Friday, November 25, 2011

Euro 7,000 billion

A few weeks ago, I wrote that the European bond market for banks was frozen since June.  The consequence of this Euro 30,000 billion funding machine grinding to a halt was that financial institutions had to replace around $ 1,000 billion per month in funding.  First to go was new lending activity; lines of credit and loan facilities were made more difficult to obtain. Second, the Euro/USD curve went ballistic (1.39:1) as European financial institutions liquidated foreign assets  and streaming the cash "back to the mother ship".  Third stage is securitize and dump on the ECB their "less than prime" assets.

European banks are now packaging their "non-core" assets and by over-collateralizing are trying to selling these portfolios to the ECB.  Rumors are that Europe's banks have "agreed" to reduce their combined assets by Euro 7,000 billion, so to improve their capital ratio. Again rumors are that things are not going well because the ECB is market the assets to market (as of today);  these lovely 10y Italian bonds acquired 8 months ago with their 4.5% coupon, are marked down to reflect their current Italian yield of 7.4%.  The resultant massive "hair cut" right now is apparently more than what the banks can stomach... so we are back at a stalemate. 

The EFSF died yesterday, when it was announced that the maximum leveraged the fund "can" sustain will be 100% -- reducing the size of the facility from Euro 1,700 billion to Euro 800 billion -- just the perfect size to absorb the Greek losses (an nothing else).  BTW so that no one is confused -- this was a market decision. No one is ready to provide the EFSF with the leverage the politicians were seeking -- BTW the 50% Greek hair cut that was "agreed to" a few weeks ago is still no closer to occurring, private lenders have not agreed to anything yet.

In my opinion, at stake now is not the survival of the Euro -- that's a done deal, its the survival of the European community and the risk that the countries that leave the Euro will engage in competitive devaluations and raise trade barriers.  

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