Naked Euro

I wonder how many ‘the Emperor has no clothes’ moments we’re going to have to go through before Mr. Market finally realizes he’s nude?  The big news about the Euro is that nothing has changed at all, except to get worse.

What the pieces I’ve selected make clear is that goverments in the Euro Zone can’t afford to pay off the banksters crap assets at anything near their notional balance sheet value.  The European Central Bank (ECB) is the only one who can print Euros and impose investor haircuts through asset inflation and they can’t lend directly to governments, only to banks.  Any country that follows the Irish example of paying off their vampire bank failures is committing economic suicide.

What they don’t highlight, but which is none the less true, is that the ECB balance sheet is running out of room without a looser monitary policy (i.e. ‘printing’) AND that the assets it’s accepting as collateral are, even under the relaxed standards, made acceptable only through Credit Default Swap ‘Insurance’ issued by the self same banks that don’t have the reserves to cover their primary obligations.

Like AIG these ‘counter parties’ have absolutely no intention of paying off and no ability to do so even if they did.

‘House of Cards’ hardly begins to describe the tissue thin fictional fig leaf these insolvent banksters are trying to hide their behinds behind.

How the ECB could be forced to print money

Felix Salmon, Reuters

Dec 6, 2011 10:52 EST

The line to concentrate on, here, is the solid one in blue. It shows a key part of the Bundesbank’s assets – its loans to other institutions – falling perilously low to zero, even as its loans to other European central banks – the maroon dotted line – continue to rise inexorably. (These loans from one national central bank to another are known as the TARGET system.)

Up until now, the Bundesbank has managed to fund the latter by means of selling off the former: when it’s asked to lend money to PIIGS central banks, it just sells off some other loans and advances the cash to the Irish or Portuguese central bank instead.

But it can’t do that any more, because the Bundesbank is down to its last €21 billion in private loans. And when that hits zero, the only things left to sell are the Bundesbank’s gold and reserves. Which, it’s pretty safe to say, the Bundesbank is not going to sell.

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Basically, there’s a constant flow of money out of the European periphery and towards the center. Up until now, that flow has been matched by an equal and opposite flow of central bank lending from the Bundesbank to the PIIGS central banks. And when the Bundesbank runs out of money to lend those central banks? The ECB will have no choice but to step in and print all the money necessary to stop those banks from going bust. And that, I think, is how we’re going to see the ECB finally take on the lender-of-last-resort role it has been so reluctant to adopt until now.

Eurozone Crisis, Act Two: Has the Bundesbank Reached its Limit?

Authors: Aaron Tornell & Frank Westermann, EconoMonitor

December 7th, 2011

In the wake of the 2008 crisis, some national central banks, especially those in Greece, Ireland, Italy, Portugal, and Spain (the GIIPS), have dramatically increased their loans to financial institutions. To fund these loans, GIIPS central banks borrowed mainly – via the ECB – from other central banks, in particular the Bundesbank.

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In principle, the limit on the amount of claims on the Eurosystem that the Bundesbank can accumulate equals the assets in its balance sheet plus the amount it can borrow in capital markets. Pressure from the German public, however, might prevent the Bundesbank from reaching the theoretical limit. There are several political thresholds. The first is when the stock of Bunds in the Bundesbank hits zero. As Table 2 shows, this threshold has been reached. Even before the 2008 crisis the stock of Bunds in the Bundesbank was practically zero. The second threshold will be reached when the stock of loans from the Bundesbank to the private sector is depleted. As we described above, the stock of loans to private credit institutions has fallen to almost zero. At the end of October 2011, it stood at €21 billion.

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As we have described, in the European monetary union, the stock of securities held by a central bank can increase in a member country even though the ECB might not pursue an expansionary policy for the Eurozone as a whole. This creation of base money is not done via the printing press as in old times, but electronically. To illustrate the mechanism consider the following example. An owner of Greek government bonds uses them as collateral to borrow from his commercial bank, which in turn borrows from the Bank of Greece. The Greek central bank wires the funds via the ECB to the Bundesbank, which in turn deposits them in the Frankfurt bank account of the Greek resident. As a consequence, the Bundesbank gets a ‘TARGET claim’ on the ECB and the Bank of Greece gets a ‘TARGET liability’ at the ECB. This TARGET claim is secured by collateral – the Greek government bonds – deposited at the ECB that were previously in the possession of the Greek resident. Through this operation, the increase in the stock of securities at the Bank of Greece is matched by a reduction of securities in the Bundesbanks’ balance sheet. The Bundesbank sells some of its assets to be able to deposit the funds into the Greek residents’ private Frankfurt bank account. As a result, German assets are replaced by ECB collateral (TARGET claims) in the balance sheet of the Bundesbank.

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How long can the central banks of the GIIPS accumulate TARGET liabilities at the ECB? In theory, as long as they have collateral that is acceptable to the ECB, which is the total stock of government debt plus other marketable assets (such as mortgage-backed securities) recognised by the ECB. However, running out of collateral won’t necessarily stop the borrowing. Should central banks run out of government bonds, the national governments could issue more bonds, and sell them to private banks. Banks in turn could use them as collateral to borrow from their central banks. Thus, practically, there is no limit to the amount of domestic government bonds the national central banks could use as collateral to accumulate TARGET claims at the ECB.

