Sovereign Debt

Phoenix Capital Research's picture

 

It’s time to settle the debate regarding Europe’s banking system. I know that the mainstream media keeps talking about another round of bailouts or an expansion to the Emergency Financial Stability Facility (EFSF) as though these things matter. But the reality is… they don’t. Europe’s problems go WAY beyond Greece’s debt. And the entire European banking system is primed for a systemic collapse.

 

 

FT Reports Europe To Sacrifice Its Banks To Bailout Sovereigns - Under €100 Billion In Bank Recap Funding Available

It's 3pm: do you know where you last hour of trading bailout rumor is? Today, the Guardian passes the baton back to the FT, which however has released a report which when digested will be very negative for the zEURo.qq. It appears that in order to accommodate more funds for sovereign bailouts under the total max EFSF guarantee cap, as reported on several occasions yesterday by Zero Hedge, only €100 billion will be set aside for bank recapatialization. There is a problem with this number: it is predicated on the European Banking Authority's estimates of capital shortfalls of between €70-90 billion, the is the same EBA which 4 months ago said Dexia was in sterling health when it passed the 2nd Stress Test in pole position. As a reminder, Goldman predicted a €1 trillion capital shortfall, while Credit Suisse said €400 billion. No matter: the EU will come out with a number from its lower colon, just to make the residual maximum sovereign debt "guarantee" notional appear that much bigger. Too bad, however, that in the process it will once again crush Europe's banks which the market will suspect, rightfully so, that they are undercapitalized even post the recap, anywhere between 90% and 75% and will have to accelerate their asset liquidations to fund themselves one more day in lieu of a functioning interbank liquidity market. And so the risk flaring will shift from Europe's sovereign to Europe's banks, and their main proxy in the US - none other than Morgan Stanley which repeatedly refuted it has any exposure to France... but said nothing about its gross (gross because counterparties will blow up fast and furious) to French banks. End result: this is very bad for Europe because it means they have finally done the math and realize that to get the €2 trillion or so in EFSF insured capital they have to sacrifice their banks. Alas, there is no outcome that saves both the banks, and guarantees future European sovereign issuance under the currently contemplated structure. None.

Global Market Update From Damien Cleusix

To everyone needing a big picture refresh of all that is happening in the world, and to focus on the forest behind the trees of endless headlines, here is Damien Cleusix' latest macro markets update. "We will start with some rumblings on the financial sector in general and banks in particular. For those only interested in the financial market calls they are at the end... THE KEY for the future of the system has we know it will be the decision which will be made in the weeks/months to come with regard to banks. If politicians screw this once more we are afraid that this will be remembered as the final trigger toward a radical change on how our financial system work. This won't happen overnight but be sure that the system you will be living in in 5 years will be RADICALLY different than today's. While the "Occupy Wall Street" movement remains marginal, be sure that it will grow exponentially if politicians make the bad choices. It will grow so much that it might ultimately dictate the political (regulator) agenda. Far fetched? Probably but we have done some far fetched prediction in the past 10 years and they have come to pass to why not try our luck once more. How could politicians and regulators screw it once more? Simply by not letting the losses fall upon those who made the wrong bets. Did they learn from the 2008-2009 mistake? We don't think so and so there is a very high probability that they will screw it again (we apologize for the choice of word but this is really what they are doing, they are paving the way for a whole generation toward insecurity, poverty and despair)."

Summarizing The "Reasons" Behind The Latest Overnight Risk Melt Up

Greek riot resumption? Debunked European bailout rumor? Spain downgrade? Apple miss? Failed German Bund auction? Continued freezing in the interbank market? No, none of these are enough to dent risk appetite overnight, driven one again exclusively by the EURUSD, which has picked over 100 pips overnight. The driver? THe same old that always drives the EUR higher: hopes, rumors and hopes that the rumors are true. Here is Bloomberg with a summary of reality and the opposite, lately better known as "capital markets."

Deutsche Bank To The Rescue: "Will PrimeX Deliver The Next Big Short Miracle Many Of Us Missed In 2007?"

From Deutsche Bank: "The PrimeX indices have experienced a sharp decline since the beginning of October despite an 11% rally of the Standard & Poor’s 500 Index, the biggest two-week rally since 2009. The price drop can be viewed as a catch-up to the overall market selloffs following investors’ growing fear over the sovereign debt crisis in Europe, increasing likelihood of a global recession, and a weak US housing market. The Fitch’s report on the prime RMBS sector published on October 5 and a subsequent article by ZeroHedge on October 7 fueled the panic selloffs in the last few days, during which we have received far more inquiries about PrimeX than the combined inquiries about PrimeX and ABX over the last two years. It appears to us that many investors have suddenly turned their attention to the PrimeX. Investors from around the world have been wondering whether the PrimeX of 2011 will repeat the ABX miracle of 2007."

