Sunday, October 30, 2011

The Never-Ending Eurofiasco By Mike Whitney / ICH

The Never-Ending Eurofiasco

By Mike Whitney

October 28, 2011 "
Information Clearing House" - Imagine if the local fire chief, in the spirit of conservation, decided he’d use no more than 1,000 gallons of water to put out any given house fire. Do you think the citizens would support that policy if their town was burned to the ground? And, yet, this is the same approach that eurozone leaders are using to address the debt crisis. The central bank (ECB) has virtually limitless resources (Think: printing press) to defend the debt of the individual states and to act as lender of last resort, but the eurocrats won’t hear of it. They refuse to use the ECB as every other central bank in the world is used. They’d rather reinvent the wheel by creating a funky, improvised emergency fund (European Financial Stabilization Facility or EFSF) that’s massively leveraged and which only provides a 20 percent “first-loss” guarantee on sovereign bonds. So, for example, if Italy goes belly-up in the next year or so and can’t repay its debts, then Mr. bondholder gets a whopping 20 cents on the dollar. Such a deal!

Can you see how ridiculous this is?

Look; US Treasuries are backed by the “full faith and credit” of the United States of America. What are Italian bonds backed by? Or Portuguese bonds? Or Irish bonds?

Under this new regime, they’ll be “partially” backed by a dodgy, undercapitalized insurance fund. That ought to shore-up investor confidence.

Is this any way to run a multi-trillion confederation of states?

And the EFSF is only part of this latest Eurofiasco. There’s also a special purpose investment vehicle (SPIV) that will be used to attract foreign investment. (Re: China) EU leaders assume that the Chinese are so yield-crazy that they’ll scarf up hundreds of billions of these (toxic?) EU bonds to stack atop their cache of USTs. Dream on. Apparently, Nicholas Sarkozy has already been on the horn to leaders in China inquiring about future investments. But, so far, no takers. The truth is, investors are exiting Europe as fast as their two feet will carry them, not lining up to get back in.

The good ship Eurozone is taking on water from all sides, which is why yesterday’s stock market moonshot was such a surprise. As soon as Wall Street got a whiff of Europe’s “breakthrough agreement” on Thursday, the Dow went through the roof, over 300 points on the day. Less than 24 hours later, however, the mood is notably more somber. The details on all the critical points–(Haircuts on Greek debt, bank recapitalisation, EFSF etc)– remain sketchy, while skepticism abounds. Here’s a clip from Bloomberg on Friday:

“U.S. stocks fell, trimming the longest weekly rally since January in the Standard & Poor’s 500 Index, as scrutiny deepens on Europe’s latest measures to contain the region’s sovereign debt crisis….

“The devil is in the details,” Don Wordell, a fund manager for Atlanta-based RidgeWorth Capital Management, which oversees about $47 billion, said in a telephone interview. “Europe is trying to do anything to solve its problems. Still, there are lots of questions on how the plan is going to work and how they are going to fix their debt issues.” (Bloomberg)

Ah, yes, “the details”. One of the details that’s been clarified is the fact that the credit markets are not “on board”, in fact, credit spreads have shrugged off the happy talk and continue to widen. This is from Reuters:

“Italy’s borrowing costs jumped to record levels on Friday, underlining its vulnerability at the heart of the euro zone debt crisis and scepticism about whether the struggling government of Prime Minister Silvio Berlusconi can deliver vital reforms.

The 6.06 percent yield paid at an auction of 10-year bonds was the highest since the launch of the euro and not far from the level reached just before the European Central Bank intervened in August to cap Rome’s borrowing costs by buying Italian paper.

Italy, the euro zone’s third largest economy, is once more at the centre of the debt crisis, with fears growing that its borrowing costs could rise to levels that overwhelm the capacity of the bloc to provide support amid chronic political instability in Rome.” (Reuters)

So bondholders haven’t been duped by all the “breakthrough” hype. Yields are climbing higher which means it will be harder for Prime Minister Bunga-bunga to fund the Italian government. After all, what good is an insurance policy (EFSF) if you can’t get funding; that’s the question? Unfortunately, their are fewer buyers. Why? Because investors have lost faith in the Eurocrats ability to fix the situation. No one gives a hoot about the EZ’s big pile of money.(The EFSF will be $1.4 trillion) What they want is the “full faith and credit” of some institution that can underwrite the whole mess. Is that hard to understand? That’s what central banks do. This is from Bloomberg:

“The rate at which London-based banks say they can borrow for three months in dollars (Libor) rose for the 35th day, the longest run of increases since November 2005…

The dollar Libor-OIS spread, a gauge of banks’ reluctance to lend, widened to 34.66 basis points …the highest closing level since July 3, 2009.

