The End of the Euro

You see, the fundamental problem is that their banks are insolvent.

European banks’ asset sales face disastrous failure

By Gareth Gore, International Finance Review

26 November 2011

European banks are being forced to abandon their efforts to sell off trillions of euros worth of loans, mortgages and real estate after a series of talks with potential investors broke down, leaving many already struggling firms with piles of assets they can barely support.

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Deadlocked talks with potential buyers – a mix of private equity firms, hedge funds, foreign banks and insurers – show little sign of making breakthroughs, say bankers taking part in those negotiations, with the stalemate threatening to block the industry’s ability to save itself from collapse through a mass deleveraging.

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People involved in asset sale talks say price is the major sticking point. Lenders want only to sell higher-quality assets near to par value so as to avoid huge write-downs, which would erode capital further. By contrast, potential buyers want high-yielding investments and are offering only knock-down prices.

“There is a huge amount of liquidity among investors right now, but they only want to buy at distressed prices,” said Stefano Marsaglia, a chairman within the financial institutions group at Barclays Capital. “Lots of discussions are taking place but there is a gulf in terms of pricing.”

The homogeneity of assets on offer is also complicating the negotiations – a number of Dutch lenders, for example, all want to sell very similar mortgage-backed securities. Several bankers advising such clients were unanimous in saying that the deals will struggle to happen.

And Now Europe’s Banks Are Starting To Panic As The Oxygen Gets Sucked Out Of The Room

Henry Blodget, Business Insider

Nov. 16, 2011, 9:27 PM

Specifically, traditional sources of bank funding in Europe, such as institutional investors and other banks, are getting cautious as fears grow about the need for sovereign debt restructurings. As liquidity dries up, the only reliable source of funding is often the ECB.

But the ECB only accepts certain types of assets as collateral for loans, and some banks are running out of those assets.

So they’re turning to investment banks and other “counter-parties” that have them. And they’re entering into “swap” agreements in which they exchange their assets for the counter-parties’ assets and then stock-pile the latter assets for use as collateral.

And that’s a fine plan… until the music stops and one big “counter-party” fails.

How does this relate to the sovereign debt crisis?  As Citi’s Willem Buiter puts it-

I think France definitely has its work cut out for itself. It has a government budgeting problem which is structural to a large extent. And then they have a large banking sector. Do not forget that the U.S. banking sector balance sheet is less than 100% of GDP. In Europe and France, it is 300%. Their banks are under fire and so their sovereigns are under fire. I do not think the sovereign will keel over, but they have their work cut out for them.

All the liquidity in the world is not going to solve the problem that European banks are holding over $7 Trillion of valuation on their books that can’t be sold for anything near that AND the sovereign governments have made an implicit promise to bail them and their investors out.

As Roubini put it–

At this point most investors would dump their entire holdings of Italian debt to any sucker – the ECB, European Financial Stability Facility, IMF or whoever – willing to buy it at current yields.

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So using precious official resources to prevent the unavoidable would simply finance the exit of others.

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If, as appears likely, Italy remains stuck in an uncompetitive recession and is unable to regain market access in the next twelve months, then even if such large official resources were mobilised, they would be wasted on financing investors’ exit and thus postponing an inevitable debt restructuring that would then be more disorderly.

As your humble servant put it shortly thereafter-

This is a liquidity fix, not an insolvency fix.  The problem it’s intended to address is that banks will no longer lend to other banks because they suspect (and rightly so) that the other banks’ assets are pieces of crap.

It does nothing at all to address the fact that those assets are pieces of crap.

For their part the governments are making the additional bad choice to pursue a program of austerity that has already stifled growth to the point of Recession and the beginnings of a Deflationary Spiral.

What Can Save the Euro?

Joseph E. Stiglitz, Project Syndicate

2011-12-05

It is increasingly evident that Europe’s political leaders, for all their commitment to the euro’s survival, do not have a good grasp of what is required to make the single currency work. The prevailing view when the euro was established was that all that was required was fiscal discipline – no country’s fiscal deficit or public debt, relative to GDP, should be too large. But Ireland and Spain had budget surpluses and low debt before the crisis, which quickly turned into large deficits and high debt. So now European leaders say that it is the current-account deficits of the eurozone’s member countries that must be kept in check.

In that case, it seems curious that, as the crisis continues, the safe haven for global investors is the United States, which has had an enormous current-account deficit for years. So, how will the European Union distinguish between “good” current-account deficits – a government creates a favorable business climate, generating inflows of foreign direct investment – and “bad” current-account deficits? Preventing bad current-account deficits would require far greater intervention in the private sector than the neoliberal and single-market doctrines that were fashionable at the euro’s founding would imply.

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There is, interestingly, a common thread running through all of these cases, as well as the 2008 crisis: financial sectors behaved badly and failed to assess creditworthiness and manage risk as they were supposed to do.

These problems will occur with or without the euro. But the euro has made it more difficult for governments to respond. And the problem is not just that the euro took away two key tools for adjustment – the interest rate and the exchange rate – and put nothing in their place, or that the European Central Bank’s mandate is to focus on inflation, whereas today’s challenges are unemployment, growth, and financial stability. Without a common fiscal authority, the single market opened the way to tax competition – a race to the bottom to attract investment and boost output that could be freely sold throughout the EU.

