December 21 2011: The forest feels denser and darker all the time

Gustave Doré Little Red Riding Hood 1883

Ilargi: Haven't we been here before?

It's the sort of question you would expect a child to ask in one of those Grimm Brothers fairy tales, a child that walks so far into the woods that it gets lost, and takes another wrong turn and then another, and the forest feels denser and darker all the time, and it doesn't even run around in circles to return to its trail of breadcrumbs, or it doesn't know, because they've all been eaten by the animals. And then night falls slowly.

That's how I increasingly picture our financial situation. We march forward full of faith and feigned innocence into uncharted territory, telling ourselves we will and must find a way out of this mess, boosted by the high priests of our economic belief systems, the media, economists and politicians.

The children in the fairy tales always escape from the dark in the end, but we're not those children. Getting lost in the woods because you ignore the warnings is in general not an act of bravery, but one of stupidity.

Characters in fairy tales serve to teach their young readers and listeners a lesson about the morals of their societies; these characters don’t perish, they get saved because they timely see the errors of their ways. A morality tale.

But whereas the children in these fairy tales go gently into a good night, we go blindly into a bad one.

Perhaps it's fittingly ironic that this time around the rally came before instead of after the announcement by ECB president Mario Draghi of €489 billion in cheap loans for European banks. It fits right in with all the other things we get totally the wrong way around. About 60% of those loans, by the way, are just regurgitated old stuff.

Looking at what they have come up with in episode 1001 of the bailout drama, and just a brief look will do, there's one conclusion and one only: what they say is not what they think.

The ECB claims that it "hopes" the banks will use the money to purchase peripheral debt, but the ECB knows they won't (and what sort of €489 billion deal depends on "hope" only?). It knows, because the ECB itself, along with other parties, has refused to guarantee that debt.

It may be presented as a good deal, but borrowing at 1% to get a 5% return is not all that attractive when you have a 50% chance of an 80% haircut. Or something along those lines.

The ECB also said they hope banks will use the money to loan out to consumers. Just as big a pile of doo-doo. Banks are shedding assets like they're fleas, because they need reserves. That is a solvency issue. Being able to borrow ever cheaper while handing out ever more doubtful collateral addresses a liquidity issue.

There are a few things that this sort of lending will indeed achieve. It will gobble up bad assets from private banks and transfer them to the risk of the public coffer. Nothing new there. The child just gets deeper into the forest, and the light starts fading. A step by step process perceived as progressing so slowly, it raises no alarm. It's still morally repugnant, but who in charge of this thing has any morals left at all in the first place?

Another effect of those €489 billion is that the divide between the ECB and Germany, in particular its central Bundesbank, will widen, and substantially so. Which endangers the entire Eurozone project.

Whatever plan Europe comes up with, be it the European Financial Stability Facility or the European Stability Mechanism, or this latest one from the ECB, there are only two countries left to carry the vast majority of the risk and the burden. One of those countries, France, will soon be downgraded. So will its banks. This will lead to a downgrade of the EFSF and, if there's still time, the ESM.

There will at that point be one country left to carry the entire rest on its shoulders. Germany's allies and relatively strong partners, Holland, Finland, are way too small to do any heavy lifting. Moreover, Holland is on the verge of a housing collapse.

The EFSF needs to be funded; it can only spend what it has received. Europe has been unable to agree on expanding the Facility. Which is why the ECB now comes with its loan plan. Which did lead to a market rally, but that rally fizzled as soon as the plan was announced, even though it was at least €100 billion larger than expected.

So France soon will no longer be a net contributor to the EFSF. Which is one of the main reasons the expansion didn't materialize. Hence, it's all Germany's responsibility, and Germany is smart enough to understand it's not strong enough to bear that responsibility.

And then out of left field comes Mario Draghi handing out half a trillion euros in loans to 523 different European banks that on average are just about to draw their last breath, selling off profitable assets because they're all buyers are interested in, and keeping the lousy ones, which they now can pledge to the ECB, with a huge chunk of the risk involved landing squarely on the shoulders of the German citizenry.

The chance that Berlin will now look even a lot more serious at cutting its losses while it can has become much bigger with Mr. Draghi's first substantial act as ECB president. It's deceptively simple, really. Germany can't guarantee Greek and Italian and Spanish debt with the risk waiting in the wings of France slumping badly. Not without risking its own wealth, its own coherence as a society, in the process.

Staying in the metaphor of the child lost in the darkening forest (and yes, the Grimm brotheres were German), it's like the child, after taking yet another wrong turn, has stumbled upon a big bad wolf.

And though it's already getting almost too dark to see, the last thing the child does notice is that the wolf looks nothing like its sweet old grandmother.

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Herr Draghi or Signor Draghi, and the ECB's Santa Rally (technical)
by Ambrose Evans-Pritchard - Telegraph

The ECB’s back-door bail-out for Italy, Spain, Belgium, and… France? …is €489bn.

Roughly €300bn of today’s eagerly awaited LTRO tender is recycled old money from earlier support operations. The new money is €200bn. This alone is not going to shore up the sovereign states of southern Europe as they grind deeper into recession/depression.

Enjoy Mario Draghi's Santa Rally while it lasts. The euphoria is likely to dissipate once markets remember the sheer scale of the task at hand.

The banks are under massive pressure to raise their core Tier 1 capital ratios to 9pc by next June. This requires a €2.5 trillion adjustment according to the BIS’s Global Stability Board. Most of that is going to be done by slashing loan books – deleveraging in the jargon – since they cannot raise fresh capital at a viable cost and don’t wish to be nationalised.

So will this extra €200bn be used to buy Italian and Spanish bonds, or instead to plug a frightening number of leaks across the financial system? "In a deleveraging world, we doubt that this will be used in any meaningful way to buy sovereign bonds… given the amount of scrutiny under which banks are regarding their sovereign exposures," said Nick Matthews from RBS. "The operation is thus unlikely to have a long lasting confidence boosting impact, in our view."

