Second Straight Hungarian Bond Auction Failure As Citi's Willem Buiter Calls For €2 Trillion European Rescue Facility, Ridicules Stress Tests

Tyler Durden's picture

A week ago we highlighted that Hungary, in addition to liquidity problems, is now back to experiencing solvency issues, after suffering a bond auction failure. Today, Hungary had its second failed auction in a row, after it was unable to raise enough money as had been initially planned. "The state debt management agency sold 40 billion forint ($174 million) of bills, 10 billion forint less than planned, at a yield of 5.41 percent compared with 5.35 percent on June 10." The domino effect in Europe (contrary to the lies by G-Pap) is now in full force and nothing can stop it. Country by country will now need to be bailed out (for a few months - recall that Greece is supposedly solvent, yet its CDS are now wider than ever) or be forced to default. Which brings us to our second point: in a note to clients (attached), Citi's Willem Buiter goes so far as to say that Europe's current €860 billion bail out facility is insufficient by more than half, and a new rescue package will promptly need to be created to the tune of €2 trillion or more. He also slams the ongoing stress tests for the vile, malicious joke (which just so happens is squarely on Europe's middle class) they are.

With banks joining sovereigns as claimants on the EU/IMF Facility (with the funds to the banks possibly routed via the sovereign– funds are fungible but appearances matter) the argument that the Facility is too small and will require at least €2 trillion is strengthened.

Buiter makes it clear why the EU/IMF is woefully underfunded:

Although we have no information with which to contest the IMF’s assertion about the quality of the loan book of the banks in late 2009 and early 2010, it is important for one’s view of the balance sheet strength of the EA banks to recognise that the IMF statements have nothing to say about the quality of the EA banks’ portfolio of securities, including specifically their portfolio of sovereign debt instruments. We now believe that, since October 2009, there ought to have been a general recognition that (1) there may well be no completely safe sovereign debt anywhere, and that (2) there are material differences between the creditworthiness of different G7 member states’ sovereigns and between different EA member states’ sovereigns. There was more than €2.8 trillion worth of sovereign debt of the 5 Euro Area Peripherals outstanding by the end of 2009 (see Buiter (2010)). Reports from the BIS (2010) and from national regulatory sources suggest that EA banks have significant exposure to the sovereign debt of the Peripherals and even greater exposure to their private sectors, which are unlikely to prosper if the sovereign were to be severely challenged in the markets for its debt.

Euro Area banks therefore need additional capital – a lot of it. This may not be apparent from their ratios of regulatory capital to risk-weighted assets but, in our view, both the numerator and the denominator of this ratio are deeply unreliable.
Many EA banks include in their definition of tier-one capital things other than tangible common equity – the only unconditional loss absorber, in our view. In addition, we think the risk weightings are deeply flawed (triple-A rated sovereign debt is assigned a zero risk weighting, for instance) and depend in part on non-verifiable model-based information provided by the banks themselves. Gross leverage ratios provide, in our view, a less distorted picture of the default risk of banks. It is true that, in principle, higher leverage can be achieved without increasing risk, simply by adding matching assets and liabilities to the balance sheet. In the real world, however, there is but one reason banks take on additional leverage: that is, to assume additional risk.

Also, as we reported previously citing Morgan Stanley, which confirmed that the Stress Tests will be a joke as they will not take in account sovereign solvency haircuts, which just so happens, is the primary concern in Europe, Buiter also agrees that European stress tests are nothing but a vile joke.

The exercise is apparently being repeated as we write this, with the results, including the results for individual banks, to be published by  the middle of July 2010. Although this represents a step forward, the stress tests are unlikely to include questions like: how would the solvency position of your bank be affected by a restructuring, with a 30 percent NPV haircut, of the sovereign debt of (1) Greece; (2) Greece and Spain; (3) Greece, Spain and Ireland; (4) Greece, Spain, Ireland and Portugal; and (4) Greece, Spain, Ireland, Portugal and Italy. In the absence of stress tests that include scenarios involving multiple sovereign defaults, we think it is difficult to view even the new exercise as a major confidence-boosting event. Added to this is the problem that the national implementation of these stress tests is left to the same national regulators and supervisors that failed in so  many countries, including Germany, France, Spain, the Netherlands, Belgium and Ireland, to anticipate and prevent the excesses that undermined so many of the institutions they were responsible for regulating and supervising. It does not matter very much whether these regulatory and supervisory failures were the result of incompetence or (cognitive) regulatory capture (see Buiter (2009)). The results of stress tests performed by those who failed to prevent the last crisis are likely to convince few market participants.

One thing is certain: no matter how many fabricated stress tests indicate that STD is actually good for you, the blow up of Europe's banks and countries can not be prevented but at best delayed. With even Citigroup seeing the writing on the wall, it is only a matter of time before the bond vigilantes push Europe beyond the edge and demand another trillion in rescue funding, to be followed by ten, hundred, and then, the death of the currency in which these rescue attempts are being conducted.

Full Buiter note below: