Fitch

While it will come as no surprise to ZeroHedge readers (as we discussed why LTRO3 is not coming here and here), it would appear that the ability to turn worthless assets into useful liquidity via a raft of collateralized lending operations with the ECB is at an end. As Fitch's, MD of financial institutions Bridget Gandy just confirmed: "Some of the European banks are becoming short on collateral to pledge with the ECB, unless they can delever and sell some of their assets, which is difficult." Of course this means the banks that need the facilities the most are now in dire need to sell assets and delever further exaggerating the vicious circle in Europe's symbiotic banking-sovereign relationship. Without postable collateral, there can be no more help from the ECB to the banks and thus any further banking system help will further subordinate the sovereign (hence our call to swap into non-local law bonds) since it will necessarily need to be funneled through them (a la Spain). Once more the ball ends up in Bernanke's lap.

Jose Manuel Barroso, President of the European Commission, thinks Europe needs a unified banking system.

But how can financing be a solution for a Zone with a fatal fundamental flaw? Banking cannot save the euro-Zone. This proposal is only the distraction du jour.

Europe continues be unable and unwilling to look at the core problem in the Zone which has morphed into huge competitiveness differences that are creating havoc.

The easiest fix for this is a break up. For the Zone to survive this will require a lot of cooperation and frankly it does not seem close to doing it.

Nobody can forget how over the weekend Spanish PM Rajoy told economy minister de Guindos to keep a stiff upper lip, and that, lest someone forget, Spain is not Uganda. Two days later nobody is laughing: Spanish bond yields just pushed to Euroarea records, Fitch just downgraded the bulk of Spanish banks, and it looks like Spain may need a second bailout before the details of the first one are even ironed out. However, one entity is not amused. Uganda. Or perhaps, is very amused, depending on one's perspective.

Spain marks the fourth bailout during this Euro Zone debt crisis saga, after Ireland, Portugal and Greece, and may need more aid, while Italy is looking good to be the fifth bailout candidate

European equities in both the futures and the cash markets are making significant gains after a mornings’ trade, with financials, particularly in the periphery, leading the way higher following the weekend reports of the Eurogroup confirming aid for the Spanish banking sector. With data remaining light throughout the day, its likely investors will remain focused on the macro-picture, seeing some relief as the Spanish financials look to be recapitalized. At the open, risk sentiment was clear, with EUR/USD opening in the mid-1.2600’s, and peripheral government bond yield spreads against the German bund significantly tighter. In the past few hours, these positions have unwound somewhat, with EUR/USD breaking comfortably back below 1.2600 and the Spanish 10-yr yield spread moving through unchanged and on a widening trend across the last hour or so against its German counterpart, and the yield failing to break below the 6% mark.

Over the past 24 hours, Zero Hedge covered the various key provisions, and open questions, of the Spanish bank bailout. There is, however, much more when one digs into the details. Below, courtesy of Deutsche Bank's Gilles Moec is a far more nuanced analysis of what just happened, as well as a model looking at the future of the pro forma Spanish debt load with the now-priming ESM debt, which may very well hit 100% quite soon as we predicted earlier. Furthermore, since the following comprehensive walk-thru appeared in the DB literature on Friday, before the formal announcement, it is quite clear that none other than Deutsche Bank, whose "walk-thru" has been adhered to by the Spanish government and Europe to the dot, was instrumental in defining a "rescue" of Spain's banks, which had it contaged, would have impacted the biggest banking edifice in Europe by orders of magnitude: Deutsche Bank itself.

First we got Spain miraculously announcing late at night local time, but certainly after close of market US time, that the bailout so many algorithms had taken for granted in ramping stocks into the close may not be coming, because, picture this, Germany may have conditions when bailing the broke country's banks out, and Spain is just not cool with that, and now, after the close of FX and futures trading, we get Moody's giving us the warning the after Egan-Jones, S&P, and Fitch, it is now its turn to cut the Spanish A3 rating."As Spain moves closer to the need for direct external support from its European partners, the increased risk to the country's creditors may prompt further rating actions. The official estimates of recapitalising Spain's banking system have risen significantly and the country's indirect reliance on European Central Bank (ECB) funding via its banks has been growing. Moody's is assessing the implications of these increased pressures and will take any rating actions necessary to reflect the risk to Spanish government creditors. Moody's rating on Spain is currently A3 with a negative outlook." Moody's also warns, what everyone has known for about 2 years now, that Italy could be next: "However, Spain's banking problem is largely specific to the country and is not likely to be a major source of contagion to other euro area countries, except for Italy, which likewise has a growing funding reliance on the ECB through its banks." Of course none of this is unexpected. What will be, however, to the market, is when all 3 rating agencies have Spain at BBB+ or below, which as ZH first pointed out at the end of April will result in a 5% increase in repo haircuts on Spanish Government Bonds, resulting in yet another epic collateral squeeze for the country which already is forced to pledge Spiderman towels to the central bank. 

Perhaps some novel solution is found but this is not the muddling along kind of thing at all. This is the changing of charters kind of thing, the changing of national banking regulations kind of thing; the ceding of power to Europe kind of thing and anyone who thinks that this can all be accomplished in a matter of days is out having tea with Cinderella’ fairy godmother. Yet equities have rallied and bond spreads stopped widening on just this kind of hope but I predict that this will all be short-lived because, on its face, it is irrational. There is nothing wrong with having hopes and prayers but to base investment decisions on irrational interventions of some Divine power where there is not even a door for the Divinity to enter is just poor judgment by this name or any other you may concoct. It is no longer a case of “Risk on/Risk off” but of “Reality on/Reality off” and I advise you to keep pressing the “Reality on” button!

That economic data out of Europe was disappointing overnight should come as no surprise to anyone. That Spain is broke, and there is no money to bail it out under the existing framework (and that Germany is unwilling to come up with a new bailout scheme), should also be no surprise. And yet they somehow manage to stun the market... each and every day. Which is why overnight action has now boiled down to a simple algorithmic exercise: is there a short covering squeeze: if yes, then rip, aka Risk On. If not, then Risk Off. So far, the squeeze has not been initiated which is also to be expected, following the biggest short covering squeeze in up to two years. This too may change if repo desks decide to pull borrow as they tend to do during regular hours, to give the impression that the latest and greatest bailout plan is "working." And in other news, which is completely irrelevant, here is the actual news.

• Obama Seeking Ally on Europe Finds Merkel a Tough Sell (Bloomberg) - but he has an election to win
• China rate cut sparks fears of grim May data (Reuters)
• China faces stimulus dilemma  (FT)
• Papademos warns of Grexit vortex (FT)
• China’s Shipyards Fail to Win Orders as Greek Owners Shun Loans (Bloomberg)
• Rajoy Holds Bank Talks With EU Leaders as Fitch Downgrades Spain (Bloomberg)
• Capital Rule Is One Size Fits All (WSJ)... now the modest question of where to get the $3.9 trillion in capital
• Merkel Pokes at Cameron With Backing for Two-Speed Europe (Bloomberg)
• City safeguards set Britain at odds with EU (FT)
• Bernanke says Fed to act if Europe crisis deepens (Reuters)

If it seems like it was just yesterday that Spain officially requested a bank bailout, it is because it was. Recall: "Spain Caves, Admits It Needs European Bailout" from June 5. What happened next is confusing, but it essentially appears that Spain retracted the course of action as it was unhappy with two things: i) the market's response to the announcement, and ii) Germany's response to the request for aid. The first, because as ZH first showed, did not soar as there would obviously not be enough money embedded in the current system to fund a full bailout of Spain, and the second, because Germany is not exactly delighted with having one more country on the dole, and has yet to clarify under just what conditions it will save Spain (in retrospect naive rumors that it has dropped all conditionality notwithstanding). Which brings us to this morning, when we are expected to forget that all of this already happened, and to be shocked that Spain is officially requesting a bailout for the first time./.. again... kinda, sorta... Reuters reports: "Spain is expected to request European aid for its ailing banks at the weekend to forestall worsening market turmoil, becoming the fourth and biggest country to seek assistance since the euro zone's debt crisis began, EU and German sources said. Four senior EU officials said finance ministers of the 17-nation single currency area would hold a conference call on Saturday to discuss a Spanish request for an aid package, although no figure had yet been set. The Eurogroup would issue a statement after the meeting, they said. "The announcement is expected for Saturday afternoon," one of the EU officials said." So now we have rumors of statements of conferences of bailouts. Lovely. At least our Belgian caterer long is doing great to quite great.

News and headlines from the day

First it Egan-Jones (of course). Then S&P. Now Fitch (which sees the Spanish bank recap burden between €60 and a massive €100 billion!) joins the downgrade party of rating agencies that have Spain at a sub-A rating. Only Moody's is left. What happens when Moody's also cuts Spain from its current cuspy A3 rating to sub-A? Bad things: as we explained on April 30, when everyone has Spain at BBB or less...

With Bernanke's speech dominated by the word 'Fiscal', is it any wonder that Fitch comes over-the-top with a warning, via Reuters and Bloomberg:

• *FITCH SAYS WOULD CUT US AAA RATING IF THERE IS NO CREDIBLE FISCAL CONSOLIDATION PLAN IN 2013
• *UK, FRANCE ,GERMANY, OTHER AAA NATIONS HAVE CREDIBLE PLANS:FITCH

Are the world's central bankers now checking back to the governments? Well we know how that will end. With the Fed's implicit tightening (as the balance sheet rolls down) and the fiscal cliff, it seems headwinds are mounting.

All you need to read.