Eurozone sovereigns must raise €1.6 trillion in 2012, and banks must raise another €700bn.

Here is the redemption calendar for Italian debt, if you like such stuff.
Note on page 3 that Italy must redeem:
• In January: €15.2bn of BOTs
• In February: €17bn of BOTs, €25.8bn of BTPs, and €10.6bn in CTZs (€53.4bn)
• In March: €17bn of BOTs, €14.9bn of BTPs, and €12.3bn of CCTs (€44.2bn)

This is quite apart from new debt issuance needed to cover the budget deficit as the economy shrinks again, starting with 0.2pc contraction in Q3 of this year even before Mario Monti’s austerity package.

I don’t wish to belittle the importance of what the other Mario has done at the ECB. As RBS says, he may have averted a Lehman-event that looked all too imminent two weeks ago. He has bought a few months.

Crucially, he has locked the Bundesbank even deeper into the EMU rescue machinery, since Buba is on the hook for much of this credit to banks in exchange for bus ticket collateral.

Of course, Buba is already deeply enmeshed through €465bn of "Target2" payments to fellow central banks. The more this goes on, the harder it is for Germany to extract itself from monetary union when the time comes. You don’t always stride across the Rubicon. Sometimes you slide unwittingly beyond the point of no return.

A few more clever wheezes like this and Draghi will have cut off any possible retreat by Germany, short of Götterdämmerung for everybody.

The small band of City specialists who really have their fingers on the pulse of the ECB are split on what happens next:

The Herr Draghi camp thinks he means what he says about respecting the EU Treaties and Lisbon’s Article 123 prohibiting monetary financing of deficits.

The Signor Draghi camp thinks he is slowly combining an alliance of ECB doves ready to spring a trap on the Bundesbank, with rate cuts to 0.5pc by February and then signals of forthcoming QE – most likely by playing the forward-looking "deflation card" and muttering about impaired "monetary transmission channels".

One notes that Signor Draghi dodged the crucial the question on QE in his interview with the Pink Paper on Monday. The transcripts show that he refused to rule out printing money. "We take that as a yes," said David Owen from Jefferies Fixed Income.

It always come down to the same question. Can the ECB doves engineer enough stimulus to head off disaster in Club Med, without causing a disgusted Germany to pick up its marbles and walk out.

Probably not.

And can any level of stimulus ever close the 30pc structural gap in labour competitiveness between North and South, still growing wider by the day?

Certainly not.

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ECB Lends Banks €489 Billion ($645 billion) for Three Years, Exceeding Forecast
by Gabi Thesing and Rainer Buergin - Bloomberg

The European Central Bank will lend euro-area banks more than economists forecast for three years in its latest attempt to keep credit flowing to the economy during the sovereign debt crisis.

The Frankfurt-based ECB awarded 489 billion euros ($645 billion) in 1,134-day loans, more than economists’ median estimate of 293 billion euros in a Bloomberg News survey. The ECB said 523 banks asked for the funds, which will be lent at the average of its benchmark rate -- currently 1 percent -- over the period of the loans. The ECB also lent banks $33 billion for 14 days in a regular dollar offering, up from $5.1 billion a week ago. The euro jumped half a cent to $1.3198.

Government bond markets may continue to rally if demand for the three-year loans exceeds 250 billion euros, Steven Barrow, head of Group of 10 currency strategy at Standard Bank Plc in London, said before the ECB announced the results.

Europe’s debt crisis has increased the risk of government and bank defaults, making institutions wary of lending to each other and driving up the cost of credit. The ECB is trying to ensure that banks have access to cheap cash for the medium term so that they can keep lending to companies and households. In addition to the longer-term loans, the ECB has widened the pool of collateral banks can use to secure the funds.

Italian and Spanish government bond yields have dropped since the ECB announced the loans on Dec. 8 as banks buy the securities to use them as collateral. French President Nicolas Sarkozy has suggested banks could use the loans to buy even more government debt.

'Carry Trades'
"What the ECB wants is that the funds be used by banks to keep handing out loans," said Michael Schubert, an economist at Commerzbank AG in Frankfurt. "But there’s a second argument, which is to do carry trades by borrowing on the cheap at the ECB and buying sovereign bonds. We don’t know what the banks are using the money for."

ECB Vice President Vitor Constancio in a Dec. 19 interview predicted "significant" demand for the loans as banks face "very high refinancing needs early next year."

Some 230 billion euros of bank bonds mature in the first quarter of 2012 alone, ECB President Mario Draghi told the European Parliament this week. "Banks represent about 80 percent of lending to the euro area," Draghi said. "The banking channel is crucial to the supply of credit." He predicted banks will experience "very significant funding constraints" for the "whole" of 2012.

No Turning Point

Banks from the euro region need to refinance 35 percent more debt next year than they did this year, according to a Bank of England study. Lenders have more than 600 billion euros of debt maturing in 2012, around three quarters of which is unsecured, the study says.

The ECB is focusing on greasing the banking system to fight the debt crisis as it resists calls to increase its bond purchases to reduce governments’ borrowing costs. It will offer a second three-year loan in February and banks have the option of repaying them after a year.

"It’s very significant and very helpful for the banks," Jacques Cailloux, chief European economist at Royal Bank of Scotland Group Plc in London, told Bloomberg Television. "But it’s not going to bring about a turning point in this crisis."

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Carry, LTRO, Data, and VIX
by Peter Chir - ZeroHedge

Once again we seem to have a discrepancy between what "credit" people think and what "equity" and "FX" people think.  The broad market rallied strongly today, at least in part because of the LTRO.

On one thing, everyone agrees, the take up rate will be high.  There will be strong demand for the LTRO.  What differs is the impact that will have on the market.

