I’m not surprised that the contagion has worked its way to France. After all, the ECB intervention policy insures that France becomes a target. “If you can't sell Italy, sell France”, is the market’s response.
But I’m absolutely blown out by the pace of things. France’s bonds are being devalued on a daily basis. Italy has been functionally shut out of the new issue market. Market liquidity has dried up. What were once routine transactions are now difficult to price. E100mm bond transactions for France and Italy were normal; today E25mm is a market amount.
What is becoming scarily clear is that there is no more announcements coming that are going to make a difference. All the news is out on expanding the EFSF. The only thing that could reverse this tide is an agreement to “federalize” the debts of Europe. This would leave Germany (massively) on the hook. There is zero chance of this happening.
The central question that the market will ask and answer in the next few weeks is whether France can withstand the onslaught. The ECB will not intervene in the French market. Will debt capital continue to move out of France? Two charts. One says France is probably okay. The other says we are headed for a hard landing.
These numbers (CIA) are a year old but they tell the story. Italy had $2.1T of public sector debt (119% of GDP) while France had only $1.8T of debt (82% of GDP). Looking at this it’s understandable why Italy is in trouble. But it does not explain why France should have a problem. This chart is the reason that there could be an issue:
On this basis France has double the debt of Italy. I call this the Money Center Bank Syndrome. The banks have debt outside their borders (they have assets too). This debt is getting sucked into the French government bond market as world investors trim exposure to the country (“If you can’t reduce exposure to the banks, sell government bonds”).
Italy and France have an average debt maturity of ~7 years. There is a total of $3T. The market value of this stock of debt has fallen by about $200b since October 1st. This is not a loss that will be recorded on anyone’s books (except the likes of MFG) but it does cause a strain on funding as the repo value has fallen.
Remember that all night conference by the EU deciders on October 26th? Central to that meeting was the commitment that the EU banks would undergo a recapitalization of E106b ($150b) by June 30 2012. The EU banks have had their assets impaired by at least that amount in just the past two months.
That all night meeting was just a joke! Anyone who trusts these people are making a mistake.
The Merkozy’s of Europe will be making “calming” statements over the next few days. We are dangerously close to a death spiral, and they know it. But they have nothing on their shelf but words. I don’t think this will prove to be enough.
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Posts
I'm a novice (at least regarding sovereign debt issues), so I'm trying to understand why more and more EU countries are having a problem.
ReplyDeleteUsing an analogy to private companies, my understanding is that Greece has a solvency problem, not a liquidity problem, in that it's budget/tax structure is not a going concern.
Do all the EU countries have a solvency problem? It feels like these other (non-Greek) countries have liquidity problems, meaning that people think that they are going concerns but credit market conditions are averse. In that case, isn't that what the ECB is for?
Or does ECB disavow all such purposes, in which case you can almost say that the EU countries have it worse than medium sized corporations, which can often get banks to accommodate them during liquidity hiccups.
Or is it that the EU is moving to a permanently higher interest rate structure so that previously solvent countries are now considered insolvent with their projected debt loads?
I guess I'm asking if you think the ECB is completely unable/unwilling to alleviate liquidity problems (as it relates to sovereigns) or whether all these non-Greek countries actually have solvency problems given the new "normal" in the EU.
Hi Bruce, I kind of agree with your view up to a certain limit ... I believe that Merkel is down to a dangerous and tricky poker game ... On one side she has to keep an eye on german presidential elections and therefore not seem to the german electorate as they're paying for the rest of Europe's welfare state, while on the other hand she's got to keep EuRo and her (and rest of Europe's) financial system alive.
ReplyDeleteHaving said that I think she's paying chicken with PIIGS to force them give up on part of their fiscal autonomy so she can justify to her electorate why ECB had to monetize Europe's debt.
As you said in your post, except from ECB buying up debt there's not much that can be done to save France et al (Germany is at the end of the queue) and words won't do much this time ...
At the pace Euro govt spreads are deteriorating it won't take long until we're all f*cked up, so I expect Frau Merkel to give up on her anti-inflacionary speech as soon as she can sell to Juergen 6-pack that she's managed to screw PIIGS and that bidding up euro govies was the optimal and best solution to save the Euro and keep on selling BMW's & Audis.
Isn't this just a big game - create a crisis that drives up yields, make the weak give up control, then justify debt monetization via the manufactured crisis.
ReplyDeleteIf you think this is deliberately manufactured crisis then you don't understand it. The obvious solution is cut the weaker members out of Euro and let them devalue. But it would hurt politicians legacies and bankers would have to lose money. Much better to pretend it's containable and destroy everyone's economies in the process.
ReplyDeleteVery interesting article and the observation of market players shifting risk to the French government is acute. If you can't identify the fool in the market is, you are it!
