Liquidity Options Running Out For European Banks - "Liquidity Crisis Scene Set"

Tyler Durden's picture

One of the key catalysts for Wednesday's market rout which originated in Europe came following news that Chinese banks had cut down on their credit lines to Europe, which highlighted the key threat to the European banking system: access to liquidity. The Chinese reaction is merely a symptom of a much deeper underlying ailment: the increasing lack of counterparty confidence across various funding markets, both traditional and shadow, which has continued to accelerate over the past week, a development summarized effectively by the latest report in the International Financing Review which uses some powerful words (of the type that European bureaucrats hate) to explain where Europe stands right now: "credit taps run dry for European lenders, setting scene for liquidity crisis." For those strapped for time the take home message is that: "with bond markets shut and investors unwilling to buy asset-backed securities, the repo market – for some banks the sole remaining source of private funding – has become the most recent tap to run dry, with some investment banks pulling credit lines worth tens of billions of euros in recent weeks." This is very disturbing as with liquidity windows shut, Europe's bank have no recourse on how to roll the €4.8 trillion in wholesale and interbank funding which expires in the next two years. End result: the only recourse is the ECB, which unlike the Fed, is not suited to be a lender of last resort and has been morphing into that role over the past year kicking and screaming. And when that fails, there are the Fed's liquidity swap lines. Too bad that the liabilities in the European banking system are orders of magnitude bigger than in the US, and should this liquidity crisis transform into its next and more virulent phase, even the Fed will find it does not have enough capital to prevent a worldwide short squeeze on the world's carry trade funding currency (once known as the reserve currency).

First, IFR summarizes briefly how the last ditch liquidity conduit, repo, has now run out. The fact that even shadow banking system aggregates, or those entirely off the books, are being withheld, is very disturbing:

Bankers who once ran the now-defunct repo facilities for mid-sized European banks say the credit lines were withdrawn after risk managers became concerned about their own exposure to the enfolding sovereign debt crisis, leaving some clients now solely reliant on central banks for cash.


“Given what’s going on in the markets, there are big question marks surrounding some of these clients,” said one banker who has closed such lines. “The appetite from investment banks is fading. There is a great deal of concern about financing wrong-way collateral.”


“Many of the wholesale banks are starting to rethink these credit lines,” added the global markets chief of one European investment bank heavily present in the repo markets. “Things can turn pretty nasty if you get these things wrong.”

This is further distressing since the traditional venue of capital raising in Europe, covered bond issuance has ground to a halt, with not "a single publicly announced European covered bond deal since June."

The culprit for the market freeze is quite simple to anyone who recalls the state of the markets in late 2008 and early 2009, when the Fed and the central bank cartel will had the option of backstopping the global financial system.

“Everyone has been cutting off their exposure,” said the head of another European investment bank. “It started with Greece, then Spain and now Italy. People don’t want to do business with these banks. Many of them have good underlying businesses but they are stuffed.”

At his point however, the global central bank intervention has not already occurred but is actively priced in at any given moment. There is no step function of additional liquidity that the central bankers can provide, which is why the status quo is scrambling so hard to avoid a quantum leap in the risk perception of European banks.

Another indication of the unwillingness to participate in the market is the complete elimination of crap collateral from tri-party repo lines:

The latest repo markets survey by the International Capital Market Association indeed shows a marked pick-up in the use of riskier assets in European tri-party repo deals. Though small as a proportion of the region’s entire €5.91trn repo market, the use of assets with a rating of below BBB– accounted for 5.1% of all transactions in December, up from 1.2% a year earlier.


That has now largely stopped, say bankers once heavily involved in such deals. Previously, they were able to hedge their exposures to such collateral – or repackage the collateral on behalf of clients to sell off in chunks to fund managers. But growing investor concern, and a rush towards safer assets, has meant that neither investment banks nor investors want to go near the stuff.