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Up to now, Bundesbank loans have allowed GIIPS central banks to buy government bonds without a corresponding increase in the monetary base of the Eurozone as a whole – ie, without the ECB printing more money (after an expansion in 2008, the monetary base returned to trend growth). Before long, however, the Bundesbank’s stock of domestic assets is going to hit zero, and it is highly unlikely that it will agree to sell its gold or borrow more in private capital markets. At that point, the Bundesbank will not be able to lend more funds to the Eurozone TARGET mechanism. As a result we are heading towards the multiple equilibria zone in which beliefs of a breakdown of the Eurozone are self-fulfilling. In such a situation, market participants may transfer funds from financial institutions in fiscally weak countries to other ‘safe’ countries like Germany. In tranquil times, such transfers can be done seamlessly through the TARGET mechanism of the ECB. However, if a critical mass of agents were to engage in such capital flight away from fiscally weak countries, the TARGET system would be overwhelmed. In principle, a speculative attack could occur within a day, and the ECB would have to assume all of the marketable securities from countries that suffer the speculative attack. Since the ECB has a relatively small capital base, it would not be able to purchase a large amount of assets from countries that suffer the attack.

EU Banks Must Raise $153B of Extra Capital: EBA

By Ben Moshinsky and Jim Brunsden, Bloomberg News

Dec 8, 2011 8:01 PM ET

German banks need to raise an additional 13.1 billion euros, Italian banks 15.4 billion euros, and Spanish lenders 26.2 billion euros in core tier 1 capital, the European Banking Authority in London said yesterday. The capital shortfalls include 15.3 billion euros for Spain’s Banco Santander SA (SAN) and 7.97 billion euros for Italy’s UniCredit SpA. (UCG)

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Other lenders needing to bolster their reserves include Deutsche Bank AG, with a shortfall of 3.2 billion euros, Banco Bilbao Vizcaya Argentaria SA (BBVA), which missed the target by 6.33 billion euros, BNP Paribas (BNP) SA, with a shortfall of 1.5 billion euros, and Societe Generale SA (GLE), which needs 2.1 billion euros. Commerzbank AG (CBK) needs 5.3 billion euros to meet the target, German regulator Bafin said. France’s Groupe BPCE, the owner of Natixis SA, had a 3.7 billion euro shortfall, and Italy’s Banca Monte dei Paschi di Siena SpA (BMPS) needs to raise 3.27 billion euros.

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Regulators more than doubled the amount of capital German lenders need to raise from the original 5.2 billion-euro estimate for the country’s banks in October.

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French banks will have to raise 7.3 billion euros, 1.5 billion euros less than previously estimated.

German Funds to Sell $3.6 Billion of Best Properties as Liquidation Looms

By Simon Packard, Bloomberg News

Dec 11, 2011 7:00 PM ET

Three German funds facing a May deadline to avoid liquidation aim to raise about 2.7 billion euros ($3.6 billion) selling trophy real estate including Berlin’s Potsdamer Platz and the European Bank of Reconstruction & Development’s London headquarters.

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Raising cash from real estate sales became more difficult after Europe’s growing sovereign-debt crisis led buyers to favor properties in prime locations occupied by tenants on long leases. Selling most-prized assets risks making more investors withdraw money from the funds when they re-open.

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Germany’s 85 billion-euro real-estate mutual fund industry may be facing the biggest crisis in its 50-year history. A dozen of the 44 funds, which own 28 percent of the industry’s assets, are liquidating or have suspended redemptions, according to Frankfurt-based BVI Bundesverband Investment & Asset Management.

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The German government stepped in to shore up an investment product favored by savers because of the reliable income returns it generates and the country’s lack of a developed real estate investment trust market. Legislation adopted in May and taking effect in 2013 will introduce notification periods, caps on withdrawals and staggered repayments to free funds from a potential liquidity trap.

EU Banks Taking Government Cash Seen Sparking ‘Vicious Cycle’

By Yalman Onaran, Bloomberg

Dec 11, 2011 7:01 PM ET

Ireland’s effort to back its banks brought the country to the verge of collapse last year. After issuing a blanket guarantee on all bank debt in 2008, the government was compelled to keep plugging holes as losses mounted. Sovereign debt doubled to more than 100 percent of GDP after about 60 billion euros were put into the nation’s lenders. Ireland sought a rescue package from the EU and the IMF in November 2010.

“The European banks (BEBANKS) can’t get fresh capital, so governments are going to have to cough up the money,” said Barbara Matthews, managing director of BCM International Regulatory Analytics LLC, a Washington-based consulting firm. “Germany is re-establishing its bank rescue fund, and it has the money to put in its banks. But when you look at public sources, you run into a problem. Do the other sovereigns have the cash to do it?”

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“The EFSF doesn’t have enough money to support Italian and Spanish sovereign debt as well as put money into the European banks,” said Desmond Lachman, resident fellow at the American Enterprise Institute in Washington. “It just can’t do all of that.”

The EU banks’ capital holes are bigger than the EBA’s latest estimate, Lachman said, citing a September IMF estimate of a 300 billion-euro risk based on more favorable prices for government bonds at the time.

Because banks can’t raise capital from the market and some governments can’t afford to provide cash, compliance most likely will be through asset sales and reduced lending in the region, said Lannoo of the Centre for European Policy Studies. The EBA has told banks not to meet the new capital requirements through such measures, instead asking them to refrain from paying dividends.

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The size of potential losses at European banks has scared away short-term creditors, squeezing the region’s lenders. The European Central Bank has stepped in to replace funds being withdrawn, providing unlimited cash and lowering requirements on the quality of collateral it will accept.

“We’re in a death spiral,” said Andy Brough, a fund manager at Schroders Plc in London. “As the yields on the peripheral bonds increase, value of the bonds decreases and the amount of capital the bank has to raise increases.”