By Mike Whitney
On Wednesday, the Federal Reserve and the central banks of Canada, England, Japan, Switzerland, and Europe launched a coordinated monetary intervention aimed at easing interbank lending in the eurozone. While the emergency action sent stocks into the stratosphere, it did not relieve tensions in the markets or increase trust between the banks. In fact, on Thursday, banks stashed €313.763 billion at the European Central Bank’s overnight deposit facility, a new high for the year. Banks leave money with the ECB overnight when they are too worried about counterparty risk to lend to other banks. At the same time, the amount of money that EU banks are borrowing from the ECB, continues to rise, indicating their inability to raise money in the capital markets. These signs of growing distress show that the hoopla surrounding the central bank action are unwarranted. Conditions in the eurozone continue to deteriorate.
Many of Europe’s biggest banks are loaded with sovereign bonds that have lost much of their value since the crisis began. Crashing collateral values have gummed up the funding apparatus and cast doubt on the solvency of the EU banking system. This same type of thing thing happened in July 2007, when 2 Bear Stearns hedge funds defaulted. The incident sent shockwaves through Wall Street as trillions of dollars in dodgy mortgage-backed securities (MBS) were downgraded leaving most of the country’s biggest banks underwater. The Lehman implosion merely exposed the extent of the damage. The capital-depleted system was bankrupt and had to be rebuilt with trillions in loans, subsidies and bailouts from the Fed and Congress. (TARP) Europe now faces a similar crisis.
While Wednesday’s CB intervention provides EU banks with cheaper access to dollar funding, it doesn’t address any of the existential problems facing the eurozone. In fact, its effects should be quite small. Here’s how Paul Krugman summed it up on his blog Conscience of a Liberal:
“So this looks to me like a non-event. Yet markets went wild. Are they taking this as a signal that substantive actions — like the ECB finally doing what has to be done — are just around the corner? Are they misunderstanding the policy? Was this cheap talk that nonetheless moved us to the good equilibrium? (If so, not enough: Italian bonds still at more than 7 percent)” (New York Times)
The Guardian provides an interesting graph that explains why the Fed acted. Here’s the link.
EU banks are in the throes of a vicious credit crunch which is deepening the debt crisis and hurtling the EZ towards a long-term slump. Bank funding costs are rising while the value of collateral (sovereign bonds) continues to fall. At the same time, the European Banking Authority (EBA) has ordered banks to increase their core-capital to a minimum 9 percent, even though credit markets are in turmoil and balance sheets are dripping red. All of this is leading to a sharp cutback in lending which will show up in slower growth and higher unemployment. This is from Forbes:
“Bank lending standards have tightened, Barclays suggests, and debt funding costs have risen sharply, both for financials and non-financials. “Historically, such a tightening of lending standards has presaged economic weakness and a consequent rise in high yield corporate credit default rates, typically with a 12-month lag,” wrote the analysts….” (“European Credit Crunch Starting As Crisis Spreads To Private Sector, Forbes)
The only way for banks to raise capital in the current environment is by shrinking their balance sheets which means that they will be forced to dump their assets on the market pushing prices down further. Here’s an excerpt from an article in International Financing Review:
“Banks are feeling pain on both sides of the balance sheet,” said Alberto Gallo, head of European credit strategy at RBS. “On the one side you have a funding squeeze with banks unable to raise cash in the capital markets. At the same time, many of the assets they hold are deteriorating in quality.”
“Banks need to reduce their balance sheets as much as €5trn in assets over the next three years or so,” he added. “The problem is that there just aren’t enough buyers. Most banks will be forced to hold on to much of this stuff to maturity, which will affect their ability to lend and impact on the real economy.”
People involved in asset sale talks say price is the major sticking point. Lenders want only to sell higher-quality assets near to par value so as to avoid huge write-downs, which would erode capital further. By contrast, potential buyers want high-yielding investments and are offering only knock-down prices.”…(European banks’ asset sales face disastrous failure, IFR)
So, EU banks are on the ropes. Their asset base is wasting away with every downgrade and they no longer have the option of raising capital through the conventional means, by issuing equity or increasing deposits. Unless the ECB launches an emergency rescue effort, it’s only a matter of time before one of the larger banks defaults and the dominoes start to tumble through the financial system.