“We’ve attempted to do some trades with illiquid assets on behalf of peripheral banks, but we haven’t managed to syndicate deals,” said one senior banker that helped repackage some past deals. “Anything slightly peripheral-orientated is completely out of the question right now.”

What is, however, bad for banks, is perfectly good for the ECB, which will gladly hand over 100 cents on the dollar for the most worthless collateral it is stuffed with. There is one problem with this: Lehman did precisely this in the days and weeks before it filed. It did not help.

So with the ECB now happy to be Europe's not-bad but thourughly toxic bank, how long until everyone realizes that the ECB is massively undercapitalized and its existence (yes, that includes its ability to print money), purely a factor of continued German good will.

Total use of the ECB’s main refinancing and long-term refinancing facilities – both part of the open market operations – are now close to €500bn, up from about €400bn in the spring.


According to Goldman Sachs, although such levels are well short of the almost €900bn used in 2009, the uptick is worrying. “This is a substantial figure, reflective of the strains in the banking system,” analysts wrote.


But banks’ use of the ECB open markets operations remains dependent upon them having ample quality assets on their books. Under the terms of the operations, the central bank will only provide liquidity against certain assets – generally those rated BBB– and above, with some exceptions.


If ECB eligible collateral runs out, banks will have little option but to sell off assets in a final fire sale, say bankers. That will depend on whether there are willing buyers for such assets, much of which were accumulated pre-2007 as retail, commercial and wholesale loans.

And as Germany has indicated, it is getting fed up with the ECB pledging what is effectively an ever increasing portion of its GDP either directly, by accepting worthless collateral, or indirectly, by funding an ever greater portion of the AAA-rating constrained EFSF. When does Germany find that the trade off between its sovereign risk and the fate of the EUR no longer makes practical sense.

So what is the conclusion:

“The financial wreckage at many of these banks is along the lines of World War Two,” added the global markets chief. “There is so much detritus. But a lot of them don’t want to sell at these current prices, they know there will be a capital hit if things are properly priced.”

Bottom line: 3 years after Lehman blew up we are in precisely the same position, only this time the culprits are European banks. This is to be expected as absolutely nothing has changed in that time period, and the end result, by implication, will be absolutely the same.

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Popo's picture

“The financial wreckage at many of these banks is along the lines of World War Two,” added the global markets chief. “There is so much detritus. But a lot of them don’t want to sell at these current prices, they know there will be a capital hit if things are properly priced.”

This is *exactly* the Japanese scenario.  Europe should take a good look at what happened to Japan.  For more than 2 decades they have dragged their people through economic pain, all because they couldn't take their lumps.

Weisbrot's picture

Liquidity Crisis based on an Equity Crisis due to False Equity from Toxic Assets that were never properly resolved - Jst like in the good old USA.

BigDuke6's picture

Came across this.

anyone from the good ol' usa out there?

he seems moronic and very sensible at the same time - who is he?  Ratigan.

NumberNone's picture

He used to be a talking head on CNBC Fast Money.  It seems Dylan's on-air self-control is in direct correlation to his self-control at the dinner table.  Keep eating Dylan, you're making more and more sense every day. 

BigDuke6's picture

He really goes off his nut admirably for a baby boomer and comes to the correct judgement that congress is bought.

it needs to be said.

one for you JW.

snowball777's picture

Not sure how an infrastructure bank addresses our campaign finance whorehouse, or how the president isn't just as beholden to the moneyed interests as congress critters.

In some sense, it would be nice to see Obama step up and show people the difference between his policies and real socialism....nationalize a few shitty national banks, for example.

BigDuke6's picture

double post - site playing up...

Manthong's picture

He has been on a rant pleading with Obama to show leadership and to magically produce government solutions out of our socialist, kleptocratic and grifter bankster financial sinkhole.

Some people think he has a refreshing perspective.

I think he's one of the many indications why we are doomed.

Cvillian's picture

My new avatar reflects the only logical savior to their solutions. And yes, he is a Uni-Brow-Corn.

machineh's picture

'the world's carry trade funding currency (once known as the reserve currency).'