The TED spread, or the difference between what lenders and the U.S. government pay to borrow for three months, widened to 41.79 basis points from 41.46 basis points yesterday, heading for the highest closing level since June 23, 2010.” (Bloomberg)

Okay. So the credit gauges are blinking again and yesterday’s announcement provided no relief at all. Banks are still reluctant to lend and credit conditions continue to tighten. And now that EU banks will be forced to increase their capital cushion, you can bet there will be another debilitating credit crunch. Take a look at this from Bloomberg:

“European banks say they have to cut assets to help satisfy a government push to boost capital faster than planned to insulate them against the sovereign debt crisis. That may trigger a credit crunch for companies and consumers throughout the 17-nation euro zone, helping to push its economy into recession, say Citigroup Inc. and Deutsche Bank AG analysts.

Leaders meet today in Brussels to approve a plan to increase lenders’ capital by about 100 billion euros ($139 billion). Banks say they will more likely achieve the new requirements by shrinking rather than raising cash from shareholders, a scenario they want to avoid partly because their share prices have fallen 30 percent this year….

“History shows that bank recapitalizations provide the catalyst for the credit crunch,” he said in an Oct. 20 note. “Japan learned this in 1998, and the U.S. and the U.K. in 2008. Continental Europe’s lesson starts now.”

Banks across Europe have announced they will trim more than 775 billion euros from their balance sheets in the next two years to reduce short-term funding needs and achieve the 9 percent in regulatory capital required by the Basel Committee on Banking Supervision ahead of schedule, according to data compiled by Bloomberg….

“The banks need to deleverage, but if they choose to deleverage by cutting assets not by raising equity then it will have negative consequences for the economy,” Simon Maughan, head of sales at MF Global Holdings Ltd. in London.” (“European Banks Warn of Credit Drought”, Bloomberg)

So, EZ leaders–after having already triggered a mini-Depression in the PIIGS with no end in sight–are on course to intensify the downturn by forcing the banks to dump hundreds of billions of dollars of assets onto the market thus pushing down prices and increasing financial market distress. Sounds like a plan. The alternative to this would be that the individual governments recapitalize the banks at their own expense which would mean higher taxes, diverting revenue from public services, and (here’s the corker) a steep downgrade by the ratings agencies. So, it’s a lose-lose-lose situation.

And what about those “overnight deposits” that banks have been squirreling away at the ECB because they’re afraid to leave their money in other banks? That must have improved now that a “comprehensive” deal has been worked out, right? This is from Bloomberg:

“The European Central Bank said banks increased overnight deposits to the most in more than two weeks.

Euro-area banks parked 218.1 billion euros ($308.8 billion) with the ECB overnight, up from 204.4 billion euros the previous day and the most since Oct. 10. They borrowed 2.7 billion euros in emergency overnight funds at the marginal rate of 2.25 percent, up from 1.8 billion euros a day earlier.” (Bloomberg)

Everything is worse. The Eurozone is imploding, and it’s imploding because the policies they’re implementing are, well, stupid, which is to say, they won’t work. And investors know they won’t work which is why they keep fleeing Europe en masse.

Can you blame them?

Mike Whitney lives in Washington state. He can be reached at

Friday, October 28, 2011

Why 'Voluntary' Haircuts On Greek Bonds Will Haunt Europe / Steve SchaeferForbes Staff

10/27/2011 @ 4:25PM |2,400 views

Why 'Voluntary' Haircuts On Greek Bonds Will Haunt Europe

German Chancellor Angela Merkel speaks during ...
Image by AFP/Getty Images via @daylife

Something seems a little off about the latest plan out of Europe, which features a 50% haircut for Greek bondholders.

