The Bazooka Stalemate – The Crisis Reaches Germany

A few more words on the problem we discussed in our previous article ('The Print or Die Conundrum'). Firstly, the recognition by market participants that France can really no longer be considered an AAA credit is – just as we have stated in these pages for many weeks – clearly tied to the deplorable state of France's banking system and its massive exposure to the euro area periphery. 

As reported in a Reuters article:

France has the biggest debt burden of the top-rated euro nations, at 85 percent of gross domestic product. Its financial institutions also have the largest debt holdings in the five crisis-hit countries, at 681 billion euros ($921 billion) as of June, according to data from the Bank for International Settlements in Basel.

“France is not a AAA at all,” said Nicola Marinelli, who oversees $150 million at Glendevon King Asset Management in London. “French banks are very exposed to euro-zone periphery. If they were to mark to market these loans at current levels, there would be huge losses.”

Moody’s and S&P currently have a stable outlook on French credit, though both have signaled the nation’s rating is at risk. Moody’s said Oct. 17 that France’s debt metrics “are now among the weakest” in the AAA club. France might be downgraded in a stressed economic scenario, S&P said four days later.

The prospect of France taking on additional liabilities to support countries such as Greece and Italy is among the main threats to its rating, according to New York-based Moody’s.  S&P roiled global markets on Nov. 10 when it sent and then corrected an erroneous message to subscribers suggesting France had been downgraded.

France says to resolve the region’s crisis the European Central Bank needs to be the lender of last resort, supporting Europe’s rescue fund. The French proposal, which would allow the ECB to fund purchases of troubled sovereign debt, has the support of leaders such as U.K. Prime Minister David Cameron.

Germany and the ECB oppose the plan.

“We don’t have any new bazooka to pull out of the bag,” Michael Meister, a senior lawmaker in German Chancellor Angela Merkel’s coalition, said in a telephone interview in Berlin today, reiterating opposition to the ECB plan.

The stalemate has added to market perception that France, the second-biggest backer of the European Financial Stability Facility after Germany, may get dragged further into a crisis that this month led to the ouster of Italian Prime Minister Silvio Berlusconi and Greece’s George Papandreou.

“Where are the guardians of the euro?” asked Eric Chaney, chief economist at Axa SA in Paris. “The EFSF, the ECB? The markets are going to continue to test them. Markets are increasingly betting on a breakup of the euro zone.”

European leaders agreed last month to boost the EFSF to 1 trillion euros to help contain the crisis. The fund owes its AAA rating to guarantees from the euro region’s six top-rated nations. The EFSF’s lending capacity would fall by 35 percent if France is downgraded, Mizuho Corporate Bank Ltd. analysts said.”

As we have noted before, the fact that the EFSF bailout fund crucially hinges on France actually keeping its triple AAA rating, means that the 'new and improved' leveraged EFSF is likely never going to get off the ground. Since the pesky details of how the EFSF is going to operate are not even decided yet (!), we would be willing to bet that if no deus ex machina appears on the scene, these discussions will turn out to be a complete waste of time as the euro area will descend into financial chaos before they are even finished.

Meanwhile, Germany asserts that the 'markets are simply wrong' in betting  on a dissolution of the euro. This appears to reflect an extraordinary disconnect from reality. Readers who are wondering about the strange dichotomy in the approach of German politicians to the crisis should note the following: 

There are certain typical German character traits, such as the view that there should be strict adherence to laws and regulations, a strong work ethic and a strong propensity to save. Then there is Germany's historical experience with the Weimar inflation and its aftermath, which as we have often mentioned has become part of its 'institutional memory' (readers may have noticed that the mainstream media have in the meantime also adopted this terminology. Alas, you have read it here first). Moreover, as the biggest euro area economy and the biggest contributor to the bailout initiatives, Germany is the EU's de facto paymaster and as such the whole country is aghast at the antics of Greece and other fiscal offenders such as Italy. All of these factors combine to produce the tough German stance regarding money printing and the reluctance regarding the idea of issuing euro-bonds.



