Best of the Week
Most Popular
1. Stock Markets and the History Chart of the End of the World (With Presidential Cycles) - 28th Aug 20
2.Google, Apple, Amazon, Facebook... AI Tech Stocks Buying Levels and Valuations Q3 2020 - 31st Aug 20
3.The Inflation Mega-trend is Going Hyper! - 11th Sep 20
4.Is this the End of Capitalism? - 13th Sep 20
5.What's Driving Gold, Silver and What's Next? - 3rd Sep 20
6.QE4EVER! - 9th Sep 20
7.Gold Price Trend Forecast Analysis - Part1 - 7th Sep 20
8.The Fed May “Cause” The Next Stock Market Crash - 3rd Sep 20
9.Bitcoin Price Crash - You Will be Suprised What Happens Next - 7th Sep 20
10.NVIDIA Stock Price Soars on RTX 3000 Cornering the GPU Market for next 2 years! - 3rd Sep 20
Last 7 days
Gold Price Setting Up Just Like Before COVID-19 Breakdown – Get Ready! - 27th Sep 20
UK Coronavirus 2nd Wave SuperMarkets Panic Buying 2.0 Toilet Paper , Hand Sanitisers, Wipes... - 27th Sep 20
Gold, Dollar and Rates: A Correlated Story - 27th Sep 20
WARNING RTX 3080 AIB FLAWED Card's, Cheap Capacitor Arrays Prone to Failing Under Load! - 27th Sep 20
Boris Johnson Hits Coronavirus Panic Button Again, UK Accelerting Covid-19 Second Wave - 25th Sep 20
Precious Metals Trading Range Doing It’s Job to Confound Bulls and Bears Alike - 25th Sep 20
Gold and Silver Are Still Locked and Loaded… Don't be Out of Ammo - 25th Sep 20
Throwing the golden baby out with the covid bath water - Gold Wins - 25th Sep 20
A Look at the Perilous Psychology of Financial Market Bubbles - 25th Sep 20
Corona Strikes Back In Europe. Will It Boost Gold? - 25th Sep 20
How to Boost the Value of Your Home - 25th Sep 20
Key Time For Stock Markets: Bears Step Up or V-Shaped Bounce - 24th Sep 20
Five ways to recover the day after a good workout - 24th Sep 20
Global Stock Markets Break Hard To The Downside – Watch Support Levels - 23rd Sep 20
Beware of These Faulty “Inflation Protected” Investments - 23rd Sep 20
What’s Behind Dollar USDX Breakout? - 23rd Sep 20
Still More Room To Stock Market Downside In The Coming Weeks - 23rd Sep 20
Platinum And Palladium Set To Surge As Gold Breaks Higher - 23rd Sep 20
Key Gold Ratios to Other Markets - 23rd Sep 20
Watch Before Upgrading / Buying RTX 3000, RDNA2 - CPU vs GPU Bottlenecks - 23rd Sep 20
Online Elliott Wave Markets Trading Course Worth $129 for FREE! - 22nd Sep 20
Gold Price Overboughtness Risk - 22nd Sep 20
Central Banking Cartel Promises ZIRP Until at Least 2023 - 22nd Sep 20
Stock Market Correction Approaching Initial Objective - 22nd Sep 20
Silver Bulls Will Be Handsomely Rewarded - 21st Sep 20
Fed Will Not Hike Rates For Years. Gold Should Like It - 21st Sep 20
US Financial Market Forecasts and Elliott Wave Analysis Resources - 21st Sep 20
How to Avoid Currency Exchange Risk during COVID - 21st Sep 20
Crude Oil – A Slight Move Higher Has Not Reversed The Bearish Trend - 20th Sep 20
Do This Instead Of Trying To Find The “Next Amazon” - 20th Sep 20
5 Significant Benefits of the MT4 Trading Platform for Forex Traders - 20th Sep 20
A Warning of Economic Collapse - 20th Sep 20
The Connection Between Stocks and the Economy is not What Most Investors Think - 19th Sep 20
A Virus So Deadly, The Government Has to Test You to See If You Have It - 19th Sep 20
Will Lagarde and Mnuchin Push Gold Higher? - 19th Sep 20
RTX 3080 Mania, Ebay Scalpers Crazy Prices £62,000 Trollers Insane Bids for a £649 GPU! - 19th Sep 20
A Greater Economic Depression For The 21st Century - 19th Sep 20
The United Floor in Stocks - 19th Sep 20
Mobile Gaming Market Trends And The Expected Future Developments - 19th Sep 20
The S&P 500 appears ready to correct, and that is a good thing - 18th Sep 20
It’s Go Time for Gold Price! Next Stop $2,250 - 18th Sep 20
Forget AMD RDNA2 and Buy Nvidia RTX 3080 FE GPU's NOW Before Price - 18th Sep 20
Best Back to School / University Black Face Masks Quick and Easy from Amazon - 18th Sep 20
3 Types of Loans to Buy an Existing Business - 18th Sep 20
How to tell Budgie Gender, Male or Female Sex for Young and Mature Parakeets - 18th Sep 20
Fasten Your Seatbelts Stock Market Make Or Break – Big Trends Ahead - 17th Sep 20
Peak Financialism And Post-Capitalist Economics - 17th Sep 20
Challenges of Working from Home - 17th Sep 20
Sheffield Heading for Coronavirus Lockdown as Covid Deaths Pass 432 - 17th Sep 20
What Does this Valuable Gold Miners Indicator Say Now? - 16th Sep 20
President Trump and Crimes Against Humanity - 16th Sep 20
Slow Economic Recovery from CoronaVirus Unlikely to Impede Strong Demand for Metals - 16th Sep 20
Why the Knives Are Out for Trump’s Fed Critic Judy Shelton - 16th Sep 20
Operation Moonshot: Get Ready for Millions of New COVAIDS Positives in the UK! - 16th Sep 20
Stock Market Approaching Correction Objective - 15th Sep 20
Look at This Big Reminder of Dot.com Stock Market Mania - 15th Sep 20
Three Key Principles for Successful Disruption Investors - 15th Sep 20
Billionaire Hedge Fund Manager Warns of 10% Inflation - 15th Sep 20
Gold Price Reaches $2,000 Amid Dollar Depreciation - 15th Sep 20
GLD, IAU Big Gold ETF Buying MIA - 14th Sep 20
Why Bill Gates Is Betting Millions on Synthetic Biology - 14th Sep 20
Stock Market SPY Expectations For The Rest Of September - 14th Sep 20
Gold Price Gann Angle Update - 14th Sep 20
Stock Market Recovery from the Sharp Correction Goes On - 14th Sep 20
Is this the End of Capitalism? - 13th Sep 20
The Silver Big Prize - 13th Sep 20
U.S. Shares Plunged. Is Gold Next? - 13th Sep 20
Why Are 7,500 Oil Barrels Floating on this London Lake? - 13th Sep 20
Sheffield 432 Covid-19 Deaths, Last City Centre Shop Before Next Lockdown - 13th Sep 20
Biden or Trump Will Keep The Money Spigots Open - 13th Sep 20
Gold And Silver Up, Down, Sideways, Up - 13th Sep 20