A complete loss on Greek debt holdings was the other option offered to creditors by leaders like Germany’s Angela Merkel, so by agreeing to take 50 cents on the euro banks render the deal “voluntary.”

That one term carries a lot of weight, since it most likely means the haircuts will not trigger payment on credit default swaps (CDS) that investors purchased to hedge against nonpayment of Greek debt, and that may not be such a great thing.

Calling a 50% haircut “voluntary” may avoid a messy shakeout in Greece, but that relatively small bond market had a small amount of outstanding CDS and the development may have more worrisome implications in bigger bond markets like Italy.
“Risk departments are going to start to say – ‘if we can haircut Greece at 50% without triggering CDS we have to look at our models elsewhere,’” says Rich Tang, head of fixed-income sales at RBS Securities.

If lopping 50% off a bond does not trigger a payout, Tang says, “Who in their right mind is going to buy sovereign CDS protection as a hedge?” Such derivatives do not serve as much of a hedge if they will not protect against a 50% loss event. “Now the only proper hedge is selling,” he adds.
Setting aside the “voluntary” haircuts for a minute, the rest of Europe’s plan raises plenty of questions too. For one thing the planned strategy for recapitalizing banks has a major flaw even before you get to the fact that the ultimate backstop – a levered-up European Financial Stability Facility (EFSF) of about €1 trillion – has no concrete funding.

“The days of private capital coming to the rescue are over,” says Tang, and the Euro Summit plan calls for banks to tap private markets for capital first, followed by their own national governments and ultimately the EFSF. (See “EU’s Debt-Saving Eggs Are All In The EFSF Basket.”)

That private capital will not rush to pile into the European banking sector should not come as a major shock. For one thing, capital is scarce, and for another the scars of 2008 are still fresh. The investors who have capital to deploy are going to demand onerous terms – think Warren Buffett’s recent investment in Bank of America or his 2008 infusions into Goldman Sachs and General Electric.
“There is no more easy money to bail out banks,” Tang adds, “and investors are weary of trying to understand what’s under the hood” in terms of assets.

Too many deals struck on seemingly good terms during the last phase of the crisis – from BofA’s Countrywide buy, to Mitsubishi UFJ’s investment in Morgan Stanley, to David Bonderman’s TPG pumping billions into Washington Mutual just before its failure – for investors to be willing to give financial institutions the benefit of the doubt on their assets.

So considering all the holes still remaining in the grand European rescue, how do you explain Thursday’s surge in the market? And a surge it was, with the Dow Jones industrial average leaping 340 points to 12,209, the S&P 500 climbing 43 points to close above its 200-day moving average at 1,285 and the Nasdaq adding 88 points to 2,739.

Tang says the magnitude of Thursday’s move into risk assets – the euro also popped, jumping to $1.4188 – came as a bit of a surprise since the plan was “the worst-kept secret in the world.” Perhaps investors were encouraged by the fact that Wednesday’s marathon negotiating session of Europe’s leaders did not water down or sidetrack the details of the deal that had leaked out.
To Lionel Mellul, a partner at broker-dealer Momentum Trading Partners, attributes the pop to rally-chasing, as money managers leading the wrong way throughout a strong October finally felt the need to get on board. Thursday’s move, with no concrete details on the EFSF’s funding, “is not a conviction-based rally,” says Mellul, and he expects the market will continue to be marked by a high correlation both within and between asset classes. What could change that? A “strong commitment” from China, sovereign wealth funds in Asia, Brazil or elsewhere to provide funding for the EFSF, Mellul believes.