Moody's Downgrades Spain Two Notches To A1, Outlook Negative

Since placing the ratings under review in late July 2011, no credible resolution of the current sovereign debt crisis has emerged and it will in any event take time for confidence in the area's political cohesion and growth prospects to be fully restored.... Moody's is maintaining a negative outlook on Spain's rating to reflect the downside risks from a potential further escalation of the euro area crisis. The rating agency expects that the next government to emerge after Spain's parliamentary elections on 20 November will be strongly committed to continued fiscal consolidation. Spain's rating would face further downward pressure if this expectation did not materialise. On the other hand, the implementation of a decisive and credible medium-term fiscal and structural reform plan coupled with a convincing solution to the euro area crisis would trigger a return to a stable outlook. In Moody's view, Spain's sovereign rating is more adequately placed in the A rating category than the Aa category given the potential for contagion from further shocks and the domestic fragilities. Long-term economic strength -- a key input into Moody's sovereign methodology -- is no longer considered to be very high but only moderate given the expectation of a lengthy economic rebalancing process. Moody's also notes that most sovereign issuers with a Aa3 rating have much stronger fiscal and external positions than Spain, including very low public debt, sound public finances and a net creditor status vis-a-vis the rest of the world. This constellation renders them far less vulnerable to a confidence-driven funding crisis than Spain.

Guardian Report That Europe Has Agreed On EFSF-As-Insurance-Policy Sends EURUSD Surging

And here we go again. Wondering what caused the surge in the market? Nothing short of this latest rehash of all the previous rumors, this time focusing on the EFSF as an insurance policy, only this time with the added twist that Europe has agreed on implementation (of something which as analyzed previously just does not work). From the Guardian, (and please note the bolded word in the middle): "France and Germany have reached agreement to boost the eurozone's rescue fund to €2tn as part of a "comprehensive plan" to resolve the sovereign debt crisis that the eurozone summit should endorse this weekend, EU diplomats said. The growing confidence that a deal can be struck at this Sunday's crisis summit came amid signs of market pressure on France following the warning by ratings agency Moody's that it might review the country's coveted AAA rating because of the cost of bailing out its banks and other members of the eurozone. The leaders of France and Germany hope to agree a deal that will assuage market uncertainties or, worse, volatility in the run-up to the G20 summit in Cannes early next month. France would now have to pay more than a full percentage point – some 114 basis points – more than the price paid by Germany to borrow for 10 years as the gap between the two country's bond yields widened to their highest level since 1992." Said otherwise - this is simply the last ditch "plan" proposed by PIMCO parent Allianz to use the EFSF as a 20%-first loss insurance policy, which as we already demonstrated using arcane concepts such as mathematics, DOES NOT WORK. But hey, it is Groundhog Day all over again.

There Is No Bailout Spoon: The Math Behind The €2 Trillion EFSF Reveals A "Pea Shooter" Not A "Bazooka"

The latest and greatest plan to bail out Europe revolves around using the recently expanded and ratified €440 billion EFSF, and converting it into a "first loss" insurance policy (proposed by Pimco parent Allianz which itself may be in some serious need of shorting - the full analysis via Credit Sights shortly) in which the CDO would use its unfunded portion (net of already subscribed commitments) which amount to roughly €310 billion, and use this capital as a 20% "first-loss" off-balance sheet, contingent liability guarantee to co-invest alongside new capital in new Italian and Spanish bond issuance (where the problem is supposedly one of "liquidity" not "solvency"). In the process, the ECB remains as an arm-length entity which satisfies the Germans, as it purportedly means that the possibilty of rampant runaway inflation is eliminated as no actual bad debt would encumber the asset side of the ECB. A 20% first loss piece implies the total notional of the €310 billion in free capital can be leveraged to a total of €1.55 trillion. So far so good: after all, as noted Euro-supporter Willem Buiter points out in a just released piece titled "Can Sovereign Debt Insurance by the EFSF be the "Big Bazooka" that Saves the Euro?" there is only €900 billion in financing needs for the two countries until Q2 2013. As such the EFSF would take care of Europe's issues for at least 2 years, or so the thinking goes. There are two major problems with this math however, and Buiter makes them all too clear....Buiter's unpleasant, for Allianz, Merkel and Sarkozy conclusion is that "that would likely not fund the Spanish and Italian sovereigns until the end of 2012. It would not be a big bazooka but a small pea shooter."

S&P Downgrades Over 20 Italian Banks, Says Difficult Climate Is Neither "Transitory" Nor "Easily Reversed"

Another day, another pervasive downgrade action by S&P. "In our opinion, renewed market tensions in the eurozone's periphery, particularly in Italy, and dimming growth prospects have led to further deterioration in the operating environment for Italian banks. We also think the cost of funding for Italian banks will increase noticeably because of higher yields on Italian sovereign debt. Furthermore, we expect the higher funding costs for both banks and corporates to result in tighter credit conditions and weaker economic activity in the short-to-medium term. We do not believe that this difficult operating climate is transitory or that it will be easily reversed. In our view, funding costs for Italian banks and corporates will remain noticeably higher than those in other eurozone countries unless the Italian government implements workable growth-enhancing measures and achieves a faster reduction in the public sector debt burden. Consequently, we envisage a situation where the Italian banks may well be operating with a competitive disadvantage versus their peers in other eurozone countries. At the same time, we think all banking systems across the eurozone, including Italy, may raise their commitment to reinforcing banks' capitalization."