Has The Imploding European Shadow Banking System Forced The Bundesbank To Prepare For Plan B?

Tyler Durden's picture

While much has been said about the vagaries in the European repo market elsewhere, the truth is that the intraday variations of assorted daily metrics thereof indicate three simple things: a scarcity of quality assets that can be pledged at various monetary institutions in exchange for cash or synthetic cash equivalents, a resulting lock up in interbank liquidity, and above all, a gradual freeze of the shadow banking system. As we have been demonstrating on a daily basis, we have experienced all three over the past several months, as the liquidity situation in Europe has gotten worse, morphing to lock ups in both repo and money markets. As a reminder, both repo and money markets (for a full list see here), are among the swing variables in shadow banking. And shadow banking is nothing more than a way to expand credit money while undergoing the three traditional banking "transformations" - those of maturity, liquidity and credit risk, although unlike traditional liabilities, these occur in the "shadow" or unregulated area of finance, interlocked between various institutions, which is why the Fed has historically expressed so much caution when it comes to discussing the latent threats in it.

Indicatively, of the $15.5 trillion in shadow US liabilities (by far the biggest such system in the world), $2.6 trillion are liabilities with money market mutual funds and just $1.2 trillion are repos. Indicatively, traditional plain vanilla bank liabilities amounted to $13.4 trillion as of Q2 (an updated for Q3 is imminent). As such, the focus on repo while useful, misses the forest for the trees, which is that not the repo market, but the entire shadow banking system in Europe is becoming unglued.

What explains this? Two simple words, which form the foundation of modern finance - "risk" and "confidence", and in Europe both are virtually nil. Seen in this light, the unwind of the shadow system explains much: the inability of Germany to place bunds, the parking of cash with the ECB, the freezing of repo, the plunge in the currency basis swaps, the withdrawal of money markets, the blow out of various secured-unsecured lending indicators, etc. All of these fundamentally say the same thing: there is too much risk and not enough confidence, to rely on the abstraction that is shadow risk/maturity/and liquidity transformation. All this is easily comprehended. What is slightly more nuanced, is the activity of the ECB and especially the Bundesbank in the last few weeks, whereby as Perry Mehrling of Ineteconomics demonstrates, we may be experiencing the attempt by the last safe European central bank - Buba - to disintermediate itself from the slow motion trainwreck that is the European shadow banking (first) and then traditional banking collapse (second and last). Because as Lehman showed, it took the lock up of money markets - that stalwart of shadow liabilities - to push the system over the edge, and require a multi-trillion bailout from the true lender of last resort. The same thing is happening now in Europe. And the Bundesbank increasingly appears to want none of it.

So just what is happening? Mehrling first explains the European funding status quo:

Apparently everybody, borrowers and lenders, public and private, wants the ECB as their counterparty.  Reluctant though the ECB may be to step into that role, and vocal as the ECB has been about that reluctance, what we are seeing in practice is that it has no choice, literally. 


Clearing imbalances within the Eurozone that cannot be resolved in the interbank market show up mechanically as imbalances between national central banks on the books of the ECB (see here  for details).  The ECB lends to the central bank of the deficit country and borrows from the central bank of the surplus country, so expanding its own balance sheet on both sides.   (Think Greece on the asset side, and Germany on the liability side.)


Something quite similar happens when private banks settle private clearing imbalances not by shifting reserves from deficit to surplus but rather by the deficit bank borrowing from the ECB and the surplus bank lending.  Again, the ECB balance sheet expands on both sides.


Why is this happening? 


The underlying problem is that deficit central banks and deficit private banks increasingly have nothing to sell (or to pledge) that surplus central banks and surplus private banks want to buy (or accept as collateral for a loan).   The ECB is also reluctant to buy--it is serving as pawnbroker of last resort , not dealer of last resort.


The consequence is that the ECB  is more or less forced to lend, against more or less whatever collateral is offered; even bad collateral is better than no collateral.  (The famous Bagehot Principle offers an out, since it urges valuation of collateral at non-stress prices.) 