At one end is a belief that banks will be borrowing this money so they can purchase new assets.  The allure of carry will be too much to pass up, and with government encouragement, they will rush to purchase new sovereign debt and maybe even lend more.  That will turn the tide in the European debt crisis since there will be buyers for every new issue, and the market can move on to "strong" economic data in the US.

The other end of the spectrum is that the banks will use this facility to plug up existing holes in their borrowing.  They won’t have to rely on the wholesale market or repo market as much as they can tap this facility.  It will take some pressure off of the "money market" as banks won’t be scrambling for as much money every day, or over year end, but it won’t lead to new asset purchases by the banks.  Banks need to deleverage and that hasn’t changed.  The bonds can have a 0% risk weighting, but that doesn’t mean anyone, including the banks, believe it.  The road to hell is paved with carry.  That is an old adage and likely applies here. 

High Yield did well today (with HY17 outperforming HYG and JNK).  Investment Grade did okay as well (LQD tightened on a spread basis, though it shows up as a loss for most retail investors).  IG17 also was tighter as no one wanted to be hedged.  Away from that, more exotic trades, like curve trades didn’t show a similar strength.  These are the sorts of trades that would do well if everyone was looking for carry and thought the problems were solved.  Little things like that further underscore how likely it is that banks will participate.

Most banks are overexposed to these risks in the minds of investors anyways.  Will buying more of something that is risky really help?  Will loading up on a single position to the point that it can wipe you out be deemed as prudent?  I think banks that have managed themselves well to this point will be very reluctant to add significantly to their exposure.  You may get some token purchases so they can tell their regulators that they are playing nice, but beyond that, they will wait and see if the situation is really fixed.

The reason banks are not buying more of these bonds has little to do with funding costs being too high.  Risk and leverage are too high.  That hasn’t changed here, and most credit people believe that this new funding will encourage new asset purchases.  Without that, it helps the banks by reducing some uncertainty on their existing debt rollover needs (let’s not forget the hundreds of billions of bank issued debt that needs to be rolled this year), but doesn’t encourage asset purchases or balance sheet expansion.

Earlier today I had a bullish tone and did see 1300 and 1100 as being equally possible.  With a 40 point move from overnight lows it seems like a lot, especially since to the extent I was right, it was for all the wrong reasons.  I continue to believe that there may be an agenda behind the truth that is emanating out of Europe recently, but this LTRO plan doesn’t do it for me.  With our models showing seasonality being strongest from close of business tomorrow until the 27th, it is hard to be short, but without real news, we will be fading this.

On the data front, I am a bit confused why housing starts going up is a good thing.  The only industry that may be worse at predicting future demand than the airline industry, is the homebuilder industry.  They build homes, it’s what they do.  Carefully managing inventory to demand is not their strong suit.  A story about great demand and shortages of homes for sale would be much bigger news and may warrant a rally, I put this in a neutral category, at best.

On the earnings front, it seems like as many companies are missing as beating.  Oracle missed after the bell and is being punished.  It is far from clear to me that the earnings story is that compelling, and the strength in the dollar is the last thing the nascent surge in manufacturing needs.

We have a political system that couldn’t agree that the sun comes up in the morning without holding special sessions.  Their ability to provide any help to the economy is zilch and no matter how many times people say it, there is no strong evidence that "gridlock" and "a government that does nothing" is actually a good thing for stocks over the short term (even though it may be by far the best thing for the economy in the long run).

VIX is back to levels last seen in August.  The fact that those levels preceded a sell-off is largely being ignored on a day the DOW moved up 337 points, but as far as I can tell, VIX is as much a "risk on" / "risk off" asset as anything else and has limited predictive value (as in none).  Somewhere out there, the quants are analyzing the skew of longer dated options as a better tool that may retain predictive value, but that is complex, and requires effort, but is probably the work that is required to make some sense of what the "vol" market is telling us.  It is definitely the sort of work that serious tail risk hedge funds and quant funds are looking at and analyzing. 

Here is the "vol skew" graph function on the SPX on Bloomberg.  As far as I can tell you would need to be either a rocket scientist or a Deadhead to understand it.  I am neither, but am convinced that to the extent the vol market contains useful information, it is far more complex to figure out, than pulling up a VIX closing level. 

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Euroland euphoria on Mario Draghi bank rescue
by Ambrose Evans-Pritchard and Louise Armitstead - Telegraph

Southern Europe's battered debt markets are basking in a glorious pre-Christmas rally as hedge funds and investors celebrate a blast of cheap liquidity from the European Central Bank.

Yields on Spain's three-month notes plummeted to 1.74pc on Tuesday from 5.11pc last month, leading euphoric moves across the eurozone periphery. Spanish 10-year yields fell below 5pc for the first time in two months, with credit rallies in Italy, Belgium, and Ireland.

Exuberance lifted Germany's DAX index by 3pc, the French CAC by 2.7pc, and FTSE 100 by 1pc, with ripple effects through commodities and risky assets worldwide.

The buying spree comes as markets wait for the ECB to turn on the monetary spigot. Funds are betting that an offer of unlimited bank credit for three years – long-term repo operations (LTROs) – will transform the underlying dynamic of Europe's debt crisis. Banks will be able to borrow at 1pc to buy Spanish and Italian bonds at 5pc or 6pc. It allows the ECB to prop up sovereign states without violating EU treaty law.

Lenders call it the "Sarko trade" after French leader Nicolas Sarkozy said the liquidity will allow each state to "turn to its banks" for finance. Markets have seized on the idea, hoovering up distressed debt in advance to lock in gains.

The ECB move is part of a string of fresh measures by the bank's new president Mario Draghi to head off a dangerous escalation of the crisis. "We are trying to avoid a credit crunch," he told Euro MPs on Monday, warning that EMU banks and states must together to raise €720bn (£602bn) over the first quarter of 2012.

This subtle form of 'credit-easing' includes a cut in the reserve requirement to free up €100bn in lending power, and looser rules to allow collateral-starved banks to pawn more of their loan books at the Frankfurt lending window. "Draghi's been smart," said Simon Ward, of Henderson Global Investors. "The spread available to banks is going to prove attractive. He has outmanoeuvred the Bundesbank by drawing it in deeper."