Thursday, October 27, 2011

EU Sets 50% Greek Writedown, $1.4T in Crisis Fight

Enlarge imageEU Sets 50% Greek Writedown

EU Sets 50% Greek Writedown

EU Sets 50% Greek Writedown
Eric Feferberg/AFP/Getty Images
Greek Prime Minister George Papandreou (R) embraces Luxembourger Prime Minister (C) under the look of Italian Prime Minister Silvio Berlusconi.
Greek Prime Minister George Papandreou (R) embraces Luxembourger Prime Minister (C) under the look of Italian Prime Minister Silvio Berlusconi. Photographer: Eric Feferberg/AFP/Getty Images
Oct. 27 (Bloomberg) -- Michael Darda, chief economist at MKM Partners LP, talks about European leaders' plan to expand a bailout fund to stem the region's debt crisis and their agreement with investors for a 50 percent writedown on Greek bond holdings. He speaks with Scarlet Fu and Erik Schatzker on Bloomberg Television's "Inside Track." (Source: Bloomberg)
Oct. 27 (Bloomberg) -- Charles Dallara, managing director of the Institute of International Finance, discusses the Greek debt agreement reached by European leaders, who persuaded bondholders to take 50 percent losses. He speaks from Brussels with Maryam Nemazee on Bloomberg Television's "The Pulse." (Source: Bloomberg)
Enlarge imageEU Sets 50% Greek Writedown, $1.4 Trillion in Crisis Fight

EU Sets 50% Greek Writedown, $1.4 Trillion in Crisis Fight

EU Sets 50% Greek Writedown, $1.4 Trillion in Crisis Fight
Geert Vanden Wijngaert/AP
From left, Sweden's Prime Minister Fredrik Reinfeldt, Czech Republic's Prime Minister Petr Necas, German Chancellor Angela Merkel, French President Nicolas Sarkozy and Slovenian Prime Minister Borut Pahor participate in a round table at an EU summit in Brussels.
From left, Sweden's Prime Minister Fredrik Reinfeldt, Czech Republic's Prime Minister Petr Necas, German Chancellor Angela Merkel, French President Nicolas Sarkozy and Slovenian Prime Minister Borut Pahor participate in a round table at an EU summit in Brussels. Photographer: Geert Vanden Wijngaert/AP
European leaders cajoled bondholders into accepting 50 percent writedowns on Greek debt and boosted their rescue fund’s capacity to 1 trillion euros ($1.4 trillion) in a crisis-fighting package intended to shield the euro area.
The 17-nation euro and stocks climbed while bond spreads narrowed after leaders emerged early today from a 10-hour summit in Brussels armed with a plan they said points the way out of the quagmire, albeit with some details still to be ironed out.
“Overall the outcome is better than we anticipated one week ago,” Laurent Bilke, global head of inflation strategy at Nomura International Plc in London, said in an interview.“There are several issues left open, but I do believe that getting a more necessary debt relief for Greece is a pretty important step.”
Last-ditch talks with bank representatives led to the debt-relief accord, in an effort to quarantine Greece and prevent speculation against Italy and France from ravaging the euro zone and wreaking global economic havoc. Greek Prime Minister George Papandreou will address the nation at 8 p.m. in Athens to outline the summit’s ramifications for the country at the eye of the two-year sovereign debt crisis.
“The world’s attention was on these talks,” GermanChancellor Angela Merkel told reporters in Brussels at about 4:15 a.m. “We Europeans showed tonight that we reached the right conclusions.”

ECB Role

Measures include recapitalization of European banks, a potentially bigger role for the International Monetary Fund, a commitment from Italy to do more to reduce its debt and a signal from leaders that the European Central Bank will maintain bond purchases in the secondary market.
The euro advanced to a seven-week high against the dollar, rising above $1.40 for the first time since September. It was at $1.4007 at 11:48 a.m. in Brussels. The Stoxx Europe 600 Index surged 2.6 percent.
“It’s long on words, short on detail,” said Peter Dixon, an economist at Commerzbank AG in London. “The solution that’s been put in place now gives us enough ammunition to stave off any immediate problems but we may well run into other problems down the track.”
The summit was the 14th in the 21 months since Europe pledged solidarity with Greece, and came amid mounting global pressure for the bloc to deliver a credible anti-crisis toolkit before a Group of 20 meeting Nov. 3-4 in Cannes, France.

Banks Summoned

Europe’s leaders took the unusual step of summoning the banks’ representative, Managing Director Charles Dallara of the Institute of International Finance, into the summit to break the deadlock over how to cut Greece’s debt to 120 percent of gross domestic product by 2020 from a forecast of about 170 percent next year.
Dallara squared off with a group led by Merkel and French President Nicolas Sarkozy around midnight after issuing an e-mailed statement that “there is no agreement on any element of a deal.”
Sarkozy said the bankers were escorted in “not to negotiate, but to inform them on decisions taken by the 17 and then they themselves went on to think and work on it.”Luxembourg Prime Minister Jean-Claude Juncker said the banks’resistance was broken by a threat “to move toward a scenario of total insolvency of Greece, which would have cost states a lot of money and which would have ruined the banks.”

Insolvency Threat

The resulting “voluntary” losses by bondholders were the key plank in a second bailout for Greece, which was awarded 110 billion euros in May 2010 at the outbreak of the crisis. The new program includes 130 billion euros of official aid, up from 109 billion euros envisioned in July.
The Washington-based IMF, meanwhile, said it is ready to disburse its 2.2 billion-euro share of the next installment of Greece’s original bailout. The release of the euro zone’s 5.8 billion-euro share was approved last week.
Greek, Spanish, Italian and French bonds all rallied today, with the spreads over benchmark German bunds narrowing. The yield on German 10-year bonds jumped eight basis points, the most in more than 11 weeks, to 2.11 percent at 10:05 a.m. London
The yield on Greek bonds due in October 2022 fell 117 basis points to 24.15 percent, Spanish 10-year yields dropped 16 basis points to 5.32 percent and Italy’s 10-year bonds advanced for a second day, with yields falling 13 basis points to 5.81 percent.
ECB President Jean-Claude Trichet, who has warned against the spillover effects of bond writedowns on the banking system, didn’t take part in the confrontation with bankers on the debt relief. He later praised the leaders’ determination to get ahead of the crisis.

Trichet’s Call

The measures agreed “have to be fully implemented, as rapidly and effectively as possible,” Trichet, who leaves office Oct. 31, said afterwards.
Leaders tiptoed around the politically independent ECB’s broader role in keeping the euro sound, making no mention of its bond-purchase program in a 15-page statement. The Frankfurt-based central bank has bought 169.5 billion euros in bonds so far, starting with Greece, Ireland and Portugal last year, then extending the coverage to Italy and Spain in August.
While Trichet didn’t mention the controversial purchases either, his successor, Mario Draghi of Italy, indicated that the policy will continue. Speaking in Rome yesterday, Draghi said the ECB remains “determined to avoid a poor functioning of monetary and financial markets.”
Leaders backed two ways of leveraging up the 440 billion-euro rescue fund, which was designed last year to shield smaller countries such as Greece, Ireland and Portugal, and lacks the heft to protect Italy, the euro area’s third-largest economy.

Leverage Options

Under plans to be spelled out in November, the fund will be used to insure bond sales and to create a special investment vehicle that would court outside money, from public and private financial institutions and investors.
Canadian Prime Minister Stephen Harper, speaking at a conference in Perth, Australia, called the agreement “grounds for cautious optimism,” and urged European leaders to work out details of the plan and implement it.
Europe cast about for more international money to aid the rescue, with France’s Sarkozy set to call Chinese leader Hu Jintao tomorrow with the goal of tapping into the world’s largest foreign exchange reserves.
While the mechanics are a work in progress, European Union President Herman Van Rompuy said the leverage effect would multiply the power of the fund by a factor of four to five. He compared it to normal banking business that needn’t entail excessive risks.

‘Detail Further’

“It will be important to detail further the modalities of how this enhanced EFSF will operate and deliver the scale of support envisaged,” IMF Managing Director Christine Lagardesaid.
Europe also struck a bank-recapitalization accord, setting a June 30, 2012, deadline for lenders to reach core capital reserves of 9 percent after writing down their sovereign-debt holdings. Banks below that target would face “constraints” on paying dividends and awarding bonuses, a statement said.
The European Banking Authority estimated banks’ capital needs at 106 billion euros, with Spanish banks requiring 26.2 billion euros and Italian banks 14.8 billion euros. It gave them until Dec. 25 to submit money-raising plans to national supervisors.
Banks that fail to raise enough capital on the markets will first tap national governments, falling back on the EFSF rescue fund only as a last resort.
To contact the reporters on this story: James G. Neuger in Brussels at; Stephanie Bodoni in Brussels at
To contact the editor responsible for this story: James Hertling at
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