Europe Crisis Deepens

According to Bloomberg, The Euribor, the European equivalent of the Libor (remember that from 2008?) is locking up as banks decline to lend to each other. Those European banks that do have money are putting it in the ECB overnight in preference to lending it to the European banks that desperately need it – such as Santander in Spain and all the Italian Banks led by UniCredit.

Once the Euroibor starts to freeze that is the signal for non-European banks to stop lending to European banks altogether. Why should they trust European banks if fellow Europeans don’t. Banks have to have overnight funding or they die.

I think we are now closer to the edge of then cliff than we have been at any time since AIG and Lehman’s collapsed.  Without short term and overnight funding Europe’s banks will die within the week, so the ECB will now certainly step up its overnight lending to any and all not as a matter of prudent banking but of political panic. That however will be merely the response to the weekend’s Euribor freeze. I say response because it is not a solution. The banks can’t stay addicted to ECB methadone. The amounts would simply run out of control.

But even before the Euribor crisis happened there was already a larger the problem which had, along with the US downgrade, caused a great part of last weeks massive sell-off and panic in Europe. Namely that the EFSF cannot, unless it is vastly increased – some are saying 2 trillion euros would be the sort of figure –  bail out Italy and Spain.

As I wrote in Fanfare of Failure the EFSF doesn’t have enough money or credibility to be seen as a credible back stop for Italy or Spain. Particularly because when it was set up just last year, as the bail out fund that would save Europe’s banks, Spain and Italy were two of its larger backers. Now they are no longer backers but desperate customers.

Once Spain and Italy ceased to be backers and turned to insolvent customers the EFSF is over as an effective force. The only solvent backers it now has of any size are France and Germany. And lots of people are just waiting for France to suffer a downgrade similar to America’s. Which leaves Germany holding the entire bill.  That won’t fly on the markets and certainly won’t in Germany. So the EFSF is over unless Merkel and Germany can be blackmailed. I don’t think that is going to happen.

What this means is the the ECB will have to start buying massive amounts of Italian and Spanish bonds – the bonds those countries now cannot sell on the open markets. And that is what we rumoured on Friday and led to a modest claw back of 50 points on the Dow. Reports now are that the ECB is going to buy significant amounts. The ECB is talking of ‘dysfunctional markets’ is an all too familiar replay of 08-09.  Nothing has changed. Same debts being hidden, same banks being saved, saved calls for more austerity cuts. From MarketWatch,

Frank Engels, head of asset allocation strategy at Barclays Capital, said in a conference call Sunday that an announcement of further fiscal austerity by Italy and Spain and possibly France is needed to stabilize investor sentiment with regards to Europe.

My question is how will the ECB now step up its buying and keep it rolling forwards so that in effect ceases to be short term loans and liquidity and become a stand in for the failed EFSF for long term transfer of private bank debts to the public (ECB) vault?

You see the ECB is not tied to any particular nation, nor Treasury nor tax base. The ECB works by governments or more recently banks (who do it through their nation’s central bank) depositing ‘assets’ in the ECB against which the ECB issues Euros. The idea is that the ECB issues Euros but always against high quality assets. By regulating how much is on deposit, it controls how much euro cash is out there. And since it was all supposed to be short term (essentially Repo arrangements – Repurchase agreements where assets are ‘bought’ by the bank under agreement to resell at a fixed later date and price) it is not a bail out because the assets are going to be re-purchased by the bank which originally deposited them.

That’s how it was. But it’s easy to see that all you have to do is keep rolling over one repo to a new one and those ‘assets’ can remain in the ECB and the bank or nation that put them there can keep a permanent bail out.

That is what I suspect is now going to vastly expand. The ECB will say any expansion will be only temporary while the markets are ‘dysfunctional’. But that will be a knowing lie because the markets aren’t dysfunctional, they are reacting to the fear that Europe’s banks can no longer rely on nations to hide and pay off their losses for them.

One interesting detail before I go. The UK is not a backer of the EFSF. A fact the UK government has made much of in the sense of saying how Europe must solve its own problems and the UK will not have to pay. BUT, the UK IS a backer of the ECB. Here are the three largest plus GB.

Bank                        % Capital   Paid up Capital

Deutsche Bundesbank

18.9373

1,406,533,694.10

Banque de France

14.2212

1,056,253,899.48

Banca d’Italia

12.4966

928,162,354.81

Bank of England

14.5172

58,580,453.65

The BoE figures look wrong. The BoE ‘owns’, has as large a percentage of investment in the ECB as France. Almost as large as Germany.  But the actual amount seems far too small. That is because Non-EU members, like the Uk don’t have to actually pay up theirn full amount.

BUT… I wonder if as part of an emergency measure the BoE would be asked to step up along side the Bundesbank and the Bank of France (especially if France faces growing rumour of its own downgrade) and pay up its full amount?

If it did – and this is 100% speculation – what assets would it put up?

You see to expand its ‘lending’ to Italy and its banks, the ECB must get large new deposits of assets in to its vaults to back the Euros’s it lends out. But what sort of worthless junk can Italy or Spain offer. Their own debt is in trouble and the debt of their private banks is the problem in the first place. Of course the ECB will accept their junk as it has already been doing for months from Greece and Portugal already. But the more it does the more it endangers its own credibility. At some point the ECB will need some real collateral. If all it can do is turn to Germany and Franc then has the same sort of problem as the EFSF.

I wonder if the BoE would be asked to dip in to the immense pile of hundreds of billions on US debt that the BoE has been buying up over the last two years.

The BoE has had all those hunderds of billions of US debt/bonds on its books as AAA rated assets. Could the ECB use them for a while? You can see where I’m going with this.  Once again, but now on the ultimate scale, we would have one lender of last hope (the ECB) using the IOU’s of another Lender of last hope (the US) to prop up its solvency.

We are once again close to the edge and the crime of it is that the problems we have now are the same as we had three years ago only now made bigger and more painful by having had three years of yet more debt creation and transfer of public money to pay off private debts.