Yet it is unclear whether liquidity alone can stop investor flight from Club Med. European banks have already cut holdings of EMU bonds by €65bn this year, and are slashing loan books to meet the EU's core Tier 1 capital ratio of 9pc. The Basel-based Global Stability Board fears that deleveraging could reach €2.5 trillion over coming months, risking a shock to the system.

"This may help sovereign debt a bit but we don't think it is a game-changer," said Mark Schofield, rates chief at Citigroup, predicting that banks will use the money to plug other holes and cover a dollar funding squeeze. "Most banks already hold too much of their own government's debt. It may take coercion to make them buy more."

Jacques Cailloux from RBS said over-excited markets may latch on to a big headline number at today's tender – perhaps €500bn – but most of this will be recycled money from old support operations. "The new liquidity will be just €100bn or €200bn. This at least prevents a Lehman event in the banking system but it doesn't solve the fundamental problem," he said.

There are nagging concerns over how long the ECB itself can keep shouldering the eurozone burden, given that it has no sovereign entity behind it. The three-year LTRO is like a 'double-up' Martingale bet. It may save the day but it also concentrates risk further for the Bundesbank and other central banks in the eurozone system, as well as private banks.

The ultimate disaster could be even worse if it all goes wrong.

Away from moves driven by the ECB's actions, stockmarkets were also buoyed by an unexpected boost to Germany's economic outlook. Despite a gloomy forecast earlier this month, the respected Ifo Institute said its latest monthy index showed business confidence had increased to 107.2 points from 106.6.

Respondents told Ifo that while the current situation was bleak, they expected the economy to improve over the next six months. Economists had expected confidence to fall. Hans-Werner Sinn, president of Ifo, said: "The German economy seems to be successfully countering the downturn in Western Europe." German consumer confidence was also up, according to GfK data.

There was less optimism across the border. Jean-Pierre Jouyet, head of France's AMF securities regulator, admitted it was unlikely his country would keep its AAA rating. He said: "Keeping it would need a miracle but I want to believe it can happen."

Making it happen will require the bondmarkets to support the €178bn of debt France plans to issue during 2012. The French debt agency said the total issuance, which is needed to fund its €78.7bn budget deficit and €97.9bn of debt, will be lower that €184bn issued this year due to austerity measures.

Fitch, the rating agency that last week warned France had "slightly higher than 50pc" chance of being downgraded, extended its warning to the AAA-rated European Financial Stability Facility (EFSF) saying it would face a downgrade if France lost its rating.

"France is the most exposed of the 'AAA' euro member states to a further intensification of the eurozone sovereign debt crisis. It provides €158.5bn of guarantees plus over-guarantees to the EFSF guarantee pool under the framework agreement," Fitch said in a report.

European leaders will conclude their plans to extend an extra €150bn to the International Monetary Fund (IMF) in "early 2012" – including the UK's possible contribution alongside the G20.
Martin Kotthaus, a spokesman for the German finance ministry said: "The UK said yesterday they want to see within the context of the G20 to what extent they will want to contribute to raising the fire-power of the IMF, and I expect these questions and details could be settled by early 2012."

Separately Dexia, the Belgian-French bank, said it was progressing with its break-up with a sale of its Luxembourg subsidiary to Qatari investors for €730m – less than the expected €1bn.

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Banks face disclosure of capital position
by Brooke Masters - FT

Banks worldwide would be forced to disclose their regulatory capital positions in a common template to make it easier for investors to compare institutions under a proposal put forward on Monday by the Basel Committee on Banking Supervision, which writes global rules for the industry.

Currently banks announce their core tier one ratios – a key measure of bank safety – but are not required to explain how they are calculated and how they relate to the figures in their published financial statements. This loophole has made it hard for investors to gauge how strong banks are and regulators fear that some institutions are using the process to improve their reported results.

The problem is expected to get worse over the next seven years as banks are forced to make the transition into the tougher "Basel III" requirements. During the switch, preference shares and other debt instruments that previously counted towards the numerator of the capital ratio will be gradually phased out.

"To enable market participants to compare the capital adequacy of banks across jurisdictions, it is essential that banks disclose the full list of capital items and regulatory adjustments," the committee said in its report.

A standardised disclosure form would take some of the pressure off the European Banking Authority, which has had to battle national regulators over different definitions of capital while conducting its pan-European Union stress tests.

The regulators proposed that banks not only be required to disclose their capital but also make clear how much of it will be gradually phased out between now and 2018.

"Investors will view the proposals positively as they map out the journey from accounting equity to the all-important regulatory measure," said Richard Barfield of PwC. "That said, weighing a turkey accurately does not make it fatter. The challenge for the industry is not measuring equity or capital ratios. The challenge is growing the profits to create more equity."

Analysts said they wished the template proposal also addressed the denominator of the capital ratio, made up of risk-weighted assets because it has been a matter of controversy. Bankers have accused their competitors of "fudging" their risk calculations to make themselves look stronger. "Better disclosure is definitely a plus, but aren’t we all worried about risk-weighting inconsistencies which won’t be dealt with by this?" asked one analyst.

Even as the Basel Committee zeroed in on capital, its subgroup that works with insurance and securities regulators put out a consultation on how best to supervise financial conglomerates to avoid regulatory "blind spots". The Joint Forum warned supervisors to take into account unregulated entities when calculating capital needs and urged countries to designate one agency to take charge of supervising financial groups that engage in a broad range of business lines.

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Banks face €350 billion ($455 billion) Basel III shortfall
by Brooke Masters - FT

European banks will have to raise nearly €200bn ($260bn) in new capital or cut their balance sheets by nearly 20 per cent, to achieve the tougher new Basel III banking reform rules that start taking effect in 2013, a new study has found.