… what eurobonds look like to Germany …

(Image via



On the other hand, Germany is the cradle of the welfare state. It was chancellor Otto von Bismarck who created the world's first welfare state in Germany in the 1880's, by introducing government-run old age pensions, as well as health and unemployment insurance. There is to this day an unquestioned undercurrent of statism in German politics. In essence, Germany's political class has a socialistic streak no matter what a political party calls itself (with the possible exception of the Free Democrats). Angela Merkel's recent adoption of the socialist positions on nuclear power and minimum wages are cases in point: a nominally 'conservative' party openly espouses socialism. In fact, the only new facet is that she has now added even more socialistic positions to the essentially already socialistic program of her 'conservative' party. It should be no wonder then that Germany's political class harbors a deep disdain for markets, especially financial markets, which are held to be only slightly less disreputable than casinos or bordellos. 'Speculation' (as a BNP analyst recently noted, 'when the markets are going down, investors suddenly become 'speculators') is generally frowned upon –  it is an activity that is at best reluctantly tolerated. Hence also the German drive to impose a 'financial transactions tax' in spite of the fact that countless studies prove beyond a shadow of doubt that such a tax would do enormous harm to capital formation in Europe (not to mention the fact that it would be a Trojan horse).

This is also why German politicians say things like 'the markets are wrong', or seem to believe that they can simply ignore financial markets.

As Bloomberg reports:

Germany rejected calls from allies and investors to do more to counter market turmoil as Spain’s financing costs surged and pressure mounted on Greek political leaders to submit written commitments to austerity measures.

Bond yields in France, Spain and Italy climbed as the absence of progress toward enacting a month-old comprehensive crisis-fighting package and a dispute over the central bank’s role rattled investors. Spanish three-month bills were auctioned today at higher yields than in Greece and Portugal.

“We don’t have any new bazooka to pull out of the bag,” Michael Meister, finance spokesman for Chancellor Angela Merkel’s Christian Democratic bloc, said in Berlin today. “We see no alternative to the policy we are following,” which sees debt cuts and keeping the European Central Bank from becoming a lender of last resort, he said in an interview.

Germany is signaling resistance to stepping up Europe’s response as the debt crisis that began more than two years ago in Greece threatens France, after snaring Ireland, Portugal, Italy and Spain. While the extra yield investors demand to lend to AAA-rated France reached 200 basis points more than Germany on Nov. 17, the highest risk premium since 1990, Meister said current policies will work if given enough time.


“If markets think that the euro is about to break up, they’re wrong,” Meister said. “We must tell markets that we are ready to defend the currency, that it has a great future and will become the strongest currency in the world.”

Frankly,  Meister appears to be completely delusional. For instance, the assertion that 'current policies 'will work if given enough time' is contradicted by the fact that these policies have not worked so far, and more importantly, that they are simply not going to be given 'enough time'. The markets have watched and waited for 18 months. Now there is no more time – the game is up.

As to the hubris evident in the assertion that 'the markets are wrong' – there is  no government in the world that has yet been able to successfully fight the markets. Not even the Soviet Bolsheviks succeeded in this task, even though they outlawed markets altogether in the territories under their control.

Meanwhile, the smug assumption that Germany itself is somehow insulated from the crisis is about to be shattered. As we pointed out yesterday, German bond auctions are now failing as well. It has just happened again – as the Irish Times bluntly states: 'German bond sale a disaster'.

“Germany failed to get bids for 35 per cent of the 10-year bonds offered for sale today, sending its borrowing costs higher and the euro lower on concern that Europe's debt crisis is driving investors away from the region.

"This auction is nothing short of a disaster for Germany," Mark Grant, a managing director at Southwest Securities in Florida, said. "If the strongest nation in Europe has this kind of difficulty raising capital one shudders concerning the upcoming auctions in other European nations."

The debt crisis that began more than two years ago in Greece and snared Ireland, Portugal, Italy and Spain has closed in on France and now risks engulfing Germany, the region's biggest economy. Political leaders are struggling to find a fix for the crisis, with German Chancellor Angela Merkel rejecting proposals for the common currency-area bonds, while the European Central Bank resists calls to boost sovereign debt purchases.

The yield on 2.25 per cent securities maturing in September 2021 climbed four basis points to 1.96 per cent at 11.37am Irish time today. The price of the bonds slid 0.40, or €4 per €1,000 face amount, to 102.520. The cost of credit default swaps on German debt rose six basis points to 107, according to CMA prices. The euro weakened as much as 1 per cent to $1.3374.

Total bids at the auction of securities due in January 2022 amounted to €3.889 billion, out of a maximum target for the sale of €6 billion, according to Bundesbank data. The securities were sold at a yield of 1.98 per cent.


(emphasis added)

Well yes, this is indeed a disaster. The crisis has now finally engulfed Germany as well. Game over.



The gentleman wearing the helmet that one better not leave lying around on top of a chair by mistake is Otto von Bismarck, inventor of the modern welfare state (which was at the time designed to bribe people into staying in Germany instead of leaving for the brighter prospects offered by the United States).