So far so good: this is the system that as noted above is slowly crumbling. So what is happening next? One read is the following:

Now comes the latest deal over eurozone fiscal rules , presumably the deal that ECB President Draghi asked for last week .  It is a deal about sovereign budget discipline.  But if I read Draghi's speech right, we should not expect him to be buying sovereign debt.  (That will be the IMF's job, if anyone's, and with strict conditionality; details to be sorted later.)


Instead, he'll be buying bank debt, specifically the debt of the banks that hold the sovereign debt.  Banks currently borrowing from their own national central banks will therefore be able to repay, and consequently the national central banks will be able to repay the ECB.  This takes national central banks out of the picture on the asset side.


What about the liability side?  Here, perhaps in a longer time frame, I think the logical move is again to take the national central bank out of the equation, by replacing liabilities to the Bundesbank with deposits to the credit of private banks.    Freed from the responsibility to fund ECB loans to other central banks, the Bundesbank will be able to return to its preferred asset holding, German sovereign bonds.

One conclusion that is possible is that one proposed by Mehrling: "we're not going to be using the payment system to hide imbalances any more.  The ECB is going to serve as a proper lender of last resort to the banking system, affirmatively and up front rather than mechanically and through the back door.  But it will be doing so only to the banking system, not to sovereign debtors." It would be expected that some combination of EFSF/IMF funding would sourced the balance. In effect the ECB would intermediate itself directly in the national bank bailout scheme, allowing it to be more like the Fed, which has been the primary complaint against the ECB all along.

There is also one other explanation: the Bundesbank wants slowly and quietly out.

As a reminder, while the Fed is the one central bank in the world which supposedly has the biggest amount of gold in possession with 8.1 thousand tonnes, Buba is #2  with 3,401 tonnes. In other words, it has a solid backing to its fiat asset representation. However, unlike the Fed, the Bundesbank is part of a nation that has a natural trade surplus and thus is cash flow positive from a current account perspective. One may say that Germany, far more than the US and the UK, is the world's truly AAA-rated nation. All this means that the Bundesbank, if disambiguated from the ECB, where it currently is accountable for funding a major portion of deficit nations' funding deficiency, would regain its status as the world highest quality monetary institution. And going back to the beginning, it is the Bundesbank which is effectively depleting "good money" in exchange for "bad" either in the form of undervalued collateral through the repo markets, or soon to be devalued fiat.

Here one has to keep in mind the primary prerogative of the Buba - keep inflation low. If that means detaching from a failing currency, or halting asset-liability matching in which it hands out good money in exchange for worthless assets, so be it.

Which is why another interpretation of the ECB's proposal is not to bring the ECB as a lender of only resort closer to the peripheral, deficit nations, but to commence proceedings for severing the umbilical cord of the Bundesbank with a Eurozone which is doomed in all but the most optimistic eyes. Bringing us to our question: for anyone wondering what the future of the Eurozone is, should they merely observe what steps  the German central bank is stealthily starting to take. Because if indeed the Buba wants to have as little as possible with Europe, what does that mean for the EUR, and for Europe itself?

Full video explanation below:

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tawdzilla's picture

Plan B??  Aren't we on Plan Z by now?

SheepleLOVEcheddarbaybiscuits's picture

this europe mess is getting really complicated.....maybe thats what theyre trying to do, make it too complicated for anyone to comprehend

CPL's picture

How is theft complicated?


You take without asking.  Couldn't be simpler.

clownfishheaven's picture

The complication lies in the pretence in generating alien excuses to justify said theft.

disabledvet's picture

"the mind martians made me do it"? what's wrong with that?

Misean's picture

So it's Plan 9 from Outer Space then?

Oh regional Indian's picture

Actually it's just Plan Six from the Stix. Just sexed up is all. All of this Euro focus, screaming, headline grabbing.... I'm sure the real shit is hitting th efan elsewhere. This much daily drama is a desperate mask.

What is that, that they are hiding?



sqz's picture

I'm not surprised people are confused. Merhling's article contains a lot of silliness.

There was no indication in Draghi's speech that he would be in the least bit interested in permanently expanding the ECB's balance sheet with non-sovereign debt (excluding the existing covered bond programs). If anything, many market participants read it and the most recent political announcements as laying the bare minimum fiscal groundwork and shared risk for large sovereign debt purchases.