The study by the Boston Consulting Group looked at the efforts of 145 large banks worldwide to comply with that ratio and found they need to raise €354bn in capital on top of what they had at the end of 2010 or cut their risk-weighted assets by €5tn or 17 per cent. Banks in Europe had significantly further to go than those in the US and Asia, which each faced a collective shortfall of slightly less than €70bn.

The global Basel III package aims to make banks more resilient by forcing them to hold more, better quality capital against unexpected losses. The rules, which are set globally, require banks to hold core tier one capital equal to 7 per cent of their assets adjusted for risk or face restrictions on paying bonuses and dividends.

The study measured the European shortfall at €221bn, but roughly 20 per cent of that will be covered by the end of this year, the authors said. They estimated that European banks have already cut risk weighted assets by 5 per cent.

Officially, the Basel III rules phase in over a nine-year period through 2022, but the BCG research found that big banks are already moving to comply and most are planning to make a big effort toward achieving the standards by 2013. "Banks want to stay ahead of regulatory timetables as a demonstration to investors that they are financially strong," said Ranu Dayal, the BCG senior partner who led the work.

EU banks face an additional push from this month’s European Banking Authority stress tests which required them to achieve a 9 per cent ratio by 2012 using a somewhat looser definition of capital. The BCG study said the EBA rules effectively compress the time frame for meeting the Basel III requirements. Quick action could do much to strengthen the shaky European financial system but, collectively, the banks’ plans could pose a threat to the broader economy if they chose to cut lending rather than raise capital.

BCG notes that some banks may also seek to cut their RWAs by tinkering with the models they use to measure risk, a process known as "optimisation", and that the industry is lobbying hard to water down the Basel III proposals that sharply limit what can be counted as core tier one capital. Many bank chiefs are reluctant to raise additional equity because share prices are relatively low.

The BCG study suggests the banks are in a much better position than they were at the end of 2009, when research by McKinsey found that European banks might need to raise €600bn in new core tier one capital.

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Don't ask the ECB to intervene
by Louise Armitstead - Telegraph

Is it possible that the European Central Bank (ECB) doesn't want to intervene to end the debt crisis is because, whisper it quietly - it can’t afford to?

Every day political and economic leaders demand that the ECB is made the lender of last resort and embarks on a policy of quantitative easing, like the Bank of England or America’s Federal Reserve.

Timothy Geithner, David Cameron and Nicolas Sarkozy are advocates. Mariano Rajoy in Madrid was the latest. Yesterday the Spain’s new prime minister used his inaurgural speech to commit his country to austerity measures that, he said, was a "thankless task, like that endured by parents who struggle to feed a family of four with enough money for only two". But he also begged for the ECB to become the lender of last resort.

But Germany’s refusal is absolute. And so is the ECB’s. Yesterday Mario Draghi said: "The treaty forbids monetary financing," he said. "We want to act within treaty. Losing credibility for the central bank is not going to do any good to market confidence or euro design."

Is Germany really that heartless? In part the answer is yes: some economists reckon there is nothing - and no country - Merkel wouldn’t sacrifice on the altar of 2pc inflation in Germany.

But Open Europe reckons there’s a big financial hurdle too: the ECB has already intervened massively - through its bond buying programme and support for banks - and is now dangerously exposed to the sinner states already.

The think-tank’s report says: "Through its government bond buying and liquidity provision to banks, the ECB’s exposure to the PIIGS has now reached €705bn, up from €444bn in early summer. This is an increase of over 50pc in only six months and shows how, contrary to popular belief, the ECB is already intervening quite heavily in the markets."

The problem is with the banks as well as the sinner states. The ECB has made supporting Europe’s beleaguered banks one of its core policies. It’s opened its doors and lowered its collateral requirements.

In practice, banks are able to both borrow and dump low quality collateral in one go. Open Europe says "though not all of these assets are bad or ‘toxic’, they are extremely difficult to value." Sound familiar? As in the previous banking crisis, this is all well and good - as long as this is a liquidity not a solvency problem.

Politicians can't be sure, yet Sarkozy and Christian Noyer, the Governor of the Bank of France, have argued the banks should stock up on sovereign debt. Yesterday Draghi said the same. If the sovereign debt plunges, the banks will need more support; and the ECB will take on the risk. Open Europe said encouraging the banks to "load up on risky sovereign debt just to keep the eurozone ticking over in the short-term" could amount to a "spectacular own goal" by the ECB.

Of course central banks can in theory expand their balance sheets as much as they like. In practice, like everyone else, they have to maintain the confidence of the markets. And at this rate, as Open Europe says, "it remains unclear how the ECB would cover losses in the event of a sovereign default."

The ECB can only absorb so many losses before it has to either ask for more capital from member states or print more money - both of which would be politically impossible and damaging to the ECB’s standing.

Faced with these options, Draghi’s opposition for either a massive bond-buying programme or direct help for a eurozone state, will necessarily remain as staunch as Germany’s.

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European Governments Devise Unusual Measures to Prop Up Their Ailing Banks
by Sara Schaefer Muñoz, David Enrich and Patricia Kowsmann - Wall Street Journal

Just Don't Call It a 'Bailout'

Governments in Europe are tying themselves in knots to prop up their banks, desperate to blunt the cost and embarrassment of a fresh wave of taxpayer-funded bailouts.

In Italy, for example, the government is encouraging banks to buy public properties that the banks then can use to borrow money. As part of a broader deficit-reduction program in Portugal, the government essentially is borrowing money from bank pension funds and could use some of the funds to help state-owned companies repay bank loans.

Governments in Germany and Spain also are using unorthodox measures to support their ailing banks.

The unusual moves come as euro-zone countries are under growing pressure to reel in soaring borrowing costs by showing investors in government bonds that their budgets are under control. In addition, bank bailouts are politically toxic, especially for governments that have sought to reassure markets about the health of their banking systems.



Some economists say such moves aren't an adequate substitute for a broader rescue package that would include recapitalizing the lenders and helping them issue new debt. "Most of these backdoor-type schemes seem to be limited in size and don't address the broader problem," said Jacques Cailloux, chief European economist at Royal Bank of Scotland.

In some ways, the recent efforts are emblematic of what critics view as Europe's piecemeal crisis-fighting measures. In the past few years, individual governments in countries like Ireland, Germany and Spain have recapitalized their banks. The European Central Bank this week is making it easier for banks to borrow emergency funds, by offering three-year loans and accepting a wider range of collateral.

But there has been widespread resistance to adopting sweeping measures aimed at banks' deep underlying problems. Some of the recent European plans resemble the supplemental measures adopted by the U.S. at the height of its financial crisis.

In November 2008, the Federal Reserve launched the Term Asset-Backed Securities Loan Facility to resuscitate the securitization market and lending to consumers and small businesses. That was followed about four months later by the Public-Private Investment Program, designed to help rid banks of their troubled assets.

But those programs were sideshows to the U.S. government's sweeping recapitalization of hundreds of banks, both strong and ailing, which played a key role in restoring confidence in the industry. In Europe, no such program exists.

The Italian government has been among the most innovative at finding ways to help its banks conserve capital or come up with fresh funds. The country's five top banks were holding a total of €156 billion ($202.8 billion) of Italian government debt as of Sept. 30, and the plunging values of those bonds have raised concerns about the banks' viability. As a result, banks have struggled to borrow money from traditional sources, which are now wary of lending to the banks.

A provision tucked into the Italian government's budget law last month is designed to defuse some of those pressures. It allows the banks to use their government bonds to purchase army barracks, office buildings and other state-owned real estate that the government has been trying to sell.

The government would then lease the properties back from their new owners. And the banks can package the income-producing properties into asset-backed securities, which can be pledged as collateral with the ECB in exchange for loans, analysts say.

Italy's real-estate-for-sovereign-bonds maneuver also gives a boost to the government. Not only can it rid itself of unwanted properties, but the government also will be able to retire the bonds that banks use to purchase the real estate—thereby reducing Italy's heavy debt load.

In Germany, Commerzbank AG is in talks with the finance ministry to transfer part or all of its troubled real-estate finance unit Eurohypo into a government-owned "bad" bank. The bank and government are in talks about ways to structure the deal so it isn't considered a bailout, possibly by protecting the government against some losses or paying the government a nominal fee, according to people familiar with the matter.

That is an important stipulation. Commerzbank executives have repeatedly promised they won't take more taxpayer money, following a 2009 bailout that still has the bank 25%-owned by the government. But Commerzbank needs to come up with €5.3 billion in new capital by next summer in order to meet the demands of European regulators.

In Portugal, the government is planning an intricate financial maneuver that could give the country's banks some relief from the mountains of unpaid loans they hold from Portugal's state-owned companies. The state just closed a plan to transfer banks' future pension responsibilities to the state balance sheet in exchange for €6 billion in assets, which include cash, stocks and bonds. Most of the money will help the government meet deficit targets.

But about €2 billion may be shifted to struggling government-owned companies, such as transport providers. Under the plan, these companies would use the funds to pay off debts to Portugal's banks.

"The move will allow debt repayments to public entities, contributing to a cut in loan-to-deposit ratios of Portuguese banks and helping the financing of the economy," Finance Minister Vitor Gaspar told parliament recently.

In Spain, the government used €5.2 billion in funds from the country's deposit-guarantee plan to clean up nationalized lender Caja de Ahorros del Mediterraneo and broker its sale to Banco Sabadell SA earlier this month.

Instead of raising more money through a Spanish government bailout fund, a central-bank spokesman said that tapping the deposit-insurance plan would leave the country's budget goals this year intact. The deposit-guarantee fund will be refilled early next year, and the government will provide a back-stop in the meantime.

While a potential short-term solution, economists say such moves are a reflection of European governments' piecemeal approach to addressing deeper bank problems, such as low growth, problem assets and sovereign exposures. Governments "haven't been proactive and gotten on top of the situation," said Gerard Lyons, chief economist at Standard Chartered PLC.

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Bankruptcy tourists cross Irish Sea
by Jamie Smyth - FT

About 15 people turned out on a cold night at the Clarion Hotel in west Dublin last week to take part in an unusual business seminar. The attendees came from different parts of Ireland and had different backgrounds but they all had one thing in common: they were in debt and considering declaring bankruptcy in the UK.

"Most of the group had property portfolios and were sophisticated investors who just got caught out in Ireland’s property crash," says Steve Thatcher, director of IrishBankruptcyUK, a company aiming to tap into the growing trade of bankruptcy tourism from Ireland to the UK.

Ireland’s economic boom and bust, which led to a bail-out from the European Union and International Monetary Fund a year ago, has left households saddled with €185bn of debt. High unemployment and a 50-60 per cent fall in house prices, which has left up to 300,000 mortgage holders in negative equity, means tens of thousands of people have little hope of ever being able to pay back their loans.

But in Ireland, unlike in many western countries, bankruptcy is not an option for most people. Just 29 people were declared bankrupt last year and 17 in 2009. This compares to 135,089 bankruptcies in England and Wales, 20,329 in Scotland and 2,323 in Northern Ireland in 2010.

"It takes 12 years to be discharged from bankruptcy in Ireland compared to just one year in the UK. It is a no-brainer for people to relocate to the UK for a few months to free themselves of debts," says Mr Thatcher, who claims to be helping about 50 people through the UK insolvency system for a fee of a few thousand euros per client.

Successive Irish governments have been advised to reform Ireland’s punitive bankruptcy laws, which business leaders say inhibit the development of an entrepreneurial culture. The EU-IMF has made reform of the bankruptcy and personal debt regime a condition of its €85bn bail-out and set a deadline of next March to draw up new legislation.