Economic Downturn Worsens


Yesterday it was reported that consumer confidence in the euro area – not surprisingly – once again nosedived.



“Consumers in the 17 countries that use the euro became more downbeat about their prospects in November as the currency bloc's fiscal crisis deepened, weakening the outlook for the economy and the jobs market.

The European Commission Tuesday said that according to preliminary results from its monthly sentiment survey, the headline measure of consumer confidence fell to minus 20.4 from minus 19.9 in October, reaching its lowest level since August 2009 and well below its average going back to 1990 of minus 12.5.

It was the fifth straight month in which the measure declined, indicating that consumer spending will weaken, and increasing the risk that the currency area's economy will slip back into recession.

"The further drop in consumer confidence in November fuels concern that the euro zone is in serious danger of seeing economic contraction in the fourth quarter and falling back into recession," said Howard Archer, an economist at IHS Global Insight.”


Consumer and business confidence in the euro area: a steep slide is underway – click for higher resolution.



Today the release of the latest euro-area industrial output data confirmed that a recession has likely begun. Industrial orders suffered a 6.4% month-on-month slide, the worst in three years, exceeding expectations of a 2.5% fall, with the contraction most pronounced in France and Germany – the very 'core' nations that are supposed to keep the euro area Titanic afloat.

Euro zone industrial new orders slumped in September, the EU said on Wednesday, the deepest fall since December 2008 and far worse than economists had forecast, in the latest sign that Europe may be heading for a recession.

Orders in the 17 countries sharing the euro tumbled 6.4 percent in the month compared to August, well below expectations of a 2.5 percent fall, with Germany and France registering sharp contractions, the EU's Statistics Office Eurostat said.

"The scale of the deterioration is surprising," said Clemente de Lucia, an economist at BNP Paribas. "We are entering some kind of contraction in the last quarter of this year that will continue in the first quarter of next year," he said.

Orders of capital goods, a measure of investment in new machinery, fell the most in September compared to the previous month, sliding 6.8 percent and suggesting factory managers and companies made a clear call to pull back expansion plans.

On an annual basis, industrial new orders in the euro zone rose 1.6 percent in September, while economists polled by Reuters expected an 8.0 percent increase.

As the epicentre of the sovereign debt crisis has moved to Rome from Athens, some economists are predicting a deeper and longer recession than first seen. ABN Amro recently cut its euro zone gross domestic product forecast for 2012 to a contraction of 0.8 percent, from growth of 0.4 percent.”

The downward revision of Germany's economic outlook released by the BuBa yesterday is highly likely to prove overoptimistic.

“Germany's central bank slashed its growth forecast for the German economy on Monday, repeating its warning that the country could hit a "pronounced" weak patch if the euro zone's debt crisis worsens.

"All in all, a weakening of economic development is expected for the coming year, whereby an increase of economic output between 0.5% and 1% in the base scenario appears realistic," the Deutsche Bundesbank wrote in its monthly bulletin. The bank added that growth will likely shift from exports to the domestic economy.

In June, the Bundesbank had predicted growth of 1.8% in 2012. The German economy is expected to grow by about 3% this year. The German federal government announced in October that it expects growth next year to be 1%.

Labor market developments are, however, not expected to experience " significant change," the bank said.

The bank did eye significant risk factors. "A pronounced weak phase is thus not excluded, if the sovereign debt crisis in Europe worsens appreciably." The bank said the German economy will probably hit a rough patch in coming months. The cooling of foreign demand is compounding nervousness on financial markets, and industry export expectations have fallen to a level below the long- term average, the bank explained.

The Bundesbank also took a critical stance toward the recent deal to agree a 50% "voluntary" haircut on Greek sovereign bonds. Though the bank argued involving the private sector in a sovereign debt restructuring is an important element of a currency union, it said that such an action also "implies risks." It must not raise expectations that missing fiscal targets would lead to a debt forgiveness or lowering of consolidation demands, the bank said.”

That 'base case scenario' of '0.5% to 1% growth' looks anything but realistic.  Germany is probably already in recession.

Meanwhile, the Markit flash PMI for November actually registered a slight bounce, alas, the details of the report give little reason for hope.



Euro area PMI's, Germany, France and the rest – click for higher resolution.