Ah -- so that's what 'zero percent till mid-2013' means: unlimited guaranteed carry trading for GS and MS.

Thanks, Ben. You're a real tool.

Oh regional Indian's picture

And this has the feeling of one of the big stories, the ones that will rattle everyone this weekend.

China says no loan for you! Of course China's loans/liquidity injections are nothing but American money pumped into China, patiently over the last 20 or so years, so it could become a hands off weapon, today.

Duck, ducks!


cbaba's picture

Not surprised, thats what i was expecting.

Banning the short sales will not help and will do just opposite , interbank lending will stop just like in 2008 . Wait and see the BIG BANG in coming weeks.

espirit's picture

Jus' print more fiatsco bitchez. Bring on the end game.

thunderchief's picture

Zero Hedge is my homepage.

It shoud be everyones..

Please text message this post to the sheeple people closest to you.

espirit's picture

The sheeple only care about their psychotropic rose colored outlook, the fall teevee lineup, and McBurgers.  Why bother?

Chump's picture

Sort of a Catch-22 there.  If the sheeple understand this post then they aren't sheeple.

monopoly's picture

September is going to be an interesting month.

We just have to get through the dog days of summer with low volume, no volatility and all the traders gone.What a sleepy week this has been. Let the teenagers party. Grown ups will be back soon enough.


24KGOLD FOIL HAT's picture

Yep; theyre in the hamptons or their very own private Gilligans Island!

The Govt is the Skipper, public is Gilligan, Professor is quants, MaryAnn the hard workin single mom, Ginger the "social director", Howells are shadow owners of earth.

These big things seem to happen in the fall- see Marty Armstrongs theories on financial history.

24KGOLD FOIL HAT's picture

Bill Banzai- I need your graphic talents to burnish Goldmans Island!

Silverstar's picture

ehh... that is bullish yes ???

Mediocritas's picture

After having so much taken away from them by austerity measures, the ECB is then going to turn around and devalue whatever euro-denominated savings Europeans had left.

Long: riots. Short: parked cars.

Is there an intrade market for Germany to leave the euro by the end of 2012?

No Bid's picture

flash crash in eur fra/ois @ 5:15amET

back to normal now and rising.  

falak pema's picture

This is the killer question. As we all know the so called sovereign debt in the West is in reality a private sector debt created by USA's laxist monetary and deregulatory policy that allowed the private sector to create the leveraged, toxic world wide financial ponzi, into which the private sector banks of the EU bought in massively. Now the governments, having panicked and thrown in the towel, have socialised this massive debt into government debt and have done nothing to stop the ponzi from growing since three years, 2008-2011; a criminal neglect.

Now without growth and with the market barking at their necks the EU sovereigns having no game plan run around like headless chickens, their banks all exposed and with falling equity to debt ratios as their market capitalization melts like snow in front of our eyes. 

So the next step is a bank liquidity run in EU. Why does this not happen in US where the debt situation is even worse? The answer is simple : the FED has the largest printing press in the world and the USD is world reserve currency. Nobody can stop BB! So no liquidity crunch in the US ...! Simple as that!

Can the ECB print money to save the euro private banks? Its not in their current mandate! That's why the US HF are having a field day in Eurozone puts! 

And the EU countries look on and moan and groan. They don't have the balls to take on the US challenge in this global financial derivative cum currency war. By going federal and issuing true EURo Bonds, which will entail concerted fiscal reforms and structural adjustments and huge investments to make Euro economies kick start. 

Big mess... The euro has to choose plan A or plan B and two tier two money economy; one for club Med one for new DM zone.

mberry8870's picture

I don't think the result will be the same, it will be much worse. When the situation is the crap assets on the books of the banks is soveriegn debt, this is a problem of a completely different magnitude.

BlackVoid's picture

Don't worry, the ECB will print as much money as necessary. Or the books will be cooked. Laws will be broken, rules will be bent. The banks will be rescued.


It will all blow up, when:

- there will be real oil shortages

- parliaments in Europe will be burning.


That is coming soon too.

Cdad's picture

The market of "stawks" is moving inversely, tick for tick, to gold.  It has become that simple.  And while I think a correction in gold will continue for another session, the idea of getting long equities into that inverse reaction is monumentally stupid.  Of course, stupidity reigns in this vacuum tube market.

As  such, selling long positions well is  simply a matter of picking just where gold will bottom today.  

Any guesses? 

24KGOLD FOIL HAT's picture

A smaller near term result: Euro declines vs $- which helps German exports?

Seems to fit.  US and Germany each have alternate "crises" to weaken their own funnymoney.

janus's picture

yup, sixteen trillion just don't go as far as it did back in day.

liquidity's just another word for nothin left to lose/

nothin, and that's all bernake left me


freedom's just another word (period),


Stoploss's picture

All i know is there is a cluster death cross, 20/50 and 50/200 that's 2 at the same time. Pay attention because everything gets liquidated.

janus's picture

i think i know what you're talking about. but would you kindly explain what you mean by 'death-cross'?  how do you identify it?

janus's picture

does anyone know a reputable source for learning about the way the repo market works...or are you people just too lazy to casually point a finger?

24KGOLD FOIL HAT's picture

They aint lazy...its just that the markets open...they might have time Sat. I know a little but traders will be worth reading.

janus's picture

that makes sense.  just thought i'd bang the ole fist on the desk.

Cvillian's picture

James Aitken has co-authored a few IMF working papers on shadow banking that are interesting

Search last name Aitken to read some of his stuff:

Hope that helps

jm's picture

I wonder about the driving reason for the funding pool shut down. Many questions. 

Is it because banks are getting hammered for holding impaired bonds they can't use as collateral in repo?

Or is it because the banks are holding imparied bonds as tier I capital?

Something else?

Won't the ECB buying bonds resolve this? 

Tic tock's picture

ECB spends money without any thought of its value - in no way is this an acceptable form of 'financial assistance to the Banking Industry'. Is there a single person in Europe who thinks that there is any relevance of popular participation in politics?- but it is not just that - the Eurocrats are not at all interested in anyone agreeing with them,.. they are right because they will bludgeon to death anyone who stands in their way - the entire history of the EU is of the same fibre: these pig-farmers are even worse.

falak pema's picture

do you then prefer the FED method? QE and then dummy QE as they can do what they like?

papaswamp's picture

Coupled with the 6.9% contraction in the greek economy was an increase in unemployment to 16.6% with over 60% being in the 15-34 yr old age group.


All is well ...rally on.

Nozza's picture

Liquidity crisis lol

I'm heading out for a Mojito - that will solve my liquidity crisis.


mcguire's picture

ZH, any thoughts on these events from a hegelian perspective?  if fractional reserve/central banking is thesis, and lehman brothers/greece is antithesis, what would be synthesis... the bancor, right??  if there is a man behind the curtain, certainly he is not just reacting to these events, but planning them???  

Reptil's picture

reaction EURUSD schizofrenic (rising) - this market is broken!

snowball777's picture

So how long until that AAA requirement gets fuzzed out in the name of piling more sovereigns into the already tipping lifeboat?


24KGOLD FOIL HAT's picture

This story from IFR was planted by Reuters.

Guess who controls Reuters. TPTB.

Perhaps they want a little crisis Monday AM?

GiantWang's picture

"Should this liquidity crisis transform into its next and more virulent phase, even the Fed will find it does not have enough capital to prevent a worldwide short squeeze on the world's carry trade funding currency (once known as the reserve currency)."

Umm, wouldn't a short sqeeze in dollars send DX through the roof and be very, very bad for gold?

This seems very counterintuitive for those thinking in terms of hyperinflation, unless we're talking about a huge run up in the dollar that amounts to a bubble which ultimately pops. 

Anyone care to elaborate?