Market Oracle FREE Newsletter

How to Get Rich Investing in Stocks by Riding the Electron Wave

Europe is Headed For a Mini Economic Depression

Economics / Euro-Zone Jun 05, 2010 - 05:34 PM GMT

By: Mike_Whitney

Economics

Best Financial Markets Analysis ArticleDespite a nearly-$1 trillion rescue operation, financial conditions in the eurozone continue to deteriorate.  All the gauges of market stress are edging upwards and credit default swaps (CDS) spreads have widened to levels not seen since the weekend of the emergency euro-summit.


Libor is on the rise and liquidity is draining from the commercial paper (CP) and money markets.  According to the Federal Reserve, the total amount of (foreign banks) CP has shrunk 15 percent or $32 billion since late April.  Central bank officials insist that there's no chance of another Lehman-type meltdown, but their actions don't match their words. Apart from the massive $920 billion EU Stabilization Fund, the ECB has beefed-up its liquidity facilities and is aggressively purchasing state bonds from struggling countries in the south. Without the ECB's assistance,  the slow-motion slide into recession could turn into a full-blown market crash. Brussels has every reason to be worried. 

From the Wall Street Journal:

"In the latest indication that European banks are in ill health, the European Central Bank warned late Monday that euro-zone banks face €195 billion ($239.26 billion) in write-downs this year and the next due to an economic outlook that remained "clouded by uncertainty....Europe's intertwined banking system remains stressed. Investors have hammered the sector, banks are stashing near-record amounts of deposits at the ECB—€305 billion as of Friday—instead of lending the funds to other institutions, risk-wary U.S. financial institutions are reducing their exposure to euro-zone banks." ("ECB Warns Write-Downs Could Reach $239 Billion" David Enrich and Stephen Fidler, Wall Street Journal)

German and French banks have vast exposure to public and private debt in Club Med countries; Spain, Greece, Portugal and Italy. When those countries finances begin to teeter, it's harder for the banks to exchange assets in the repo market where they get the bulk of their funding. They are forced to take a "haircut" on the value of their collateral which erodes their capital cushion and pushes them closer to default. This is what happened in the US  when the French Bank Paribas started listing in late 2007.   PIMCO's Paul McCulley explains the origins of the financial crisis in a speech he gave at the Fed’s annual symposium in Jackson Hole. Here's an excerpt:

  "If you have to pick a day for the Minsky Moment, it was August 9. And, actually, it didn’t happen here in the United States. It happened in France, when Paribas Bank (BNP) said that it could not value the toxic mortgage assets in three of its off-balance sheet vehicles, and that, therefore, the liability holders, who thought they could get out at any time, were frozen. I remember the day like my son’s birthday. And that happens every year. Because the unraveling started on that day. In fact, it was later that month that I actually coined the term "Shadow Banking System".... 

  ..."What’s going on is really simple. We’re having a run on the Shadow Banking System and the only question is how intensely it will self-feed as its assets and liabilities are put back onto the balance sheet of the conventional banking system."....It was pretty much an orderly run up until September 15, 2008. (Lehman Bros default) And it was orderly primarily because the Fed...evoked Section 13-3 of the Federal Reserve Act in March of 2008 in order to facilitate the merger of under-a-run Bear Stearns into JPMorgan. Concurrently, the Fed opened its balance sheet to the biggest shadow banks of all, the investment banks that were primary dealers, including most important, the big five. It was called the Primary Dealer Credit Facility." ("McCulley: After the Crisis, Planning a New Financial Structure", Credit Writedowns)

So when Paribas made its announcement on August 9, the collateral (mainly mortgage-backed securities) that the banks had been using in exchange for funding in the repo market, was called into question. No one really knew what MBS were worth, because many were comprised of subprime loans that would never be repaid. Thus, repo transactions slowed to a crawl, interbank lending collapsed, libor spiked to record highs, and the banking system suffered a major heart attack.

Now it's Europe's turn. But don't expect a repeat of the Fed's strategy.  The member states won't allow the ECB to dictate policy without deliberation.  Germany has already forbidden quantitative easing (QE) unless the funds that are used to purchase state bonds are sterilized, that is, unless the ECB soaks up the extra liquidity via some other offsetting transaction.

Officials with the Bundesbank say that  ECB head Jean Claude Trichet has launched a "stealth bailout" of the eurozone banks holding Greek debt.  The facts appear to support the claims. Greece has already received the $135 billion bailout, enough to meet its funding needs until 2012. But the ECB has purchased an additional $25 billion in Greek debt in the last three weeks. That means the debt must have been purchased from French or German banks. It looks like Trichet is trying to pull a fast-one on Germany by secretly diverting money to underwater banks. 