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Even if those from Europe’s northern countries are right in claiming that the euro would work if effective discipline could be imposed on others (I think they are wrong), they are deluding themselves with a morality play. It is fine to blame their southern compatriots for fiscal profligacy, or, in the case of Spain and Ireland, for letting free markets have free reign, without seeing where that would lead. But that doesn’t address today’s problem: huge debts, whether a result of private or public miscalculations, must be managed within the euro framework.

Public-sector cutbacks today do not solve the problem of yesterday’s profligacy; they simply push economies into deeper recessions. Europe’s leaders know this. They know that growth is needed. But, rather than deal with today’s problems and find a formula for growth, they prefer to deliver homilies about what some previous government should have done. This may be satisfying for the sermonizer, but it won’t solve Europe’s problems – and it won’t save the euro.

Is there some hope?  How about some new leadership?

Wolf Richter: French Presidential Election – Coup De Grâce For The Euro?

Naked Capitalism

Friday, December 2, 2011

France isn’t doing well. Unemployment, which has been rising since May, breached 9%. Wages haven’t kept up with inflation, and purchasing power has dropped. Industrial orders plummeted. Layoffs have been announced. Yields are rising. Banks are teetering. Sarkozy had tried to reform the French welfare and tax system. Result: rising income disparity, tax loopholes for the rich, diminished pension benefits for the middle class, reduced subsidies for the poor, etc., and now ugly unemployment trends.

Voters are angry. And the poll numbers that came out today show to what extent (L’Exress, article in French). During the first round on April 22, François Hollande of the Socialist Party would obtain 29.5%, Sarkozy 26%, and right-wing populist Marine Le Pen 19.5%. And this after Sarkozy got a 6-point bump from an anti-nuclear imbroglio on the left that Hollande had trouble squelching. In a face-off during the second round on May 6, Hollande would win by a landslide 56% against Sarkozy’s 44%.

If the economy deteriorates further, Marine Le Pen, president of the National Front, might beat Sarkozy in the first round. Media savvy and endowed with a captivating presence, she’d stunned the French political establishment by beating Sarkozy in the polls earlier this year.

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François Hollande is more temperate. … His camp has come up with a five-point plan:

1. Expand to the greatest extend possible the European bailout fund (EFSF)
2. Issue Eurobonds and spread national liabilities across all Eurozone countries
3. Get the ECB to play an “active role,” i.e. buy Eurozone sovereign debt.
4. Institute a financial transaction tax
5. Launch growth initiatives instead of austerity measures.

But the core of their solution-monetizing sovereign debt without central control over national budgets-is totally unacceptable to Germany. So, if the euro and the Eurozone as we know them are still alive by early May, then the French presidential election may well deliver the coup de grâce.

That is, if Germany remains intransigent.

On the other hand it’s highly likely Mr. Market isn’t going to wait that long.  German bonds (I refuse to confuse you by calling them bunds just to pretend to be hip and cosmopolitan) were already under considerable pressure before the latest optimism bubble and projected growth of the German economy has been sharply revised downward even from the anemic 1.5 to 2% of a month ago.

The vast majority of German exports are to EU partners who can no longer afford them under the austerity regimes dictated by the German banks who in fact hold more of that unsellable crap sovereign and commercial debt than most of their peers.  If they continue this policy they’ll be committing economic suicide.

There is no confidence fairy.  You can’t cut your way to prosperity.

I say good riddance to bad rubbish in my very best imitation of Hayek and refer you again to David Apgar-

As far as costs go, massive European bank restructuring comes to mind, especially following a cool €300 billion or so of losses on government bond holdings. It’s hard to say anything nice about bank restructuring, but at least we know how to do it. We know, for example, how to split good banks from bad banks. (Hint: rank balance sheet assets by quality and liabilities by seniority and draw a line across the balance sheet after the last asset of reasonably determinate value.) That’s handy when you need banks with systems in place ready to restart lending. And we know these transactions work when free from political interference as they were in Sweden in 1992.

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(M)assive European bank restructuring may be unavoidable even if Europe somehow enlisted enough ECB printing presses, enough future earnings of all those carefree northern European taxpayers, and enough future benefits of all those docile southerners to plaster a smile on the face of every bond portfolio manager at BNP Paribas and Commerzbank. The scale of the bailout needed to avoid further investor losses as of today – much less tomorrow or next week – would entail cross-border consolidation or de facto nationalization of a significant portion of the euro banking sector.

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The most popular alternative has the ECB stepping in to buy bonds every time investors try to cut their exposure. At first blush, it looks clean – no forced austerity, no messy investor losses and bank restructurings, no burden on taxpayers in creditor countries like Germany.

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With such ECB generosity on offer – and with euro zone inflation looming – why would any bond trader with a pulse stop after dumping her Greek, Portuguese, Irish, Italian, and Spanish exposure? Why not get rid of the French and German paper in the vaults, as well? Get rid of it all.

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This, then, is the impasse euro zone bond investors have reached. To avoid losses, they clamor for alternatives that could disrupt the currency itself – one of the few things that might actually make them worse off in real terms than they are right now.