Italy

Better stock up on the Depends now. 

Herb Stein’s Law is in full alert: "If it isn’t sustainable, it will end."

George Soros has been a busy man the last few days. Appearing at the INET Conference a number of times and penning detailed articles for the FT (and here at Project Syndicate) describing the terrible situation in which Europe finds itself - and furthermore offering a potential solution. Critically, he opines, the European crisis is complex since it is a vicious circle of competing crises: sovereign debt, balance of payments, banking, competitiveness, and structurally defective non-optimal currency union. The fact is 'we are very far from equilibrium...of the Maastricht criteria' with his very clear insight that the massive gap, or cognitive dissonance, between the 'official authorities' hope and the outside world who see how abnormal the situation is, is troublesome at best. Analogizing the periphery countries as third-world countries that are heavily indebted in a foreign currency (that they cannot print), his initial conclusion ends with the blunt statement that "the euro has really broken down" and the ensuing discussion of just what this means from both an economic and socially devastating perspective: the destruction of the common market and the European Union and how this will end in acrimonious recriminations with worse conflicts between European states than before.

Of the twenty-five largest banks in the world there is only one that does not need to raise additional capital to de-lever to a 20x leverage and a 5% of Tangible Capital Ratio and that is Citigroup which has a current leverage of just 13 times and I also point out that Wells Fargo with a 14 times leverage needs a minor amount of capital to accomplish these goals. At the far other end of this scale is Deutsche Bank which is levered 62 times and would need a massive amount of new capital and tremendous shrinkage to accomplish these goals. The assets of DB are also equivalent to the entire GDP of Germany so that the bank could devour the country if Deutsche Bank were to hit the wall. Then the most leverage can be found at Credit Agricole at 66 times which would also swamp France, given its size, if asset values continue to decline or if Spain or Italy need to be bailed out and the contagion worsens.

Volatility is back. The S&P moved more than 1% on 4 of the 5 days, had the biggest down day of the year, and even the least volatile day was a 0.7% move.

It appears the chaotic volatility of last Summer is rearing its ugly head once again as credit and equity markets in Europe flip-flop from best performance in months to worst performance day after day. With Spain front-and-center as pivot security (as we have been aggressively noting for weeks), sovereigns and financials are lagging dreadfully once again. The Bloomberg 500 (Europe's S&P 500 equivalent) back near mid January lows, having swung from unchanged to pre-NFP levels back to worst of the week at today's close, European banks are leading the charge lower as the simple fact that liquidity can't fix insolvency is rwit large in bank spreads and stocks. Treasuries have benefited, even as Bunds saw huge flows, outperforming Bunds by 18bps since pre-NFP but it is Portugal +33bps, Spain +22bps, and Italy +9bps from then that is most worrisome. LTRO Stigma remains at its 4 month wides but financials broadly are under pressure as many head back towards pre-LTRO record wides. Europe's VIX is back up near recent highs around 30%. With too-big-to-save Spain seeing record wide CDS and even the manipulated bond market unable to hold up under the real-money selling pressure, the ECB's dry powder in SMP looks de minimus with only unbridled QE (since banks have no more collateral to lend) and the ECB taking the entire Spanish debt stock on its books as a solution, access to capital markets is about to case for Spain (outside of central-bank-inspired reacharounds) and as we noted earlier - every time the ECB executes its SMP it increases the credit risk for existing sovereign bondholders (and implicitly all the Spanish banks). Spain's equity market is a mere 5% above its March 2009 lows (55% off its highs).

As Spanish CDS surge and bonds shrug off the very recent gloss of a 'successful' Italian debt auction, the sad reality we pointed out this morning is the increasing dependence between Spanish banks, the sovereign's ability to borrow, and the ECB. As ING rates strategist Padhraic Garvey notes this morning, the bulk of the LTRO2 proceeds were taken down by Italian (26%) and Spanish (36% of the total) and the latter is even more dramatic given the considerably smaller size of Spanish banking assets relative to Italy. The hollowing out of the Spanish banking system, via encumbrance (ECB liquidity now accounts for 8.6% of all Spanish banking assets), is a very high number - on par with Greek, Irish, and Portuguese levels around 10% where their systems are now fully dependent on the ECB for the viability of their banks. His bottom line, Spain is not looking good here and while plenty of chatter focuses on the ECB's ability to use its SMP (whose longer-term effectiveness is reduced due to scale at EUR214bn representing just 3% of Eurozone GDP), consider what happened in Greece! The ECB did not take a Greek haircut and so the greater the amount of Greek debt the ECB bought, the greater the eventual haircut the private sector was forced to take. By definition, every Spanish bond that the ECB buys in its SMP program increases the default risk that private sector holders are left with.

