

according to Morgan Stanley’s Huw Van Steenis, who has just produced a very interesting note on the carry trade du jour ...

Adding together the various sources of potential demand for the December tender, we get a number that could be around €160bn-€250bn, with a further potentially large take-up at the February 3-year tender. But the size of the take-up is not the point (although incremental government bond buying would help). What’s important here is that the combined set of initiatives of 3 year LTRO, + wider collateral + $ lines together makes a significant positive difference to the tail risk on European banks.

11--Weber Throws ECB Race Open by Ruling Out Second Bundesbank Term (from the archives, Bloomberg

Excerpt: The race for the European Central Bank’s presidency was thrown wide open as Axel Weber told officials he may not seek a second term as head of Germany’s central bank, casting doubt over his future career plans.

Weber told some Bundesbank officials in confidence that he’s not necessarily interested in another eight-year term when his current mandate ends in 2012, said an official who spoke on condition of anonymity. That may also call into question whether he’ll be available to succeed Jean-Claude Trichet as head of the world’s second-most powerful central bank.

European Union leaders need to appoint a new ECB chief by the time Trichet’s term expires on Oct. 31 and economists had named Weber as a leading candidate to succeed him. Reuters earlier reported that Weber was pulling out of the running to head the ECB. At the same time, Weber could rule out a second Bundesbank term and still take over at the ECB provided he resigns this year....

Weber, who has headed the Bundesbank since 2004, emerged as the ECB frontrunner even after breaking from European policy- making consensus by opposing the central bank’s bond-buying program. Such opposition to a main plank of Europe’s crisis- fighting campaign fanned speculation he may not win the support of some EU leaders and lacked the ability to forge consensus on the ECB’s 23-member Governing Council...

12-- Let there be credit claim collateral, Ft Alphaville

Excerpt: OK — you’re sick to death of hearing about the European Central Bank’s three-year liquidity may, or may not, get banks to buy sovereign debt to pledge as collateral.

So why not hear about all the other extra trash assets the ECB will now accept? Potentially much more economically critical trash. assets. (Update — well, that’s our point about these assets being diverse and difficult to value made for us… we’re sorry for calling them trash. That is indeed unwarranted hyperbole...

That’s a chart (click to enlarge) of corporate and SME loans sat on banks’ balance sheets — some €7,100bn of them.....

The NCBs [national eurozone central banks] are allowed, as a temporary solution, to accept as collateral for Eurosystem credit operations additional performing credit claims that satisfy specific eligibility criteria. The responsibility entailed in the acceptance of such credit claims will be borne by the NCB authorising their use. Details of the criteria for the use of credit claims will be announced in due course.

Furthermore, the Governing Council would welcome wider use of credit claims as collateral in the Eurosystem’s credit operations on the basis of harmonised criteria and announces that the Eurosystem is aiming to:

- enhance its internal credit assessment capabilities; and

- encourage potential external credit assessment providers (rating agencies and providers of rating tools), and commercial banks that use an internal ratings-based system, to seek Eurosystem endorsement under the Eurosystem Credit Assessment Framework...

Mario Draghi referred to the ECB’s measures here in detail in a Thursday speech, making its importance overall quite clear:

Our second measure will allow banks to use loans as collateral with the Eurosystem, thereby unfreezing a large portion of bank assets. It should also provide banks with an incentive to abstain from curtailing credit to the economy and to avoid fire-sales of other assets on their balance sheets.

The goal of these measures is to ensure that households and firms – and especially small and medium-sized enterprises – will receive credit as effectively as possible under the current circumstances. Of course, we have to screen the collateral carefully so as to protect our balance sheet...

we thought we’d share with you Goldman’s thoughts on how these corporate and SME loans might be valued as collateral. It’s well below €7,100bn but still a big chunk of change:

It is unclear how much of this €7.1 tn will ultimately qualify as collateral. That depends primarily on the size threshold (for individual loans) and the minimum IRB [internal rating based] rating. The responsibility for setting these will be with individual central banks. But preliminary expectations are for some 20%-50% of corporate loans qualifying as collateral, before the haircuts are applied.

Of course we know the ECB has been a good bank with rubbish assets for a long time. Even so, this is credit easing, on a huge scale, directly targeted at European bank deleveraging. What it could do about so-called “natural” deleveraging, or banks simply not making new loans, is a good question. In any case it’s going to change the ECB balance sheet a great deal.

Just as important as the Sarko trade we think.

13--ECB Still Not the White Knight, Tim Duy, Economist's View

Excerpt: The Wall Street Journal has the story on today's speech by ECB President Mario Draghi:

The ECB's purchases of government bonds are "neither eternal, nor infinite," Mr. Draghi said in a speech in Berlin, stressing it would take "a lot" more than monetary-policy measures to restore market confidence in the euro zone.

Asked whether the ECB should copy the U.K. and U.S. in printing money to buy government bonds, a policy known as quantitative easing, Mr. Draghi said: "I don't see any evidence that quantitative easing leads to stellar economic performance" in those economies. EU treaties forbid monetary financing of government debt, he added.

14--The cost of global central bank balance sheet expansion, FT.Alphaville

Excerpt: From a speech by Jaime Caruana, the general manager of the Bank for International Settlements, given at the Bank of Thailand-BIS conference on December 12:

A stylised central bank balance sheet can be helpful in clarifying the various transmission channels (Table 1). Any accumulation of assets implies an increase in corresponding liabilities. In addition, the purchase of domestic assets will directly affect their prices and therefore credit spreads, term premia and long-term interest rates. An increase in monetary liabilities – eg reserve money – will have implications for the liquidity of the banking sector in the short run, and this may undermine price stability in the medium term. But an increase in long-term liabilities could also crowd out lending to the private sector.

Taking into account these transmission channels, it is quite clear that large expansions of central bank balance sheets have implications for both the real and financial sectors of the economy. They do create risks – and we must watch these closely. In some historical episodes, central banks did expand their balance sheets too much in order to finance profligate government spending. This often had inflationary results. On other occasions, central banks were too slow in reversing expansionary policies when conditions improved....

Caruana believes so:

Even so, many central banks feel distinctly uncomfortable about the longer-term implications of such large balance sheets. This sustained expansion means that the central bank’s balance sheet becomes more exposed to market developments – a fall in the value of foreign assets or a rise in long-term interest rates could reduce the value of its assets while leaving the value of its liabilities intact.

At some point, the capital of the central bank could be put at risk. This could in some circumstances raise unwarranted political questions and may even undermine the central bank’s credibility. A country is better off if the central bank has the financial strength needed to carry out its functions....

I would like to consider whether balance sheets of the current size could create broader policy risks. Such risks could include: inflation; financial instability; distortions in financial markets; and conflicts with government debt managers....

For example, foreign official institutions now account for almost 80% of aggregate foreign holdings of US Treasury securities (Graph 3).

In the years before the recent financial crisis, the preference of foreign central banks for US Treasuries tended to depress US yields and boost bond and other asset prices. More recently, large-scale asset purchases by the Federal Reserve have lowered US long-term yields, tending to push down yields also in overseas markets. The paper by Chen et al (2011), to be presented later in this conference, documents the significant spillover of quantitative easing onto Asian financial markets.

Result? A potential feedback loop of horror:

...this could create a potent cross-border feedback loop: large-scale asset purchases in the West depress the domestic yield curve, which tends to widen the interest rate gap with emerging Asia; the threat of capital flows encourages more foreign reserve accumulation in emerging Asia and easy monetary policy; and this puts additional downward pressure on US Treasury yields as the demand in Asia for US Treasury securities rises. Anticipating such a dynamic, investors can become overly sensitive to expected central bank policies

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