So, how would a major bank failure in the EZ effect things in the US? That’s a question the Economist answers in a recent article. Here’s a clip:
“Financial markets are far more integrated than product markets, and they acted as a conduit of contagion from the American banking system to banks abroad. Falling asset prices in one place impact the balance sheet of leveraged institutions in another place. This transmits the crisis, which then impacts the real economy….
Should trouble in the euro zone lead the European banking system to freeze up entirely, the crisis will quickly be transmitted to America’s economy; credit will dry up to American firms, and the real economy will lurch downward. That is the big risk to most large, non-European economies. Trade accounts for too little activity in big economies for a European collapse to be too disruptive; the financial spillover, on the other hand, will be dreadful. Where the Federal Reserve could do quite a lot to shield the American economy from the drop in European demand stemming from a deep euro-zone recession, it is more difficult for the central bank to provide insulation against an all-out banking panic.” (“US will not decouple from eurozone”, The Economist)
So, what should be done?
The simplest remedy–as most of the experts have noted–would be for the ECB to step in as lender of last resort and buy enough Italian and Spanish debt to keep interest rates at a manageable level. That, in turn, would put a floor under the value of the assets on banks balance sheets, so they wouldn’t be dipping deeper into the red. And this is exactly what new ECB chief Mario Draghi–former managing director of Goldman Sachs– intends to do, as soon as he creates a big enough crisis for him to impose the terms of the settlement on the member states. That’s the real goal, to reshape the EZ so it best fits the objectives of finance capital.
So what does Draghi want?
He wants his ministers to control national budgets, he wants more money diverted from working people into an over-bloated financial system, he wants his own appointments in positions of power (ie–check Italy and Greece’s new “technocratic” governments), he wants to dictate economic policy, he wants to abolish the welfare state and the social safety net, he wants to keep Europe in a permanent state of Depression (“austerity measures”) so more of the EZ’s wealth flows to the 1 percent at the top. Here’s an excerpt from a Thursday article on Dow Jones:
“European Central Bank President Mario Draghi called Thursday for a recommitment in the euro zone to sound fiscal policy. Speaking to the European Parliament, the new president said the euro zone needed a “new fiscal compact.”
The compact would be “a fundamental restatement of the fiscal rules together with the mutual fiscal commitments that euro area governments have made,” Draghi said…. “a fiscal compact would enshrine the essence of fiscal rules and the government commitments taken so far, and ensure that the latter become fully credible, individually and collectively.” (“ECB’s Draghi Calls For New Euro Zone Fiscal Compact”, Dow Jones)
And what will this new “fiscal compact” look like?
Well, it’s probably going to look a lot like the German plan for enforcing the EU’s Stability and Growth Pact. Here’s a summary from the Financial Times blogsite:
1. All planned deficits in excess of 3 per cent of GDP should require unanimous approval across euro area governments. All planned deficits in excess of a country’s medium term objective (but less than 3 per cent of GDP) have to be approved by qualified majority.
2. A commitment to correct past fiscal slippages with essentially no room for discretion: countries to adopt national “debt brake” rules.
3. A country requiring assistance under the ESM (note: European Stability Mechanism–a permanent bailout facility) is placed in financial receivership if its adjustment programme fails to remain on track, with the planning and execution of budgets requiring the agreement of the appointed financial receiver. This is necessary “where countries have no political consensus in support of reforms” to mitigate risks of countries failing to comply or defaulting.
4. Automatic fines and sanctions upon breach of the 3 per cent deficit limit.
5. All national countries introduce an independent budget office to produce budgetary forecasts, create an independent entity at European level to monitor national policies and administer ESM programmes.” (“Europe’s grand bargain”, FT Alphaville)
Take a good look: This is the future of European democracy; one country after another stuffed into a fiscal straitjacket while their public assets are privatized, their unions are crushed, and their sovereignty is surrendered to unelected bankers and eurocrats.
Europe is being handed over to big finance on a silver platter. This isn’t a crisis; it’s blackmail.