Mish's Global Economic Trend Analysis

German Parliament Expected To Hold Full Vote on EFSF; Incomplete Step in Right Direction
Spain Slips on Deficit, Will "Never Make Deficit Targets", Nor Will Portugal; Firepower Insufficient
EU Weighs Insurance, SPIV Leverage, Needs Rating Agencies to Go Along; German-French Spread at New Record High 1.20%; Fear "of" Reaching a Deal
Recapitalization Agreement Set at 108 Billion Euros; Krugman Argues for ECB Printing; Contagion Spreads to Insurance Sector

German Parliament Expected To Hold Full Vote on EFSF; Incomplete Step in Right Direction

Posted: 24 Oct 2011 09:23 PM PDT

Der Spiegel reports German Parliament Expected To Hold Full Vote on EFSF

The German parliament is expected to hold a full vote on Wednesday on proposals to leverage the euro-zone rescue fund, contrary to earlier plans to confine the vote to its budget committee, SPIEGEL ONLINE has learned from sources in Chancellor Angela Merkel's conservative Christian Democratic Union (CDU).

At issue is the need to boost the impact of the €440 billion rescue fund, or European Financial Stability Facility (EFSF). There is concern that the current size of the (recently expanded) fund isn't sufficient should additional countries, particularly Spain and Italy, be infected with debt contagion. The fund is also designed to indirectly prop up European banks, which could also become expensive if European leaders this week agree to an even greater haircut on Greek debt. Up to 60 percent is currently under consideration.

The news raises the stakes even further for Merkel, who struggled to contain a rebellion in her ranks against the initial expansion of the EFSF in a parliamentary vote on Sept. 29, before the leverage plans took shape. Indeed, one of the strategies she pursued in putting down that rebellion was discounting speculation that the fund would be leveraged.

It is unclear when the proposed guidelines for the EFSF will become available for lawmakers to review -- it is possible that a new version will arrive from Brussels on Monday evening.

Incomplete Step in Right Direction

The proposal is a step, but a severely incomplete step in the right direction. The German supreme court has ruled that no more German taxpayer funds can be out at risk without a common referendum.

Please see Germany's Top Judge Throws Major Monkey Wrench Into Leveraged EFSF Machinery, Demands New Constitution and Popular Referendum for Further Powers for details.

Merkel wants to ram through a package outside parliament. It is clear that parliament needs to act, but it goes far beyond that. A leveraged EFSF puts more German taxpayer funds at risk and does so sooner.

This vote should not go to the Bundestag, but rather to German taxpayers. We know the score in advance on the latter. Leveraged mechanisms would not pass.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Spain Slips on Deficit, Will "Never Make Deficit Targets", Nor Will Portugal; Firepower Insufficient

Posted: 24 Oct 2011 05:17 PM PDT

While the debate over Greek haircuts still lingers on, Spain Slipping on Deficit Means Chances of Contagion Increase

Spain will struggle to meet its deficit-reduction target this year as economic growth slows, threatening further debt-crisis contagion as Europe fails to erect a fail-proof firewall.

"They will never make it," said Ludovic Subran, chief economist at credit insurer Euler Hermes SA in Paris. "Our September forecast sees Spain's deficit at 7 percent" of gross domestic product this year, he said, adding that the prediction was made before the nation's credit rating was cut this month.

Spain's region of Castilla-La Mancha was cut five levels to junk on Oct. 20 by Moody's, which also downgraded nine other regions on "growing liquidity pressures" and difficulties "reining in their cost base." It'll be "very difficult" for the 17 regions to reach their 2011 deficit goal of 1.3 percent, opposition leader Mariano Rajoy said on Cope radio yesterday.

"There is insufficient firepower to meet all the potential liquidity needs," David Mackie, chief European economist at JPMorgan Chase & Co., said of the proposed EFSF enhancements in an Oct. 18 note to investors.

Firepower Insufficient

Reader Ernst is tired of the "overused" term "firepower" and threatens to scream if main stream reporting uses the term anymore.

No doubt Ernst is screaming right now on the usage by Bloomberg and me repeating it.

Inquiring minds can find 379,000 usages of "EFSF Firepower".

Yet the idiocy of it all is that increased "firepower" will do nothing but make matters worse. Please see EU Weighs Insurance, SPIV Leverage, Needs Rating Agencies to Go Along; German-French Spread at New Record High 1.20%; Fear "of" Reaching a Deal for further discussion of the hopelessness of increased "firepower"

Spain 10-Year Government Bond Yield

Portugal 10-Year Government Bond Yield

It should be clear to everyone that Portugal will be the next country to blow. It is equally clear there is insufficient "firepower" to save Portugal, Spain, and Italy.

Don't scream too loud Ernst. Usage will drop of as soon as the EU clowns come up with their non-solution in a few days. Unfortunately, when the "firepower" proves insufficient, expect Krugman and others with non-solutions to chant "I told you so".

Please see Recapitalization Agreement Set at 108 Billion Euros; Krugman Argues for ECB Printing; Contagion Spreads to Insurance Sector for more on Krugman's preposterous proposal to fix this mess via ECB printing.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

EU Weighs Insurance, SPIV Leverage, Needs Rating Agencies to Go Along; German-French Spread at New Record High 1.20%; Fear "of" Reaching a Deal

Posted: 24 Oct 2011 09:59 AM PDT

Once again the bond market flashes huge warning signals even as equity prices head North. This will resolve in a major way, and the bond market is likely right.

Meanwhile the EU still looks to increase the firepower of the EFSF and that leverage is one of the things weighing on the bond market. In the latest absurd proposal, the EU may combine insurance, SPIV to boost euro fund

The euro zone should combine two proposals for increasing the firepower of its rescue fund -- an insurance model and a special purpose investment vehicle (SPIV) -- according to an EU paper for the mid-week summit obtained by Reuters on Monday.

The paper said neither option would require politically-difficult changes to the existing European Financial Stability Facility (EFSF), which has been approved by national parliaments after some problematic debates.

The euro zone wants to boost the firepower of its 440 billion euro bailout fund without putting more money into it.

Under the credit enhancement or insurance model, the EFSF could boost market confidence in new debt issued by a struggling member state by guaranteeing an unspecified proportion of the losses that could be incurred in the event of a default.

This would work via the EFSF extending a loan to a member state, which would buy EFSF bonds in return. The bonds would be the collateral for a partial protection certificate to be held in trust for the state. Both the bond and the certificate would be freely tradable, according to the paper.

Under the SPIV scheme, one or more vehicles would be set up either centrally or in a beneficiary member state to invest in sovereign bonds in the primary and secondary markets.

Its structure -- the senior debt instrument could be credit rated and targeted at traditional fixed income investors -- is meant to attract international public and private investors, according to the paper.

"The SPIV ... would aim to create additional liquidity and market capacity to extend loans, for bank recapitalization via a member state and for buying bonds in the primary and secondary market with the intention of reducing member states' cost of issuance," the paper said.

The paper said the insurance option would not work for every member state because some are no longer on the primary market, and also because some have negative pledge clauses on existing debt, which prevent them from granting new security to creditors without granting existing creditors the same level of security.

It concluded that "the leverage which can be achieved can only be determined after dialogue with investors and rating agencies.

Can't Get Something For Nothing

Every proposal to date wants to get something for nothing. France wants to print money and so does Krugman. The monetary printing non-solution would violate the Maastricht Treaty.

The insurance scheme and the SPIV scheme cause one or more of the following four problem.

Increase losses beyond the size of the EFSF fund
Create complex bonds investors will shun,
Cost the EFSF its AAA rating
Cost France its AAA rating

Nonetheless the EU is hell-bent on increasing the firepower.

Fear of Reaching a Catastrophic Deal

Wolfgang Münchau writing for the Financial Times says Europe is now leveraging for a catastrophe

It is time to prepare for the unthinkable: there is now a significant probability the euro will not survive in its current form. This is not because I am predicting the failure by European leaders to agree a deal. In fact, I believe they will. My concern is not about failure to agree, but the consequences of an agreement.

A leveraged EFSF is attractive to politicians for the same reason that subprime mortgages once appeared attractive to borrowers. Leverage can have different economic functions, but in these cases it simply disguises a lack of money. The idea is to turn the EFSF into a monoline insurer for sovereign bonds. It is worth recalling that the role of those monolines during the bubble was to insure toxic credit products. They ended up as a crisis amplifier.

Leveraging also massively increases the probability of a loss for the triple A-rated member states, who ultimately provide the insurance. If a recipient of the guarantee were to impose a relatively small haircut – say 20 per cent – the EFSF and its guarantors would take the entire hit. Under current arrangements, they would only lose their share of the haircut.

The way eurozone leaders have been handling the crisis ultimately vindicates the German constitutional court's conservatism in its definition of what constitutes a functioning democracy. Policy co-ordination among heads of state is both undemocratic and ineffective. A monetary union may require more than just a eurobond and a small fiscal union. It may require a formal, if partial, transfer of sovereignty to the centre – that includes the rights to levy certain taxes, impose regulation in product, labour and financial markets, and to set fiscal rules for member states.

Under normal circumstances, European electorates would not accept such a massive transfer of sovereignty. I would not completely exclude the possibility that they might accept it if the alternative was a breakdown of the euro. Even then, I would not bet on such an outcome. Current policy is leading us straight towards this bifurcation point, which may only be a few weeks or months away.