Backstopping the banks is still a fiscal choice, even if it were implemented by the ECB. In that latter case, it would be a joint and several fiscal risk at the EMU level. Even to the ECB, this would be a step too far in fiscal involvement. It would be far more likely that the EFSF or another vehicle would buy at least the senior bank debt. It is this effective (joint) nationalisation that the politicians would have to work out how to do.

As for this strange solution of replacing the NCBs with private banks (yes, I know many CBs are "private" entities in law, but they are fully state backed and central authority), what is the point? These semi-NCBs would no longer be private any more and it would permanently crystallize the concept of TBTF/G-SIFI.

The Bundesbank is not the problem here. They may have some issues with the TARGET2 imbalances impacting on the flexibility of their monetary tools and having to keep mopping up the excess liquidity, but its nothing they cannot handle for the foreseable future, especially if they coordinate it with the ECB who also have unused sterilization tools.

I'd go as far as to say, there is absolutely nothing inherently wrong with the Eurosystem inter central bank framework. Of course, I couldn't say the same for having a currency area with no political or strong fiscal union in the first place.

Ghordius's picture

I completely agree with you, except with the "currency area with no political or strong fiscal union" part.

Yes, "the markets" have treated the peripherals "too well" for a decade (Squid "advise" to Greece was just the topping), so we'll have now a long period of "the markets" treating the complete EZ "badly". The "treatment" can be the "cure".

Central Banking advocates would say that's why you have CBs in the first place...

At the end, it's all about how you mop up this kind of mess (not really the first time):

- defaults (banks and/or sovereigns)

- or nationalization of (bad) banks

- or inflation

- or a combination of the above

sqz's picture

Please don't tell me after already 3 years of Eurozone sovereign crises hell and more to come, let alone the inevitable enormous consequences of the crises on not just their own real economies but on the entire world, that you believe the Eurozone is in any way sustainable without being a much stronger union?

There is simply no rational argument otherwise. Period. Either the Eurozone rapidly converges to at minimum a strong fiscal union or it will inevitably break apart due to its enormous structural imbalances.

Also, the solution cannot be driven by structural changes, almost every union everywhere has large outstanding structural issues that are extremely difficult to eliminate. For example, England vs Scotland, Northern Italy vs Southern, Flanders vs Wallonia, West Germany vs East, etc. The only reason these regions have a common currency is a political union. Even simply attempting to fix the imbalances causes serious fiscal problems.

So, from the outset, political convergence with a minimum of a strong fiscal union is not only what is historically proven to be required but is also expected by the global markets or the Euro will fail since a currency only has value while people (especially others) believe in it. If all your trading counterparties first ignore your debt, then start demanding even a small part of your trade must be denominated in external currencies or commodities, then your currency has failed. Just ask the South Americans, Asians and now Greeks how that worked or is working out!

The markets are just a function of confidence, expectations and time. It is not some conspiracy. We could go back a 50 years, 100 years, 1000 years and the exact same process we are witnessing today can be shown to have happened then as now. The only difference now, even with greater access to global resources, is that events happen faster and are more globally interconnected.

the tower's picture

Why is it that the US and the UK are running after Europe, flying in and out, practically begging Europe to do this and that? They NEVER run after Europe...

When the UK and the USA start to beg you KNOW who's in DEEP shit...


Think about it: the UK does not produce anything. The city gives the UK 30% of the GDP... 30%...


If the financials get worse the UK will be left with NOTHING, and it's not much different in the USA.

walküre's picture

The vast majority of people can't understand the judging on Dancing with the Stars. You honestly think they'd have any brains to get this?

Now the elite is a different matter. They thought their advisors would be able to make sense of it all and now they're at a total loss. The advisors wouldn't want to look like complete idiots to their masters so they make stuff up.

NOBODY understands this except for the money changers who have invented every scheme in the history of mankind to steal money from you and me without us knowing.



pods's picture

Clarke and Dawes explain the European fiat-sco very well.  



walküre's picture

Thanks for that. I passed it to an Australian friend.

But that was not my point. EVERYONE understands that too much debt gets you in trouble and too much lending among each other is but a circle jerk of debt.

That's what the world has become, a circle jerk of debt.

The elite understands debt and lending and eternal debt slavery - of course.

What NOBODY understands are these alleged plans to keep the show going now that everyone is tapped and everybody owes everybody debt payments.

Merkozy is a puppet. They play their part, they're actors. The plans are schemes from the grand masters of financial wizardry that have been bamboozeling the world with financial schemes forever! Why do we have leverage on monetary "products"? Why can a banker lend out multiple times the asset value their bank is holding? It starts right there and it evolved into further perversions that are clearly from sick and demented minds.


pods's picture

Agree totally with you.  When I got halfway through the article my head started to hurt.  Then seeing others here explaining it made me get that sad feeling that many WANT to believe that somehow this will work out.  So we can all go back to being good little debt serfs, slowly being sapped of our labor over the years so some bankster may aquire more power.

I think that this charade has to be done, so it looks like "they" are actually trying to solve a problem.  

What they are going to do is the same thing that the USA did in 2008.  Provide oodles of liquidity to banks and allow them to deleverage while we think things are getting better.  When the banks (the real ones, not the little guys) are healed, then comes the money spigot shutoff (austerity).  Then real property can be taken possession of and a new, bigger system will be implemented to save us.  The majority of people, being simple, will claw for this newer, better, more stable system that merely provides them more security.  

Each iteration of this process removes more property from the masses and concentrates it at the top.  There is no real endgame to this, as a new crop of debt serfs are born every year, being educated just enough to jump on the debt wheel to power some rich ass bankster's house.

Knowing all this, I merely try to inject a bit of humor every now and again to keep someone from sucking on a gun barrel.

BTW, check out their skit "The Front Fell Off" too, it is absolutely hillarious!



TrulyBelieving's picture

Agree with just about averything you say. Now when you say 'Merkozy is a puppet' I'll assume that not only her, but all the players in this insidious scheme are puppets. The problem I have with this is, I can't believe that she would get a call or message, somehow from her supposed boss every day or so telling her what she must do. Can't envision all the players getting their orders in this manner... but I might be wrong. Just thinking it's more like a culture that teaches one to behave and do in a way that the culture accepts as normal. Any odd behavior out of what is expected would not be tolerated, indeed would not even be thought of, by any person desiring inclusion in this culture. So what is driving them, or 'pulling their strings', is the own desire to please the culture. Now what drives this wicked culture is another matter, a matter of the heart. This is the perfect culture for a base human, all the human instincts being used to satisfy man-based cult. And morality would drive someone away from this culture. For a heart that desires justice, honesty, and integrity could find no peace in such a place. Just wonder if this is really what it comes down to, each individual choosing which culture to belong.

the tower's picture

PS here you can clearly see that "our leaders" actually get direct commands from their bosses: http://www.youtube.com/watch?v=QTcL6Xc_eMM

the tower's picture

I agree, Merkozy are working on solutions to not let this happen again - if we are to believe that - but no-one is working on finding solutions to the shit that we're in... because there aren't any... it's the biggest show on earth...

stuman's picture

I might be wrong but it seems to me...that as long as all (or most) of the parties sitting at the Monopoly table "keep" playing, keep opening up new game boards and using the new money...that the game can just keep going. It doesn't matter how much debt you have IF you just continue to borrow/print and keep the game rolling.

Everyone's going along with it because everyone knows they're screwed once the game ends...the answer?

Never let the game end ;)

At some point it'll crash, someone will have to leave the table to eat or go to the bathroom...one might even have a heart attack from too many energy drinks and no sleep...

But till then, might as well ride it till it breaks ;)  

masterinchancery's picture

Just a shell game, not complicated in any other sense.  Europe has far too much debt, generally stagnant economies, and rapidly aging and retiring populations.  Because of the bad demographics, the eurozone's problems will get worse every year.  So long term bets on its viability are doomed, and that has caused even short term bonds to decline sharply.  What the eurozone and its accomplished liar politicians need is a sucker with a lot of money--paging Bernanke.

