The Lone Bulwark of Monetary Rectitude Against the Rest of the World

Over recent days and weeks, the pressure on Germany and the ECB to 'do something' – which is to say, to crank up the printing press – has continually increased. For example, Ireland's Taoiseach Enda Kenny (the Irish use the old Gaelic term for 'chieftain' to identify their prime minister, which is an endearing tradition) is said to have 'clashed' with German chancellor Angela Merkel and her finance minister Wolfgang Schäuble over this point at a recent visit.

According to the Irish Independent:

“Mr Kenny said the European Central Bank should be the lender of last resort in a bid to resolve the debt crisis, clashing with Mr Schaeuble in the process.

Earlier he disagreed with Ms Merkel who said the treaty should be changed so countries not abiding by stability and growth rules could be fined.

The Taoiseach made the suggestion about the ECB at a discussion at the Konrad Adenauer Foundation in Berlin but Mr Schaueble knocked it on the head, unsurprisingly.  Officials from that country have ruled out such a move despite growing pressure on the German bank to play a bigger role in solving the debt crisis.

"The ECB should be the ultimate firepower," Mr. Kenny said. "I know the chancellor disagrees with this … but what we've been concerned about is contagion" – a reference to the growing number of eurozone countries that are having to pay increasingly higher rates of interest to borrow on open markets including France and Spain.

"A US Federal Reserve model will not work" in the eurozone,” Mr Schaeuble said. Earlier the Taoiseach said he had had "frank" discussions with Ms Merkel and admitted that any changes to the treaty would be "challenging".

He also said countries should use existing schemes to deal with the debt crisis clashing with Ms Merkel’s more radical plans for treaty changes that would include reviews of national budgets, although some flexibility for individual country strategies.

“We need to deal with the crisis with the tools we have now,” he said, speaking at a joint press conference in Berlin after their meeting. “I don’t want to get into a position where you have major a major competency change that would open the door to many countries wanting treaty change from their own point of view.  “That would be a long situation.”

But Ms Merkel pointed out that counties which breach the stability and growth pact rules, governing their budget deficits, should be punished and that Berlin would push for such proposals.

“We are of the opinion that member states should be able to be taken before the European Court (of Justice) for not adhering to the terms of the Stability and Growth Pact,” she said. “This is possible for all other EU legislation but not for the stability and growth pact.”

We admit the Taoiseach has a point when he notes that the rather more ambitious German plans for closer European integration and a massive loss of fiscal subsidiarity are, even if ultimately agreed upon, not very useful for tackling the crisis in the here and now. Moreover, we guess that Kenny is highly suspicious of these proposals. After all, Ireland is a great example for tax and regulatory competition in the EU and the emerald isle would likely be forced to abandon its competitive tax rates if the EU's centralizers had anything to say about it. We admire the German intransigence on the money printing question, but the centralization idea must be vehemently rejected.

In any case, the Taoiseach didn't get what he wanted – the Germans not surprisingly remained implacable regarding altering the ECB's approach.

Then yesterday, we heard from Reuters that 'France and Germany clash over ECB crisis role'. Evidently yet another emissary came to beseech the Teutonic hard money  encampment on the shores of the river Main.

France and Germany, Europe's two central powers, clashed on Wednesday over whether the European Central Bank should intervene more forcefully to halt the euro zone's accelerating debt crisis after modest bond purchases failed to calm markets.

Facing rising borrowing costs as its 'AAA' credit rating comes under threat, France urged stronger ECB action, adding to mounting global pressure spelled out by U.S. President Barack Obama.

Bond market turmoil is spreading across Europe. Italian 10-year bond yields have risen above 6,6 percent, unaffordable in the long term. Yields on bonds issued by France, the Netherlands and Austria — which along with Germany form the core of the euro zone — have also climbed.

"The ECB's role is to ensure the stability of the euro, but also the financial stability of Europe. We trust that the ECB will take the necessary measures to ensure financial stability in Europe," government spokeswoman Valerie Pecresse said after a cabinet meeting in Paris.

