A Few Quick Reminders Why NOTHING Has Been Fixed In Europe (And Why LTRO 3 Is Not Coming)
While Europe is once again back on the radar, having recently disappeared therefrom following the uneventful Greek CDS auction (which in itself was never an issue - the bigger question is any funding shortfall to fund non variation margined payments, as well as the cash to make whole UK and Swiss law bonds) following Buiter's earlier announcement that Spain is now in greater risk of default than ever, coupled with Geithner and Bernanke discussing how Europe is 'fine' in real time, here are three quick charts which will remind everyone that nothing in Europe has been fixed. In fact, it is now worse than ever. As a reminder, when thinking of Europe, the shorthand rule is: assets. And specifically, the lack thereof. Why is the ECB scrambling to collateralize every imaginable piece of trash that European banks can procure at only some valuation it knows about? Simple - quality, encumbrance and scarcity. When one understands that the heart of Europe's problem is the rapid "vaporization" of all money good assets, everything falls into place: from the ECB's response, to Europe's propensity for infinite rehypothecation, to the rapidly deteriorating financial system. It also explains why America will be increasingly on the hook, either via the Fed indirectly (via FX swaps), or indirectly via the IMF (such as two days ago when US taxpayers for the first time funded the first bailout check to the ECB using Greece as an intermediary).
We discussed the quality of European assets recently, first showing that they have aged to a record degree, since European corporates simply do not have the cash to spare to reinvest, replenish and renew their asset base. We have also previously discussed the huge encumbrance (or progressively declining ability to incur addition liens) of European bank assets, which are now increasingly pledged to the ECB, as well as the European eagerness to engage in ultra-rehypothecation (specifically in the MF Global context but also everywhere else). The latter is nothing short of a direct consequence of two things: unprecedented high leverage (recall that UK consolidated debt/GDP is nearly 1000%!), and more importantly, that Europe just does not have the "free" assets it needs to be able to extract more credit money by pledging said assets to third party intermediaries, either in the open banking system, or the shadow banking system (and now that the skeletons in the closet in the European shadow banking system are finally coming to light, the ICMA feels obligated to defend Europe's repo market where the real bodies are buried).
But why this distinct difference between the European banking system, and America's, where one can say that things have gotten progressively better in recent years (if even with $1.7 trillion in fungible excess reserves, which once again courtesy of shadow banking repo ledger entries, allow banks to plug capitalization shortfalls, courtesy of money's fungibility). Simple - presenting a chart showing the difference in sources of coarporate debt between the US and Europe.
What is immediately obvious here, is that unlike in the US, where these are less than 30% for corporates, in Europe, bank loans account for nearly a whopping 90% of total corporate funding! These are secured, LTV loans, made by banks, and not syndicated, which means they are kept on the banks' balance sheets. As a result the bulk of Europe's assets held by levered entities, are already encumbered through existing security arrangement in the debt market (recall that bond debt is for the most part unsecured, and is thus a junior piece to secured bank loans). It also explains why European banks have to scramble to find new assets which they can "pledge" to the ECB in exchange for some additional cash to plug this liquidity shortfall hole, or that. And unfortunately, since the liability side of European balance sheets demands constant cash outflows, unless this is matched by consistent asset inflows, the "transitory" liquidity holes will appear more and more often, until the ECB is finally forced to print uncollateralized money to preserve the illusion of wholesale solvency, sending all of Europe in a hyperinflationary mushroom cloud. In this context, it is also clearly obvious why liquidity band aids such as the LTROs are completely meaningless.
So can Europe change the funding structure of its corporates? No. Here's why: a historical chart showing the distribution of funding for Europe's corporates. There is just too much history and legacy here for Europe to suddenly go "American" and start issuing HY bonds.
And while one can wax philosophical for many more pages, we will end here, because the problem is front and center. Repeat after us:
EUROPEAN COMPANIES HAVE ALMOST RUN OUT OF ASSETS!
Actually, there is one more thing. Deposits, or specifically, the Loan to Deposit Ratios of European banks. The chart below explains why not only is Europe's several asset constrained, it is also running out of funding, in the form of depositor cash: the most critical bank liability. Remember: without incremental deposits, banks can not invest in new assets, unless they generate cash from operations, and thus grow shareholder equity. There is a problem: as the final chart below shows, Europe, and especially Scandinavia which has consistently remained off the radar, is literally off the charts when it comes to LTD ratios.
With banks such as Danske, SHB, Swebank, DnB, and Nordea literally at 200% Loan-to-Deposits, but most other European banks too, even the tiniest outflow in deposit cash (ala what is happening in the PIIGS) will send the system into yet another liquidity spasm. Only this time, since what little unencumbered assets remaining have already been pledged to the ECB, there will be no quick LTRO collateral-type fix this time.
And judging by the market's reaction today, more muppets, pardon, people are starting to grasp this.
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