• ECB Seen Favoring Bond Buying Over Bank Loans (Bloomberg)
• Italians Rally Against Monti’s Pension-Overhaul Limbo (Bloomberg)
• Spain Cracks Down on Fraud as Rajoy Says Aid Impossible (Bloomberg)
• Europe’s Capital Flight Betrays Currency’s Fragility (Bloomberg)
• China’s Less-Than-Forecast 8.1% Growth May Signal Easing (Bloomberg)
• China Banks Moving to Lower Mortgage Interest Rates (China Daily)
• Fed Officials Differ on Need to Keep Rates Low to 2014 (Bloomberg)
• North Korea Confirms Rocket Failure (Reuters)
• Yuan Lending Set to Cross New Border in Pilot Plan (China Daily)

On Easter Friday we presented the parabolic egg that Italy laid in March in the form of Italian bank borrowings from the ECB, which had surged by a record €75 billion to €270 billion from €195 in one month. Of course, since the US market was closed and everyone was preoccupied with the ugly NFP report, nobody paid much attention. Today, however, everyone is paying attention as Italy's counterpart in the unsalvageable periphery - Spain, just posted its monthly consolidated Eurosystem borrowings update for March. And if last week's Italian data was the Easter egg, today's parabola is the Friday the 13th funny, because Spain bank borrowings from the ECB in March soared by... €75 billion, or precisely the same amount as Italy, to €227.6 billion, the highest ever, and a 50% increase over the €152 billion in February. The result: Spain CDS touching 491 bps according to CMA, just 2 bps shy of the November all time wides. Other securities impacted: 10 Year Spanish yield + 10 bps to 5.92%, and a spread over bunds now well into the 400 bps, or 418 bps to be precise. Italy is also catching the contagious bug, with its own 10 year starting to grind wider yet again, now at 5.47%. We have the feeling as more wake up this morning, that this latest glaring confirmation that the PIIGS banks now exist solely courtesy of the ECB, will not be liked by many.

So let's talk Greece, Paris and Natural Gas. 

The introduction of the “Mintchip” is really just another extension of the state’s effort to wield supremacy over private affairs.  It is creeping socialism under the guise of efficiency.  But, as anyone familiar with the nature of state understands, government efficiency is an illusion.  As anonymity in free transactions goes, so goes another barrier on further centralized planning. The trick here is that nothing government does is voluntary.  The forced usage of the Canadian dollar via legal tender laws renders the assertion of “voluntary” laughable.  The Mint claims the chip can be used anonymously but this assurance comes from the institution in cahoots with a central bank that can’t manage a simple metal standard for more than a few decades. 

A Monetary Cliff or a Fiscal Cliff: these are the two poisons that Barton Biggs sees rushing straight toward America, with little hope of an uneventful collision. While we have not been shy of our opinions on Barton Biggs' flip-flopping positions, his note on the US "as a nation of totally self-centered special interest groups that terrorize our politicians" struck a chord and deserves praise in its clarity. Noting that Europe seems stuck again, he points to the US market being data and Europe-dependent for the next month and believes the correction is little less than half way over (in terms of size not time). In Biggs opinion "although the Monetary Cliff is more long-term dangerous, the proximity of the Fiscal Cliff, if not dealt with, will trigger the dreaded double-dip recession we are all terrified of and bring on another financial crisis."

"In the last three plus years, central banks have had little choice but to do the unsustainable in order to sustain the unsustainable until others do the sustainable to restore sustainability!" is how PIMCO's El-Erian introduces the game-theoretic catastrophe that is potentially occurring around us. In a lecture to the St.Louis Fed, the moustachioed maestro of monetary munificence states "let me say right here that the analysis will suggest that central banks can no longer – indeed, should no longer – carry the bulk of the policy burden" and "it is a recognition of the declining effectiveness of central banks’ tools in countering deleveraging forces amid impediments to growth that dominate the outlook. It is also about the growing risk of collateral damage and unintended circumstances." It appears that we have reached the legitimate point of – and the need for – much greater debate on whether the benefits of such unusual central bank activism sufficiently justify the costs and risks. This is not an issue of central banks’ desire to do good in a world facing an “unusually uncertain” outlook. Rather, it relates to questions about diminishing returns and the eroding potency of the current policy stances. The question is will investors remain "numb and sedated…. by the money sloshing around the system?" or will "the welfare of millions in the United States, if not billions of people around the world, will have suffered greatly if central banks end up in the unpleasant position of having to clean up after a parade of advanced nations that headed straight into a global recession and a disorderly debt deflation." Of course, it is a rhetorical question.

All it took was a Frenchman losing his nerve, some chatter on QE, and a few more weak US and EU data points, and hope for better Chinese GDP, and sure enough - free-money-flow is back on the table and risk assets are responding. European equity and credit markets have all but totally recovered to their Thursday closing (pre-NFP-plunge) levels. European sovereigns are mixed with Portugal 27bps wider than pre-NFP, Spain unch, and Italy -11bps but EURUSD is higher on the day and now back above last Thursday's highs as we note Europe's VIX dropped in sync with US VIX today - still maintaining relatively elevated levels historically relative to the US.

This is the mother of all bombshells in Europe and no one is talking about it. Germany basically announced that it will allow German banks to DUMP euro-zone government bonds off their balance sheets. It also announced it will provide up to 400 billion euros in backstops and 80 billion euros for bank recapitalization.