Unprepared's picture

Plan B is a continuously recursive option: When all fails, try plan B. When all fails, try plan B. When all fails, try plan B ...

That way, you're not limited to 26 options.

BurningFuld's picture

There is the unlikely possibility of B1 B2 etc. Or B1a B1b..........

Misean's picture

Can't use that. Those are soon to be Euro zone credit ratings.

WhiteNight123129's picture

Good post, I guess that goes in teh same direction of people like Pettis and Bass arguing about a hard default of Greece pronto.


francis_sawyer's picture

Plan B??  Aren't we on Plan Z by now?

We're on Plan "B Cups"... (just ask Becky & Uncle Warren)...

MayIMommaDogFace2theBananaPatch's picture

Plan B?? Aren't we on Plan Z by now?

Plan B-12 is currently on-deck...


Zgangsta's picture

We have run out of alphabet letters to label the plans, so we have switch to Chinese characters (which ZeroHedge apparently doesn't support)

Buck Johnson's picture

They want out and since they don't want to yell it out, they will do it by stealth.  The only thing holding the EU (England too) up is Germany and if they go then everything ends.

Onohymagin's picture

Plan H, Recuscitate Adolph Hitler?

falak pema's picture

15 T shadow banking in Euro land; we live n learn. How does this compare to US?

LawsofPhysics's picture

Last I looked seriously it was over 70 T.  How do you say "fucked" in Chinese again?

LeBalance's picture

"interesting."  Chinese are too polite to say that.

Solarman's picture

LOL, you don't know many Chinese.

francis_sawyer's picture

May you live in 'INTERESTING' times...

Does that explain the correlation between 'fucked' & 'interesting' to you?


See... It's kind of how central bankers feel as well... They want you to live in 'INTERESTing' times... Or, as the Chinese used to say...

"Man who run behind car become EXHAUSTED... Man who run in front of car become TIRED"...

I am Jobe's picture

15T is chump change the way things are going. 16T by Election

disabledvet's picture

well, yeah...actually in the world of ones and zero's and where info tech is King then 16 trillion is actually "el zippo." having said that this is a very well put together missive. my understanding of 2008 however is not that the money markets caused the blow up but the commercial paper market--in other words "counter party risk." you simply didn't trust the other guy to come through with the money. this in fact CAUSED a money market fund to blow up ("break the buck.") this may sound crass but "that's nothing compared to Europe." i mean so what if Lehman failed? and the Fed i might did "did exactly the right thing." i frankly have no idea what Super Mario can do here. Sure "save the banks" sounds good--but when the country of Greece itself failed obviously the banks had long since become worthless. The only "plan" that works is the original one that i can see: "Germany must rescue Greece." It has done everything but. Now Germany itself is at risk cuz "there's no such thing as liquidity" if you're talking "currency union" either. I call this phucker "the ultimate arb play" when it first broke out--and outside of some "crazy government shit" that still holds true. German interests must rise to reflect the risk of existing in the currency union itself. is it like AT&T having to basically bankrupt itself because it failed to take over that other wireless provider? yeah, pretty much. it really doesn't seem all that complicated to me. obviously if you have anything deonominated in euros don't expect it to be getting more valuable for the forseeable future.

nmewn's picture

Saaay, we're startin to talk some serious unbacked paper here.

lewy14's picture

It's all backed. By more paper. It's paper all the way down.

LawsofPhysics's picture

Shadow banking finally realizing that unicorns shitting skittles are not real.  Fine with me, fuck these paper-pushing fucknuts.

Unprepared's picture

And BAC is what? Underworld? Fuck those too.

binky's picture

Buba taking it on the arches.

A Lunatic's picture

Lender of last resort..........True lender of last resort........Ultimate lender of last resort........Final lender of last resort......Super Duper Mega lender of last resort..........This could take awhile.

LawsofPhysics's picture

Wait until America learns that they have been on "double secret probation" all along.

I am Jobe's picture

NAH, Sheeples are still shopping like there is no more fucking waffle irons left in the country along with towels.