From the Wall Street Journal:

"ECB critics within the Bundesbank say the price of Greek bonds is now largely irrelevant to Athens, making the main beneficiaries of the bond purchases the banks that hold much of Greece's roughly €300 billion in outstanding debt."..."We haven't gone beyond our goal of re-establishing a more correct transmission mechanism of our monetary policy," said Mr. Trichet......"In simple words: We are not printing money." ("Bundesbank Attacks ECB Bond-Buying Plan",  David Crawford Brian Blackstone, Wall Street Journal)

German officials haven't been fooled by the hype surrounding quantitative easing. In a recent interview in Der Spiegel,  Bundesbank chief Karl Otto Pöhl summed up the ECB's efforts like this:


  "It was about protecting German banks, but especially the French banks, from debt write-offs. On the day that the rescue package was agreed on, shares of French banks rose by up to 24 percent. Looking at that, you can see what this was really about -- namely, rescuing the banks and the rich Greeks."

This is a banking crisis not a sovereign debt crisis. Bank funding is getting more expensive because shadow banks are not willing to pay as much for collateral that looks dodgy. The problem is particular to the repo system, where the demand for triple A collateral creates a powerful incentive for ratings inflation. High ratings lead to mispriced risk and credit excesses. When the bubble finally bursts, assets prices plunge leaving balance sheets deep in the red. If the banks had done their jobs and performed due diligence, they would have seen that Greece was headed for trouble and their bonds were a bad investment.  But they purchased the debt anyway, to boost leverage and to increase short-term profitability. Now the downgrades are coming fast and furious, and the "run" on the shadow banking system is gaining momentum. Eventually, Greece will have to restructure its debt and the losses will push banks in France and Germany into default. Equity and bondholders will be wiped out or suffer big losses.

The amount of money at stake is humongous, certainly enough to trigger another banking crisis or mini-depression. Here's an excerpt from the Wall Street Journal:

"All told, more than €2 trillion of public and private debt from Greece, Spain and Portugal is sitting on the balance sheets of financial institutions outside the three countries, according to a Royal Bank of Scotland report last week. Investors, bankers and government officials are worried that as that debt loses value, banks across Europe could be saddled with losses.

"Make no mistake: This is big," said Jacques Cailloux, RBS's chief European economist and the report's author. "We're talking about systemic risk [and] the potential for contagion." ("ECB Warns Write-Downs Could Reach $239 Billion" David Enrich and Stephen Fidler, Wall Street Journal)

EU banks are over-leveraged, under-capitalized, and too exposed to emerging market debt. In the next 12 months, they'll have to roll over more than $400 billion in loans in a market where funding is scarce and liquidity is drying up. The ECB should present a plan for restructuring Greek debt now instead of trying to keep the bubble afloat and hoping for a miracle. 

The run on the shadow system is forcing more banks to seek funding from the ECB. The central bank has loaned out more than $850 billion and that figure is expected to rise. The ECB's balance sheet is proof that the wholesale funding system is broken and needs basic structural change. The EU is moving forward with a raft of regulatory reforms on everything from hedge funds to naked shorts, from corporate governance to a financial transaction tax, from tighter oversight on CDS to revamping the ratings agencies. So far, however, the shadow banking system has escaped their attention, which is unfortunate. The system is inherently unstable and will lead to more serious crises in the future. Financial institutions that act as banks (investment banks, hedge funds, insurers) must be regulated as banks, that's the bottom line. The dangers of maximizing leverage and unsupervised credit expansion, should be clear to everyone by now.

By Mike Whitney

Email: fergiewhitney@msn.com

Mike is a well respected freelance writer living in Washington state, interested in politics and economics from a libertarian perspective.

© 2010 Copyright Mike Whitney - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

Mike Whitney Archive

© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules