Shadow Banking Contagion Approaches As European Banks Sign Private Repo Agreements With US Counterparts
In what is probably the riskiest escalation of the second credit crisis to date, IFR has released information that was until now speculated, but not confirmed, namely that European banks not only continue to make a mockery out of LiEbor by posting whatever rates they deem appropriate (for the simple reason they don't use interbank funding), while in the meantime going directly to US banks, using shadow, and hence completely unregulated conduits, in the form of private repo arrangements with "at least three of the five biggest US banks." Now where this is interesting is that as Zero Hedge disclosed three months ago, the bulk of the cash generated for the pendancy of QE2 went not to US banks, but to US-based branches of foreign banks. Which probably means that there is a roadblock to repatriating the US held cash (even in exchange for perfectly legitimate receivable debits). Because one would think that this is where the first source of cash for troubled banks would come from. Assuming it hasn't been repatriated already, or is not stuck in some IOER-GC carry trade that generates virtually no return (and when the Fed lowers IOER even more, absolutely no return). Alas this means that the 3M USD Libor which we update every day is substantially under-representing the true funding squeeze in Europe. Even worse, it means that US banks have lent us tens, if not hundreds of billions of cash, in exchange for collateral that could be virtually anything, and which collateral bypasses traditional Fed supervision. As a result, US banks can and will go hog wild in lending repo dollars (at big collateral haircuts but still) to European banks until everyone suddenly runs out of money, and the Fed realizes it has to not only fill traditional liquidity holes, but a massive shadow banking shortfall, precisely the stuff that none other than the Fed has been warning about over and over. Just like in 2008 when the big hit to the system came not from traditional sources of risk but perfectly innocuous and thus ignored money markets, so the same will happen this time, as the biggest crunch will come completely out of left field. It always does.
US banks have become the unlikely saviours of their ailing European counterparts, signing private agreements to lend them billions of dollars in recent weeks after an exodus of nervous money market funds left many without ready access to short-term funding.
Agreements worth tens of billions of dollars have been signed in the last month alone, according to bankers directly involved, who added that senior management of firms on both sides of the transactions have been closely involved with hammering out deals.
French lenders are among those using such facilities, say bankers, although deals have also been struck with UK and other European firms. Loans have been made as repo agreements, with banks posting assets such as corporate loans and mortgage portfolios as collateral.
“We were able to use some of our assets to get long-term repos,” said one board member at a French bank. “It was a move we made to monetise some of the assets we had on the balance sheet which were good, quality assets, and also to mitigate the withdrawal of money market funds.”
Paris-based Societe Generale said that it had struck US dollar repo deals equivalent to €6bn against a portfolio of commercial mortgage-backed securities and collateralised loans with maturities longer than six months. US bankers say other banks have struck similar deals in recent weeks to generate cash.
One source at BNP Paribas with knowledge of the situation said the bank was using US dollar repo markets for fixed income activity, but “not more than usual”, though the bank acknowledged that its use of short-term US money market funds dropped by €10bn to €36bn since the end of July.
“Doing repo means you don’t have to sell and don’t have to take the loss on many of these assets upfront,” said another banker at a US bank, who has signed off on such deals in recent weeks. “You can do it privately, so nobody needs to know, and spread losses over the lifetime of the assets.”
The fact that US banks are willing to increase their exposure to European firms – even if they insist on significant haircuts and conservative interest rates – demonstrates that they are happy dealing with such counterparties, at least for the moment.
Yes: for the moment. Alas, when the moment ends, and said banks can no longer afford to lend out cash, and in fact need it, may we ask: who will provide this source of global bailout capital? Oh yes: Ben Bernanke of course, and who will be facing trillions of dollars in full loss exposure should central planning not be successful in patching up the second Great Financial Crisis?
Why you, dear reader.