French Finance Minister Francois Baroin repeated Paris's view that the euro zone's EFSF bailout fund should have a banking license, something Berlin opposes. Such a move would allow the fund to borrow from the ECB, giving it extra firepower to fight the spreading crisis.

"The position of France … is that the way to prevent contagion is for the EFSF to have a banking license," Baroin said on the sidelines of an awards ceremony.

But German Chancellor Angela Merkel made clear Berlin would resist pressure for the central bank to take a bigger role in resolving the debt crisis, saying European Union rules prohibited such action.

"The way we see the treaties, the ECB doesn't have the possibility of solving these problems," she said after talks with visiting Irish Prime Minister Enda Kenny.

The only way to recover markets' confidence was to implement agreed economic reforms and build a closer European political union by changing the EU treaty, Merkel said.

ECB policymakers continue to reject international calls to intervene decisively as Europe's lender of last resort, stressing that it is up to governments to resolve the debt crisis through austerity measures and reforms.

However, many analysts believe such a move now represents the only way to stem the contagion, despite the potential risk of inflation from printing money.”


(emphasis added)

In other words, it is believed by just about everyone outside of Germany that the expedient of money printing is now urgently called for, as otherwise uncomfortable intrusions of reality can no longer be kept at bay. Printing money of course does not just create a 'potential risk of inflation' as 'many analysts' erroneously hold. It is inflation.

Further below in the same article we learn that US president Obama is also throwing his weight behind the idea. Since he is on a visit to Australia, he  was inspired to use the 'bush fire' analogy to describe the crisis.  Concurrently, the IMF has suddenly lost its chief bureaucrat dealing with Europe (sinking ships and certain rodents come to mind):


Obama, on a visit to Australia, turned up the heat on Europe to act more boldly to extinguish the bush fire. "Until we put in place a concrete plan and structure that sends a clear signal to the markets that Europe is standing behind the euro and will do what it takes, we are going to continue to see the kinds of market turmoil we saw," he said.

Obama said that, while new unity governments in Italy and Greece represented progress, Europe still faced a "problem of political will.

International efforts to fight Europe's worsening debt crisis received a setback when the International Monetary Fund's European chief resigned, citing personal reasons.

Antonio Borges last month suggested the IMF could buy Spanish or Italian bonds alongside the euro zone's bailout fund but quickly backtracked, saying the IMF could only lend to states, not intervene in bond markets directly.”

To the above it must be once again noted that France is so eager to throw the ECB into the ring because it rightly fears for its AAA rating. Readers may recall the recent 'erroneous dissemination of a credit rating cut' for France by S&P that was 'corrected' after about two hours. We have asked ourselves ever since how such an 'error' could have come about. Not to sound too conspiracy-minded, but can one rule out that it actually wasn't an error and that the reason for the retraction was a threatening phone call from very high up? We'll never know of course, but it did look suspicious.

To summarize all of the above: Germany, and to a lesser extent the nominally independent ECB itself, are all that stands between a cranking up of the printing presses in Europe, which is demanded by everyone else.

However, we wonder why no-one has as of yet stopped to ask what seems to us to be a rather obvious question: how come that government bond yields are exploding all over the euro area, except in Germany?  In fact, German yields have been in a sharp downtrend ever since the crisis erupted – and yet, Germany is the 'core nation' of the euro area. If one looks at Germany's debt, both public and private as well as its government's so-called unfunded liabilities, it does not appear that Germany is in much better shape than most of the nations the bond markets of which are now under attack.

So what accounts for the rush into German bonds? Here is how we see it: investors are contemplating the possibility that the euro area will fall apart and that the national currencies will be readopted. If that happens, then where will their money be safe? Consider what would happen if e.g. Greece had its own currency again. The currency would probably collapse in short order, as the Greek central bank would print all out. To a lesser degree this would apply to all the other countries as well. Clearly, the one nation most opposed to money printing therefore makes the cut.

Perhaps the German opposition to money printing is not such a bad idea after all?


Public and private debt levels of selected countries – click for higher resolution.



Italy Gets Techocracy Pure; Greece Misses Another Deficit Target (yawn); Bank Troubles Intensify

Italy's new prime minister Mario Monti has now installed his 'technocratic government', which reportedly is completely free of career politicians (the presence of Corroda Passera, the CEO of Intesa Sanpaolo in the new cabinet has been mocked by some observers in light of the trouble the bank finds itself in). As Reuters notes, this new government is not safe from parliamentary sniping. Contrary to the widespread belief that it is the modern-day equivalent of the temporary Roman dictator Lucius Cornelius Sulla, parliament's powers have not been suspended.

“In Italy, Mario Monti was sworn in as prime minister, his main task being to push through unpopular reforms designed to placate financial markets that have driven Italy's borrowing costs to untenable levels. His government of 16 experts features several academics and Intesa bank Chief Executive Corrado Passera. Monti, a respected economics professor and former EU commissioner, kept the key economy portfolio for himself in a drive to implement long-delayed structural reforms and austerity measures.

"All this will, I trust, translate into a calming of that part of the market difficulty that concerns our country," said Monti, who unveils his austerity program on Thursday.

Some analysts say the cabinet of technocrats could be vulnerable to ambushes in parliament, but Monti said the absence of politicians in the team would free its hands.

Federico Ghizzoni, chief of Unicredit, said he would ask the ECB to increase access to central bank funds for Italian banks, whose funding problems have grown since Italy was sucked into the debt crisis in July.”


(emphasis added)

Color us completely certain that this new government will soon see its share of 'ambushes' in  parliament. It is noteworthy that once again, there are new pleas directed at the ECB, to 'increase access to central bank funds'.

Over in Greece, the new 'technocratic' Papademos government has just survived its first confidence vote (to be sure, a mere formality in this case), however, it has turned out that Greece's budget deficit once again widened way beyond the 'target' in October. This reflects a combination of a severe economic bust and the utter failure of Greece's government to improve its lax tax collection efforts (as we noted before, even the tax collectors are on a permanent 'go-slow' strike).  Greece's bond and note yields continue their journey into absurdity, with the one year note yield lately clocking in at 268% (no, that is not a typo).

At the same time, the funding situation for euro area banks continues to deteriorate sharply. As you will see in today's chart update, euro basis swaps have as expected broken through a major support level and are now at fresh crisis wides. A major new down-leg seems imminent.

“New data showed that Greece's austerity-fueled recession had widened the budget deficit in October, the government failing to boost revenues despite unpopular new taxes.

Europe's debt crisis is increasing strains in the money market, the plumbing of the international financial system. Euro zone banks are finding it harder to obtain dollar funding. While the stresses are nowhere the levels of the 2008 financial crisis, they have continued to mount despite ECB moves to provide unlimited liquidity to banks.”

We must qualify the assertion that the 'stresses are nowhere near the levels of the 2008 crisis': this is true in some respects, but not in others. For instance, the market assigns a far higher default probability to euro area banks today than it did in 2008. Meanwhile, Moody's has just taken rating action against the German 'Landesbanken', which is set to further complicate the funding situation. Funny enough, one of the reasons cited by Moody's for the downgrade is “that future government (or systemic) support for German public-sector banks has become less certain, partly owing to the new bank resolution regime that enables the government to impose losses on creditors outside of liquidation”.

This is truly funny, given that these are in fact state-owned banks. Is Moody's really saying that the state won't bail out its own banks? In the same report Moody's ironically notes:

“Moody's view that German public-sector banks continue to benefit from a very high probability of external support is driven by two important factors:

(i)  Systemic importance of German public-sector banks: The Landesbanken, their subsidiaries and DekaBank belong to the broader public-sector banking group, which accounts for more than one third of total lending and deposits in the German system; the public-sector banks are thus a cornerstone of Germany's financial system and its economy.

(ii)  Direct and indirect government influence: Ownership and control of German public-sector banks relates ultimately to government entities. The government's influence underpins a high probability of support.”

Well, which is it? Do they or they not enjoy government support? It almost reads as though the writer of the ratings report was hit by a bout of multiple personality disorder in the middle of composing the rationale for the downgrade.


Derivatives Exposure of US Banks

Speaking of banks and their exposure to euro area stresses: the US banking system continues to cleverly hide the true extent of its derivatives related exposure to Europe.  However, we know from the BIS that they hold about $520 billion in notional exposure to sovereign euro area CDS alone. To put this number in perspective: it amounts to about 60% of the entire capital of the US banking system. Now, it is of course clear that when everything is 'netted out'  their exposure will look far smaller – alas, 'netting out' means that they must rely on all counter-parties in the derivatives chain performing, a heroic assumption indeed when it comes to over-the-counter derivatives (see the AIG case). In fact, since contracts can be sold multiple times, it is impossible to know for sure who all the counter-parties involved actually are. At the end of a long chain there could be some mud hut in Calcutta as the ultimate guarantor. We are of course oversimplifying here, but it has been shown on multiple occasions that it is nigh impossible to consistently track a large otc derivatives book. Fannie Mae once need a 2,000 strong army of outside accountants to sort out its derivatives positions and it took them six months to do so. So there is no point in asserting that the big derivatives dealers have 'everything under control' – they haven't, because it is simply not possible. The OTC swaps market has by the way grown to a size of more than $708 trillion in notional terms, up 18% over just the past year.

As regards the euro area exposure of US banks, Bloomberg writes:

JPMorgan Chase & Co. (JPM) and Goldman Sachs Group Inc. (GS), among the world’s biggest traders of credit derivatives, disclosed to shareholders that they have sold protection on more than $5 trillion of debt globally.  Just don’t ask them how much of that was issued by Greece, Italy, Ireland, Portugal and Spain, known as the GIIPS.

As concerns mount that those countries may not be creditworthy, investors are being kept in the dark about how much risk U.S. banks face from a default. Firms including Goldman Sachs and JPMorgan don’t provide a full picture of potential losses and gains in such a scenario, giving only net numbers or excluding some derivatives altogether.

“If you don’t have to, generally people don’t see the advantage to doing it,” said Richard Lindsey, a former director of market regulation at the U.S. Securities and Exchange Commission who worked at Bear Stearns Cos. from 1999 through 2006. “On the other hand, if there were a run on Goldman Sachs tomorrow because the rumor was that they had exposure to Greece, you’d see them produce those numbers.”

A case in point: Jefferies Group Inc. (JEF), the New York-based securities firm, disclosed every long and short position it held on European debt earlier this month after its shares plunged more than 20 percent. Jefferies also said it wasn’t relying on credit-default swaps, contracts that promise to pay the buyer if the underlying debt defaults, as a hedge on European holdings.

By contrast, Goldman Sachs discloses only what it calls “funded” exposure to GIIPS debt — $4.16 billion before hedges and $2.46 billion after, as of Sept. 30. Those amounts exclude commitments or contingent payments, such as credit-default swaps, said Lucas van Praag, a spokesman for the bank.

Goldman Sachs includes CDS in its market-risk calculations, of which value-at-risk is one measure, and it hedges the swaps and holds collateral against the hedges, primarily cash and U.S. Treasuries, van Praag said. The firm doesn’t break out its estimate of the market risk related to the five countries.

JPMorgan said in its third-quarter SEC filing that more than 98 percent of the credit-default swaps the New York-based bank has written on GIIPS debt is balanced by CDS contracts purchased on the same bonds. The bank said its net exposure was no more than $1.5 billion, with a portion coming from debt and equity securities. The company didn’t disclose gross numbers or how much of the $1.5 billion came from swaps, leaving investors wondering whether the notional value of CDS sold could be as high as $150 billion or as low as zero.

“Their position is you don’t need to know the risks, which is why they’re giving you net numbers,” said Nomi Prins, a managing director at New York-based Goldman Sachs until she left in 2002 to become a writer. “Net is only as good as the counterparties on each side of the net — that’s why it’s misleading in a fluid, dynamic market.”

Investors should want to know how much defaulted debt the banks could be forced to repay because of credit derivatives and how much they’d be in line to receive from other counterparties, Prins said. In addition, they should seek to find out who those counterparties are, she said.”

JPMorgan sought to allay concerns that its counterparties are unreliable by saying in the filing that it buys protection only from firms outside the five countries that are “either investment-grade or well-supported by collateral arrangements.” The bank doesn’t identify the counterparties.”


(emphasis added)

Now you know why the concerns about the euro area crisis have 'gone global' in such intense fashion. The interconnectedness of the financial system practically ensures that the dominoes will tumble everywhere if and when Europe blows up. As to JP Morgan not divulging who its counter-parties are: it probably doesn't even know who they really are. As noted above, these otc contracts can be transferred and we're not convinced that everything can be properly tracked. Note that such a transfer can happen indirectly by writing a new contract with a third party.

Clearly the risks are staggering, considering the range of worst case outcomes imaginable in the context of the euro area debt crisis.



Euro Area Credit Market  Charts


Below is our customary collection of CDS prices, bond yields, euro basis swaps and several other charts. Both charts and price scales are color coded. Prices are as of Wednesday's close.

The most notable move was the breakdown in euro basis swaps, which indicates that dollar funding problems remain acute for euro area banks.



5 year CDS on Portugal, Italy, Greece and Spain – slight pullbacks on Wednesday – click for higher resolution.



5 year CDS on France, Belgium, Ireland and Japan – click for higher resolution.



5 year CDS on Bulgaria, Croatia, Hungary and Austria – click for higher resolution.



5 year CDS on Latvia, Lithuania, Slovenia and Slovakia – click for higher resolution.



5 year CDS on Bahrain, Saudi Arabia, Morocco and Turkey – click for higher resolution.



Three month, one year and five year euro basis swaps – breakdown! – click for higher resolution.



The three month euro basis swap in isolation, short term. This doesn't look good – click for higher resolution.



The three month euro basis swap, long term. It is now approaching the levels last seen during the 2008/9 panic – click for higher resolution.



Our proprietary unweighted index of 5 year CDS on eight major European banks (BBVA, Banca Monte dei Paschi di Siena, Societe Generale, BNP Paribas, Deutsche Bank, UBS, Intesa Sanpaolo and Unicredito) – small dip from its all time high made on Tuesday – click for higher resolution.



10 year government bond yields of Italy, Greece, Portugal and Spain – Spanish yields continue to explode higher. In today's trading they actually briefly exceeded 7% (not yet shown on this chart) – click for higher resolution.



10 year government bond yield of Austria, the 9 year government bond yield of Ireland, UK Gilts and the Greek 2 year note. Austrian yields keep streaking higher. The Greek 2 year note at 113.4% – there's not much one can say to that anymore that isn't self-evident – click for higher resolution.



10 year government bond yield of Italy, short term. Back above 7% (it rose again today) – click for higher resolution.



10 year government bond yield of Italy, long term. Keep in mind, Italy's government debt of € 2 trillion represents the third biggest government bond market in the world – click for higher resolution.



Italy's 10/2 year spread, still close to inversion – click for higher resolution.



10 year government bond yield of Spain,  short term – this is a new crisis high – click for higher resolution.





10 year government bond yield of Spain, long term. A classical bullish chart pattern – click for higher resolution.



5 year CDS on the debt of Australia's 'Big Four' banks – bouncing higher once again – click for higher resolution.




Charts by: Bloomberg



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10 Responses to “Euro Area – Wrangle Over ECB’s Role Continues”

  • mc:

    Wiedmann isn’t going to print while the EU lets Germany have a vote. This is a great article about the perspective of the Bundesbank:,1518,797666,00.html

    The problem for Germany isn’t finding people to loan money to, it is getting them to pay it back. In hindsight, the giant pile of Euros lent to Spain, Italy, Greece, etc, will not be paid back to Germany. The Germans did the savings, and sent their surplus to the PIIGS, whom immediately consumed it. There is no asset that can be returned to Germany nor collateral to be assumed by the jilted bondholders. They can continue to transfer more wealth to the profligate countries (bailout throwing good money after bad), allow the ECB to massively print and devalue the PIIGS loans (inflation), pursue the path of deflationary debt-destruction (default+austerity), or let the weak nations leave the EMU (get repaid with less valuable currency).
    Ideas 1 and 2 just ensures more of the same, as there is no incentive to change as long as Germany foots the bill. Default is certain if the PIIGS all stay in the euro and they dont print, and the resulting austerity would be politically volatile in the affected countries – Germany is still not getting paid back, but at least some pain is going to those who were profligate. Letting the countries reintroduce their own money and devalue would result in a similar partial-payment to Germany, but might save some of the internal political pain that austerity would bring. The only way a sustainable path is found is one of the second two options, and none of them ever compensate Germany for what they have lost already.

  • uneasy:

    As Peter Tchir today asked (zerohedge):
    What will be if the ECB is NOT printing???
    No one tries to find answers to this.
    Everybody cries–printprintprint.
    Then what???

    • Imo printing can only delay the eventual denouement, it can not avert it. Of course this is not the argument of those in favor of it – they all say ‘it’s an emergency’ – apparently in the (false) belief that in an ’emergency’ economic laws are somehow suspended.

  • uneasy:

    With every Nazi-comparison and every bank which is looting the EFSF(think Proton) the opposition of us is rising.
    As I said yesterday, all is heading for a referendum in Germany.
    Then it is over.

    • I agree – a referendum would put paid to the whole enterprise. Moreover, Germany imo will not agree to any further subsidization of the profligate debtors without extracting a political price. The price consisting of more control over their fiscal policy. However, time is running short.

  • This sounds like the philosophy of a doctor admitting he killed the patient to keep them from dying. The idea of buying junk debt with ECB funds merely pollutes the monetary base itself and exposes the currency to a indefensible run. The point about buying German bonds as opposed to other bonds is such an illustration. It is clear the problem isn’t so much the relative debt, but the dead economies of the weaker parties. Care must be taken in rescuing a drowning man or the rescuer themselves could be drowned as well. It appears Germany is set up to receive such a drowning.

  • Andrew Judd:

    Obviously the Germans will eventually enable printing of whatever is needed to ensure price stability. Germany also needs growth to avoid problems with its own debt and for that it needs reasonably robust consumer confidance in the Euro area.

    • Clearly we see this differently Andrew. This is nothing but a ploy to pass the buck to Germany. This is how all socialist governments work and the EU is nothing but a modern politboro. Once the ECB is full of bad debt, it will have no defense of a flight of capital or a speculative run. Germany has been reminded of Weimar for close to 100 years. Maybe the people that experienced the run on that currency are dead, but the humiliation of the nation is still fresh in their minds. I will never know why some outfits are never exposed to the bad side of the trade they enter. The rumor of Landesbanken and how it would be resolved is right on the head of how it should be resolved. Shareholders equity wiped out and the depositors own what is left. Fraudulent systems need to produce the results of fraudulent transactions. Henry Ford or someone of his time once stated that if the people in America knew how banking worked, there would be a revolution by sunrise. At best 1% understand.

      • Andrew Judd:

        Germany now appears to hold most of the cards so can work things out in a way that suits Germany, but if there is to be a Euro it seems inevitable that it cannot only suit Germany. The ECB can give some of these countries time to make the necessary changes by offering a carrot and beating them with a stick, or it can just allow the whole thing to collapse to the ground along with much of the worlds economy. Obviously Germany will do whatever is in Germanys best interests where as an exporting nation they need customers.

        I am not sure Ford knew how a bank operated. His comments suggest banks just invent the money. They still need creditors. Without creditors they can invent nothing more than worthless cheques. A loan is just like a cheque. Obviously anybody can write out a cheque ‘out of thin air’ and thereby create the means of exchange. Loans create deposits because a bank can find creditors.

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