Leaks from the Irish government suggesting the new law may set a three-year discharge period has prompted an intense lobbying campaign from banks and concern at the Central Bank of Ireland.

Matthew Elderfield, Ireland’s financial regulator, recently warned that too short a discharge period for people with mortgage debt could damage the banks, which have been recapitalised with €63bn in taxpayers’ money. "Any approach to restructuring needs to take account of the risk that it creates incentives for borrowers to cease meeting their obligations," he said.

But groups representing people in mortgage arrears say the banks will not begin writing off distressed mortgage debt until a bankruptcy regime is put in place. Many people are not waiting to see how, or whether, the government will act.

This month Sean Quinn, who three years ago was listed as Ireland’s richest man with a fortune of $6bn, declared bankruptcy in Northern Ireland, rather than in Ireland where he lives with his wife. By choosing Belfast over Dublin he should be discharged from bankruptcy within a year and he can hold on to his pension. Under the Irish bankruptcy regime pensions can be used to pay off creditors.

Mr Quinn’s bankruptcy was challenged in a Belfast court on Monday by Anglo Irish Bank, to which he owes more than €2bn.

John and Linda, who didn’t want to give their real names due to the stigma of bankruptcy in Ireland, declared bankruptcy in Wales to get rid of €300,000 mortgage debt on a house they bought at the peak of the boom in 2007.

In an interview with the Financial Times they said the most difficult part of the process was moving to Wales for several months to establish their main centre of interest in the country – a condition of UK bankruptcy law.

"My husband lost his job and we couldn’t keep up with the payments on our house. But we couldn’t sell it because it was worth only half our mortgage and the debt in Ireland would have followed us," said Linda.

The couple initially considered staying in Wales to make a new life. But they have since returned to Ireland where their house has been repossessed but they now live debt free. "It was the best thing we ever did," says Linda. "We don’t have the stress of the debts and even though we can’t get a bank account, it is not the end of the world."

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European Leaders Face Hurdles Over IMF Loan
by Costas Paris, Matina Stevis and Matthew Dalton - Wall Street Journal

European Union finance ministers held emergency talks on Monday in a bid to finalize a multibillion-euro loan to the International Monetary Fund and other steps to build a credible firewall around Italy and Spain, but continued political resistance means commitments are likely to fall short of expectations.

A target for a total contribution of €200 billion ($260 billion) in the form of additional bilateral loans to the IMF by the EU aren't likely to be reached, IMF and euro-zone officials said Monday, because the euro zone has to overcome objections to the deal from the U.K. as well as Germany's Bundesbank. Poorer Eastern European nations, such as the Czech Republic and Poland, have also expressed concerns that the deal is too expensive for them.

The teleconference of the 17 euro-zone finance ministers plus their 10 EU counterparts that don't use the euro focused on the details of the bilateral loans pledged to the IMF and the finalization of the permanent-rescue-fund treaty, the European Stability Mechanism, an EU official said.

A statement from the euro-zone governments after their Dec. 9 summit said the EU governments would provide "up to" €200 billion—with €150 billion from the euro zone—in bilateral loans to the IMF that could be used for lending to troubled euro-zone governments. They set Monday as a deadline for sorting out the technical details.

The additional IMF loans are a linchpin in the EU's latest plan to stave off a collapse of the euro zone, agreed to by a majority of EU nations at the Brussels summit earlier this month. The hastily called teleconference shows the urgency with which European leaders have to act and the hurdles they face.

"There will be an effort to get an agreement on the €150 billion committed by the euro zone but it's not certain it will happen today and it certainly looks like we'll fall short of the total €200 billion by all of the EU," said a senior IMF official with direct knowledge of the talks.

The 17 euro-zone governments may commit to move ahead with the bilateral loans to the IMF without the immediate support of the U.K., another euro-zone official said Monday. The U.K. didn't sign on to an agreement reached on Dec. 9 among the other 26 EU member states to commit to tougher fiscal rules. "The U.K. has a couple of formal problems," he said. "They think that the firewall that's been constructed is not fireproof enough."

EU governments must also overcome the resistance of the Bundesbank, Germany's powerful central bank. The Bundesbank is still in talks with the German government over IMF loans, and sees no urgency in that regard, a spokesperson for the Bundesbank said Monday.

Bundesbank President Jens Weidmann has signaled the central bank's willingness to contribute €45 billion in loans to the IMF, but only if other European and non-European countries such as the U.S. follow suit and the funds aren't specifically directed at Europe.

Facing re-election next year, U.S. President Barack Obama has already poured cold water on the IMF's largest contributor giving more taxpayer money to the IMF, saying Europe is rich enough to solve its own problems.

"If, for example, the U.S. and other important donors say they will not participate, then, from our viewpoint, it will be uncomfortably close to state financing," Mr. Weidmann said last week.

Euro-zone governments expected that a quarter of the €200 billion funds would come from EU members outside the euro zone, while they also urged other international contributors to consider additional lending. Countries that are currently under bailout programs and receiving IMF aid—Greece, Portugal and Ireland—weren't expected to contribute. But that could change, an EU official said Monday.

"Many questions about the €200 billion remain unanswered and the ministers will have to decide whether countries receiving financial assistance have to contribute," the EU official said. "If member states can't contribute then others may have to give more," he added.

A Greek government official didn't rule out a bilateral contribution by Greece to the IMF. "We have to wait and see what they [the finance ministers] say this afternoon," he said.

Irish Prime Minister Enda Kenny, however, has said his country wouldn't participate. An Irish official said on Monday that Dublin's position remains that program countries won't be contributing to the extra IMF funds.

So far, among EU members, only Denmark has made a clear commitment for contributing as much as €5.5 billion. Sweden has also signaled that it is ready to lend as much as 100 billion kronor ($14.3 billion) to support the fund's efforts to deal with the debt crisis in Europe, while among non-EU countries, only Russia has promised extra financial support of up to $20 billion.

The IMF official said there have been efforts to persuade London to make a minimum €30 billion loan to the Fund, but following Prime Minister David Cameron's move to veto an EU treaty change at the Dec. 9 Summit, that looks unlikely.

"The U.K. understands the need to give the IMF greater firepower, but it will consider a pledge at a different forum like the G-20. The politics behind a contribution that calls on the Bank of England to be part of a euro-zone member bailout are currently prohibitive," the euro-zone official said. "We all understood that by Mr. Cameron's stance at the last summit."

Euro-zone ministers will also discuss changes to the ESM treaty during the conference call, including the question of bringing the ESM forward into 2012 instead of July 2013, an EU official said.

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Draghi Says Break-Up Speculation 'Morbid'
by Margit Feher - Wall Street Journal

The existence of the euro zone is "irreversible" and speculation about its breakup is "morbid," European Central Bank President Mario Draghi said Monday.

"I have no doubt whatsoever about the strength of the euro, about its permanence and its irreversibility. The one currency is irreversible," Mr. Draghi said at his first hearing of the European Parliament's Committee on Economic and Monetary Affairs since he took the helm of the ECB Nov. 1. A break-up of the currency union would have extraordinary costs, he added.

The ECB welcomes the latest decisions by European Union heads of states and governments for sound and transparent fiscal rules, as the "new fiscal compact is an essential signal, showing a clear trajectory for the future evolution of the euro area," Mr. Draghi said. Expectations that the summit would be a silver bullet that solves all issues were unrealistic and the agreement was less appreciated by markets than it would deserve, he added.

The design of the fiscal compact should reassure markets but more needs to be done, Mr. Draghi added. European countries need progress in the economic governance of the deeper fiscal union. They need to implement structural measures throughout the region, as austerity in itself by a single country won't produce the desired results. Austerity produces short-term economic contraction but structural reforms ensure long-term sustainable growth, Mr. Draghi indicated.

The ECB embarked Dec. 8 on "major" liquidity-providing steps for banks in the euro-zone to prevent a recession, as its mandate prevents it from buying bonds to finance governments, Mr. Draghi said. The ECB aims to head off the possibility of an economic slowdown or even a recession next year by providing unlimited liquidity to euro-zone banks, which are facing a credit crunch.

"We have to ensure whatever it takes that we don't have a recession coming from the funding pressure," Mr. Draghi said. Banks are also facing a capital shortage because "the situation has changed profoundly," Mr. Draghi warned. Amid capital pressures, banks may reduce lending, and that would be the worst alternative, he said.

Banks will experience a difficult period of funding constraints in the first quarter of next year and probably throughout all of 2012, and the ECB "wants to avoid a further slowdown in economic growth and a possible recession," Mr. Draghi said. The ECB is trying "to do its best" to avoid a credit crunch stemming from the lack of funding, he added. Avoiding a funding crunch is all the more important, since worries about banks' liquidity could easily turn into fears over their solvency, he said.

Calls have been mounting for the ECB to act as a lender of last resort to crisis-hit euro-zone sovereign states. The ECB must boost financial stability without weakening its credibility, Mr. Draghi explained, as a reason for the ECB rejecting large-scale government bond purchases. The ECB's mandate is more restricted to maintaining price stability than that of the U.S. Federal Reserve, Mr. Draghi said.

The ECB has been buying government bonds on the secondary market but those purchases, which are neither eternal nor infinite, are one of its most powerful tools, Mr. Draghi reiterated. Whenever the ECB sees its monetary policy has been paralyzed it has to renew and conduct the bond purchases, Mr. Draghi said.

The ECB's monetary policy is accommodative and the liquidity measures, which also include the broadening of the collateral the ECB accepts for its unlimited loans to banks, are aimed at supporting the real economy, economic growth and job creation. "We have to act within the limits of the treaty," Mr. Draghi added, noting the ECB must protect its own balance sheet.

The price of government bonds reflect the stressed conditions but they also serve as a signal for governments to act, Mr. Draghi said.

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Americans ditch home ownership
by Richard Blackden - Telegraph

The switch by Americans from buying to renting homes since the financial crisis has been underlined by a surge in the construction of flats.

The development of multi-family units - a category made up of flats and townhouses - jumped 25.3pc last month to an annual rate of 238,000, the Commerce Department said on Tuesday. That helped drive overall construction on new homes up 9.3pc to an annual pace of 685,000, the strongest since the spring of 2010.

The better-than-expected figures were enough to cheer investors who have become accustomed to a flow of depressing news from the housing market since the bubble first burst in 2006. They also showed the degree to which the downturn is unwinding American homeownership, an objective of successive US governments since World War Two.

Ownership dropped to 66.9pc last year from a high of 70pc in 2005, and some are forecasting it will drop as low as 62pc as the hurdles to owning a home increase. "We expect the shift from owning to renting to persist for the next few years," said Michelle Meyer, an economist at Bank of America. She points to the prospect of further repossessions next year and the tougher criteria banks are now imposing on potential borrowers.

Thanks to the increase in activity, economists now expect residential investment to make a positive contribution to US growth this quarter for the first time since the crisis.

However, its impact is likely to be muted because the sector now accounts for less than 3pc of America's gross domestic product. And concern over the prospects for the housing market in 2012 were echoed in Tuesday's figures on the construction of new single-family homes.

Accounting for two-thirds of the market, they rose at a much more modest 2.3pc to an annual pace of 447,000. "Housing continues to bump along the bottom, facing a lingering overhang of supply and downard price pressure," said Lindsey Piegza, an economist in New York at FTN Financial.

November's annualised rate of construction on 685,000 new homes remains less than a third of the peak of 2.27m that was reached in January 2006. Should US consumer spending slow next year, efforts to quicken a revival in the housing market are likely to come onto the political agenda. With interest rates already at a record low level, the Federal Reserve has in recent weeks signalled that Congress and The White House should consider doing more.

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