Eurozone Government Bonds

Italy 10-Year Government Bonds - 5.95%
Spain 10-Year Government Bonds - 5.55%
Portugal 10-Year Government Bonds - 12.38%
France 10-Year Government Bonds - 3.32%
Germany 10-Year Government Bonds - 2.12%

The spread widened between every country and Germany. The French-German spread is at a new record high 1.20%, reflective of the likely use of a leveraged EFSF.

You can't get something for nothing, no matter what the fools at the EU summit think.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Recapitalization Agreement Set at 108 Billion Euros; Krugman Argues for ECB Printing; Contagion Spreads to Insurance Sector

Posted: 24 Oct 2011 12:39 AM PDT

True to his form, Paul Krugman does not understand the difference between problems and solutions in Europe any more than he does in the US.

In Deck Chairs, Titanic Krugman states ...

OK, yes, European banks do need more capital. But their problems are a symptom of the underlying sovereign debt problem, which can only be resolved, if at all, with ECB lending AND a commitment to reflate. Without that, the losses on sovereign debt will blow right through any amount of newly raised bank capital.

The housing bubble came from the Fed's unwillingness to let the recession of 2001 play out to its normal end. Europe is in a bigger mess today because of foolish attempts to prevent Greece from defaulting.

In both cases, the proper solution is to let banks fail. Bondholders will take a hit, but so what? The world will not end when it isn't.

Printing Money Will Not Solve the Crisis

Bundesbank president Jens Weidmann disagrees with Krugman in an interview with the Bild stating Rescue Packages Will Not Solve the Crisis

Weidmann: Increased leverage increases the risk.

Bild: French President Sarkozy wants the EFSF to furnish a bank license, so as to have unlimited resources.

Weidmann: That would be a state financing by printing money and thus in my view a fatal way. It is forbidden for good reasons by the EU treaties. I am pleased that the federal government sees it the same way.

The 60-40 Violent Dispute

The Financial Times Deutschland discusses the Violent Dispute Over Haircut Percentages.

The euro countries and the banks have provided the EU crisis summit on Sunday a violent dispute over the amount of the debt waiver, you want to accept the services in Greece. According to FTD information provided bank representatives a loss of 40 percent, while the governments of the monetary union in the evening called for a cut of 60 percent debt.

The real difference between the two proposals is even greater, because the banks want to stretch the loss in the long term, while EU negotiators at a meeting with the Banking Association IIF on the edge of the summit demanded an immediate depreciation. The bank claims were "a joke", said a €-group representatives.

Contagion to Insurance Sector

The Financial Times Deutschland reports German watchdog Bafin fears contagion to insurance sector

The supervisory authority BaFin has asked the major insurers operating in Germany to disclose tell the exact amount of their deposits with banks. Companies must quantify all forms of investment in financial institutions as well as specify whether it is secured or unsecured loans. The papers include collateralized mortgage bonds.

A survey was conducted by BaFin in the spring showed the ten largest insurance companies have invested up to 55 percent of their deposits with banks. Rolf Wenzel, Assistant Secretary, Federal Ministry of Finance said "there is a risk of contagion".

The above links from the Euro Intelligence article Towards another agreement that won't solve the crisis.

Here is a snip of their "half-time" report.

This is the half-term report of this marathon summit, which will run until Wednesday. Of the three main issues under discussion, agreement has been reached over the recapitalisation of banks, which is going to be around €108bn. Germany has refused demands by southern European countries that this should be funded by the EFSF, insisting that it should only come in as a last resort (that means we are back to the contagion between sovereign and the banking sectors in countries where this matters the most. The continued lack of a European solution, and the continuation of the policy that member states backstop their domestic banking sector means that one of the largest crisis propagators has been strengthened.)

There has been little progress on the Greek haircut. See more on this story below. On the EFSF, the number of options have boiled down to two – the much discussed Achleitner first-loss insurance option, and an SPV that could draw in foreign money (a monoline insurance plus a CDO – the two most toxic instruments of the credit bubble). The summit definitely rejected the French proposal to turn the EFSF into a bank, and Nicolas Sarkozy announced a tactical retreat from his demand (which means that he will make again at some point). Technical discussions are now going on today and tomorrow to sort out the remaining issues, especially the Greek haircut and the precise structures of those EFSF/IMF vehicles. Complex financial instrument are complex for good reason. The devil is in the small print. A final agreement is expected when the summit resumes Wednesday.

Full Speed Ahead to Nowhere

So far the only agreement that makes any sense is the victory of Merkel over Sarkozy regarding turning the EFSF into a bank. Unfortunately, Sarkozy has not given up on that point, he has only taken a "tactical" retreat.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Home Refinance Calculator

Monday, October 24, 2011

Mish's Global Economic Trend Analysis

Mish's Global Economic Trend Analysis

No comments:

Post a Comment