According to Markit (the entire report can be seen here, pdf):

“While the improvement in the flash Eurozone PMI indicates that the rate of contraction eased in November, it is unlikely that the region is over the worst. The higher PMI reading reflected a slower fall in services activity, but that sector also saw confidence about the year ahead slide to its weakest since March 2009. Companies are clearly shaken by the debt crisis and its growing impact on the real economy, both in Europe and further afield.

“Meanwhile, manufacturers reported the steepest fall in new orders since May 2009, with domestic and export sales both declining at sharper rates. It therefore looks highly likely that business activity could weaken across the board again in coming months.

“Companies’ concerns about the future were reflected in a stagnation of employment. Any further drop in new orders in December could mean staffing levels will begin falling again.

“Overall, the survey data suggest that the Eurozone is contracting at a quarterly rate of approximately 0.6% in the fourth quarter. As feared earlier in the year, malaise has spread from the periphery to the core. Even Germany is stagnating and France contracting by around 0.5%.”

The fact that the euro area is likely already in a recession will further complicate the efforts to get a grip on the sovereign debt crisis. When it rains, it pours.


Eurobond Proposals Revived

We have no idea why the eurocrats keep proposing the issuance of eurobonds, knowing that Germany has completely ruled them out as a crisis fighting tool. In fact, Germany has no choice: its supreme court has ruled the option out. The government can not agree to eurobonds even if it wanted to.

A nd yet, here we go again:



“The European Commission proposed Wednesday significantly tighter controls over euro-zone members' budgets, alongside options for a common euro- zone bond market. The proposals would see struggling governments forced to submit to frequent reviews of their economic policies and accounts, and could see euro-zone governments effectively forced to seek financial assistance by a vote of their peers.

"To return to growth, Member States need to raise their game when it comes to implementing their commitments to structural reforms, as well as embrace deeper integration for the euro area," said European Commission President Jose Manuel Barroso. The commission said the deteriorating economic climate requires greater reform efforts from member states. If a government doesn't comply with the EU's demands, they could be locked out of European Union budget funding, which can amount to billions of euros a year. The Commission wants to require governments to have independent fiscal councils in place to base their budgets on, and independent forecasts.

The proposals are designed to strengthen the way the euro zone is governed and they go as far as the Commission believes it can go without changing the European Union treaty.

Closer integration would set the groundwork for issuing joint bonds among the euro currency's 17 governments.”


Italy's new 'technocratic' prime minister Monti has given his placet to the idea. Apparently he is trying to package the eurobonds idea in a way that makes it more palatable to Germany – alas, that still leaves the problem that the legal impediments thrown up by the German supreme court in Karlsruhe must be somehow circumnavigated.

“Euro-zone bonds can be designed and deployed so as to "bolster budget discipline" rather than offer fiscal relief, Monti said in Brussels, after meeting Herman Van Rompuy, president of the European Council, and European Commission President Jose Manuel Barroso.

Last year, Monti wrote a report for the Commission, where he served two terms, saying euro-zone bonds would further the integration of European financial markets.

As government debt often plays a role as a benchmark asset in banking transactions, the fact that the euro area has 17 types of sovereign debt securities is a source of fragmentation.

While a single euro-zone bond would clearly require new and more "intelligent fiscal discipline," it would avoid the risk of weaker countries being unable even to finance productive investments needed to rebalance their economies and also mitigate the risk of such debtors being funded only by "public" lenders such as EU institutions, said Patrick Artus, chief economist at Natixis.

Avoiding the latter risk is of critical interest to Germany, where Chancellor Angela Merkel has repeated this week her doubts about euro-zone bonds, seen as giving less prudent EU partners the benefits of her country's triple-A rating.

Monti said he had been specifically asked by Merkel and French President Nicolas Sarkozy to "bring new ideas" to Thursday's meeting.

Meanwhile, a rally in European stock markets was cut short yesterday and devolved into a big decline when it became known that Germany's Commerzbank will once again have to raise more capital – this time an estimated € 5 billion. Why anyone was surprised by this revelation is a mystery.

“Commerzbank's share price fell by more than 17 percent to below 1.12 euros, making the stock the biggest decliner on Germany's blue-chip index.

Germany's second-biggest lender could need around 5 billion euros ($6.7 billion) instead of the 2.9 billion euros previously expected, should the European Banking Authority (EBA) proceed with plans to tighten the capital requirements it wants to impose on banks to withstand the euro zone sovereign debt crisis. This is based on internal Commerzbank calculations, the sources said.

Chief Executive Martin Blessing must hammer out a strategy to comply with the EBA's target by Christmas and the lender may have to cut risk-weighted assets by 20 percent to free up enough capital to reach the 5 billion-euro goal, one person close to the company said.

"It's a difficult feat of strength and if it doesn't work, Blessing will be under pressure," the person added. Blessing has vowed to close the capital gap without again turning to the government for help, as he was forced to do during the financial crisis.

"I'm not going there again," Blessing told journalists last month.”

This once again underscores that the credit crunch in euro-land (and elsewhere) is going to continue to worsen.


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 Tuesday's close.

The massacre continues – CDS on Greece now stand at a truly incredible 9,177 basis points, which means it costs now $9.177 million per year to insure $10 million in Greek debt for five years. In other words, the expected recovery has basically gone to 'zilch', since an investor insuring the bonds now fixes a 91.77% loss on them beforehand.

Evidently the markets now fully expect a disorderly and complete Greek default. Several other sovereign CDS in the euro area have also hit new highs, as has our euro-land bank CDS index. Things continue to look grim.



5 year CDS on Portugal, Italy, Greece and Spain – all rising further, with Greece the standout this time and CDS on Spain at a new high as well – click for better resolution.



5 year CDS on France, Belgium, Ireland and Japan. We already showed this one in the previous article, but here it is again for the sake of completeness. CDS on France and Belgium are at new highs – click for better resolution.



5 year CDS on Bulgaria, Croatia, Hungary and Austria – more new highs – click for better resolution.


5 year CDS on Latvia, Lithuania, Slovenia and Slovakia – the latter two are at new highs as well – click for better resolution.



5 year CDS on Romania, Poland,  Lithuania and Estonia – note, new highs for CDS on Estonia and Lithuania – click for better resolution.



5 year CDS on Bahrain, Saudi Arabia, Morocco and Turkey – all except Saudi Arabia are now within striking distance of their highs made earlier this year – click for better resolution.



5 year CDS on Germany, the US and the Markit SovX index of CDS on 19 Western European sovereigns. The SovX is close to making yet another  new high – click for better resolution.



Three month, one year and five year euro basis swaps – a tiny bounce on Tuesday – click for better 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)  – yet another new all time high for this index, which now trades at about three times its 2008/9 crisis high level – click for better resolution.



5 year CDS on two big Austrian banks (Erstebank and Raiffeisen) reach new highs as well (note, these are indexed to 100 – the absolute levels are 380 basis points for Erstebank and 385 basis points for Raiffeisen) – click for better resolution.



10 year government bond yields of Italy, Greece, Portugal and Spain – there's no let-up in sight – click for better resolution.



10 year government bond yield of Austria, the 9 year government bond yield of Ireland, UK Gilts and the Greek 2 year note.  The recent pullback in Austrian yields didn't last long – click for better resolution.



10 year government bond yield of Spain – a new high – click for better resolution.



Italy's 10-2 spread has now inverted further, and stands at minus 0.522 basis points. This is a highly alarming development – it means people are no longer prepared to lend to Italy long term – click for better resolution.



5 year CDS on China – China has reported a disappointing drop in PMI to the 48 level overnight, indicating that its manufacturing sector is in contraction. This comes on the heels of news that the real estate bubble is now in grave trouble. We plan to discuss the Chinese situation in more detail soon.



5 year CDS on the debt of Australia's 'Big Four' banks – racing higher again as risk aversion increases across the globe – click for better resolution.




For charts on Belgium's bonds we refer you to our previous post, 'The Print or Die Conundrum'. We should add with regards to Belgium that according to the press in Europe, there are rumors that Belgium will be unable to contribute to the Dexia rescue to the extent hitherto envisaged. Apparently there are now negotiations with France (which has been officially denied, a strong sign that it is true) in order to get France to take over a bigger share of the burden. Ever since Dexia floundered, the sell-off in Belgium's sovereign debt has accelerated markedly, a sign that the market does not believe it can actually stem its share of the rescue.



Charts by: Bloomberg, Markit



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You may have noticed that our header carries ab black flag. This is due to the recent passing of the main author of the Acting Man blog, Heinz Blasnik, under his nom de plume 'Pater Tenebrarum'. We want to thank you for following his blog for meanwhile 11 years and refer you to the 'Acting Man Classics' on the sidebar to get an introduction to his way of seeing economics. In the future, we will keep the blog running with regular uptates from our well known Co-Authors. For that, some financial help would be greatly appreciated. A special thank you to all readers who have already chipped in, your generosity is greatly appreciated. Regardless of that, we are honored by everybody's readership and hope we have managed to add a little value to your life.


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