ReplyDeleteFunny, it feels like a solvency crisis (it obviously is) but liquidity is the immediate problem. The Germans have backed themselves into a corner of their own creation by having a captive central non-bank that cannot create liquidity without fixing all the liabilities onto Germany. How deliciously ironic: if the ECB prints Germany capsizes due to the liabilities, if the ECB does not print the euro dies in a rush of runs out of euro-denominated assets, many of which are Germany's: vicious cycle indeed.
Where an imaginative leader might come up with a solution (dual currencies per country including the euro) any such leader is beaten down by Germany's insistence on obedient clones working within a defective EU 'diktat'. Good Grief!
Another choice would be for Germany to submerge itself into a 'United States of Europe'. At that point German liabilities wouldn't matter any more than do US liabilities matter to Connecticut or Arizona. Sooner to hear Merkel whistling the Marseillaise.
The ALWAYS-ADMITTED objective of the euro was and is a United States of Europe; the public won't have it so it's going to be sneaked in - or rammed down our throats by the megalomaniacs who infest Brussls.
ReplyDeleteThere are arguments, strong ones, for a USE but creating it thus poisons the concept.
Dave (and others)
ReplyDeleteWhat we have is both a liquidity and a solvency issue.
Greece is definitely a solvency problem. Italy/France definitely a liquidity problem.
Spain, Portugal Ireland may be a bit of both.
In November of 2011 the liquidity issues are more important than the solvency ones. If the liquidity problems are not addressed soon, then more states will face insolvency.
I don't think the EU states can afford 7% long term debt and 3% short-term. That won't work for long.
What a HOLEY f--kup. Bring in the Chinese and
ReplyDeletethe Russians to sort it out.
Thanks Bruce for weighing in. Since I have your ear, let me ask one more question. In the current EU system, suppose it wasn't a sovereign debt problem, but a cyclical recession with weak demand, and the EU governments wanted to pump it up with some monetary stimulus. How would they do it?
ReplyDeleteWould the existing EU system function like the US with the ECB trying to lower interest rates by buying up government bonds? Or is the ECB not set up to do this?
Assuming it's set up like the US, then isn't the ECB treating the sovereigns of EU more shabbily than they would private businesses by not intervening in a liquidity crisis?
I understand the desire of the ECB not to intervene in a solvency crisis like Greece as that's a form of back door monetization.
Or is it all so politically tied together now that they can't intervene without symbolically giving in on the monetization issue.
Dave,
ReplyDeleteThere is a solution. It would require that the ECB issue debt on behalf of all of the countries. Call that a federalization of the debt.
This, by itself would make a big difference but it would also require that the ECB print money and buy the newly issued bonds. This is the same as the Fed has done with QE1 and QE2.
The problem is that Germany has said Nien! to this. And Germany has the only vote that matters.
All I know, I learned from Michael Lewis.
ReplyDeleteI learned the Irish accepted their politicians taxpayer bailout of their failed banks. So that the Irish got screwed. And, remained silent. While the germans, mostly, got their money back. And, out. And, Ireland will become poor, again. It only had a decade of "swell times." The Irish emigrate. But now? They can't. Americans are enforcing their borders. And, the Irish who try to come to America are picked up and sent back. (Maybe, Americans think it's a Mexican "illegal" thing. But it's much bigger than that.)
Greece is an entirely different situation. They don't export much. Capital never really went in and built factories. ALL the money that was grabbed in loans by the Greeks, went out into BIG TIME fake payouts to the public sector. (Who work on 14 months in the year. Just to absorb more government payouts.) And, the Greeks DON'T pay taxes! Their avoidance schemes are amazing. Including that if you buy and sell real estate, you don't have to record this with the government. There is NO official recognition of properties changing hands. And, to whom they go!
After this debacle is over Greece will revert to the backwater setup they've owned with their own drachmas. Their major industry is tourism. But so many strikes in the public square just bring disasters to tourism.
It's the tragedy of the COMMONS.
What does Joe Corzine know?
ReplyDeleteHow did his bet against the Italian loans ... which he was betting would lose value ... DON'T in the short term! Corzine couldn't cover what he bet at the table.
There are now 1600 MF Global traders without jobs. (The other arm of the country is foreign. So GM Global's remaining arm ... with about 2,600 employees ... is out there. Waiting for what? BRUSSELS?
How did Corzine get caught short on a subject he knows like the back of his hand? COMPLEXITY IN BOND OFFERINGS WAS HIS BABY!
The "complexity" only grew.
I don't think the story's over, yet.
And, I don't think Corzine pocketed the $600-million, or more. (Bernie Madoff, on the other hand, "ran his business" out of his pants pocket.) A Ponzi scheme wasn't what MF Global was about.
In other words, here's my question:
Merkel made the ECB absorb TOXIC LOANS?
How did Corzine "guess" the "turn of events" so wrong? Isn't there a story to be told?
In the heydays of easy flowing money and credit, multipliers worked and interest rates were low. When interest rates rise then other countries become insolvent with their projected debt load, so ZIRP in America will end ultimately as real interest rates go up. What too has dried up is trust.
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