By Mike Whitney
On Thursday–exactly 3 years after Lehman Brothers defaulted igniting the greatest financial crisis in 70 years–the world’s most powerful central banks launched a massive intervention to staunch a liquidity squeeze in the eurozone that threatened to wreak havoc on the EU banking system. The European Central Bank –acting in cooperation with the Federal Reserve, the Bank of England, the Bank of Japan and the Swiss National Bank–agreed to provide limitless loans to banks that are having trouble getting dollar funding. European banks access to US money markets has been sharply reduced in the last year due to worries over their solvency. The joint-central bank action is designed to ease liquidity problems, allay investor fears and avoid the painful task of restructuring underwater banks. Stocks rose on news of the emergency intervention. The Dow finished up 186 points on the day. This is from the Wall Street Journal:
“European banks need the U.S. currency to fund loans they have extended to U.S. companies and consumers. European banks also need dollars to repay past borrowings they made in dollars, such as loans from U.S. money-market funds…
European banks have lost access to more than $700 billion in U.S.-dollar funding—short-term IOUs and interbank loans—over the past year from U.S. money-market funds and others worried about exposure to Greece and other troubled European economies, according to J.P. Morgan Chase & Co. and CreditSights research…..
“Things are deteriorating,” said Joseph Abate, a money-markets specialist at Barclays Capital in New York. “This week and certainly probably since August, it seems like their access to unsecured [funding] really has tightened up.” (“Europe Lending Woes Deepen”, Wall Street Journal)
Money markets are withholding funds from EU banks because the credit crunch is getting worse and because the banks have been lying about the true condition of their balance sheets. This is a point that Jonathan Weil makes in a recent article in Bloomberg. Here’s an excerpt:
“Back in October 2008, after the European Union threatened to override its standards legislatively, the London-based International Accounting Standards Board changed its rules on balance-sheet classifications retroactively, so that companies could immediately shift many of their financial assets out of categories where fair-value accounting was required. This meant a company holding lots of dodgy mortgage bonds, for example, could delay recognizing future losses simply by changing the bonds’ balance-sheet label….
The markets… know better than to believe the banking industry’s balance sheets. And so we get the present situation where most of Europe’s largest banks, including France’s BNP Paribas (BNP) SA and Societe Generale (GLE) SA, are trading for far less than what their books say their net assets are worth. The problem with fair-value accounting now is investors don’t get enough of it. Those banks that are destined to blow up will do so regardless.” (“European Bank Blowups Hidden With Shell Games: Jonathan Weil, Bloomberg)
So, by removing the “onerous regulation” of having to accurately report the true value of the assets on one’s balance sheet, the banks have triggered a panic as investors ditch their stocks and slash their funding. “Fair value accounting” is an oxymoron.
There’s no telling how long the central bank intervention will calm the markets. The basic problem still has not been resolved. Greece is bankrupt as are many of the other so-called PIIGS (Portugal, Italy, Ireland, Greece and Spain) That means that bondholders will eventually face severe writedowns on their holdings and banks in Germany, France and England will have to be recapitalized or restructured. The system is broke. Here’s an excerpt from an article by Win Thin, the Head of Emerging Markets Currency Strategy at Brown Brothers Harriman, over at Credit Writedowns:
“This latest dollar funding scheme addresses the symptoms but not the illness. The illness is that Greece is insolvent, and one of the symptoms is that banks are afraid to lend to each other and are instead hoarding cash. Today’s actions won’t PREVENT a Lehman-type event (Greece is insolvent, period), but they could MITIGATE the dislocations and market turmoil that will likely result from such an event. We fully expect policy-makers are preparing quietly for a Greek default, and would look for more and more preparatory measures in the coming months.” (“Some Thoughts On The ECB/Fed Announcement”, Credit Writedowns)
So, while Wall Street clicks its heels and celebrates, the news is less auspicious than it seems. The intervention is just another stalling tactic. The troubles continue to mount. The gauges of market fear (Libor, Euribor-OIS) are still rising, interbank lending has slowed, many of the largest banks have suffered downgrades which will increase their funding costs, the spreads on default insurance continue to widen, and EU banks have parked more than $800 billion at the Federal Reserve. In other words, the credit markets are in turmoil.
Here’s more from the Wall Street Journal:
“European banks are woefully short of capital to cope with multiple losses on euro-zone sovereign bonds… this year’s European “stress test” disclosures, which showed a capital shortfall of €80 billion if Greek, Irish, Portuguese, Spanish and Italian debt had been marked to market prices. That deficit would rise to over €200 billion if the pass rate had been a 9% core Tier 1 capital ratio…
But this only tells part of the story. Any losses arising from multiple restructurings of euro-zone sovereign debt are sure to go well beyond merely first order effects given the scale of interconnectivity. If the euro zone started to fall apart—perhaps as a result of an ECB refusal to keep funding Greek banks—the consequences would be incalculable as instant deposit flight led to a toppling of peripheral country banking systems. It is hard to see what scenario banks should be recapitalizing themselves to withstand, bearing in mind official euro zone policy is that there will be no sovereign defaults beyond Greece….
… stock market valuations suggest markets are now focused on extreme scenarios.” (“Euro Banks’ Capital Conundrum”, Wall Street Journal)
Policymakers have only recently shown they even understand the problem, let alone have any interest in fixing it.
And what would “fixing it” really mean anyway?
Would it mean, creating a “supra national” fiscal authority as many experts have suggested?
No. That’s just another banker fantasy. Imagine the United States with no president, no congress, no judiciary, and no bond market; just a free-wheeling Treasury Department putting out fires and transferring tax revenues as it sees fit. Yes, that is something the banks would like, but would it really be enough to win the support of the people?
Not likely. This whole fiasco is a perfect example of what happens when elites try to impose their governing institutions without broad popular support. Now they’ve backed themselves into a corner with no way out. And it’s all because they never built the public support they needed to get them through the tough times. So, now they’re doing everything they can to pull the wool over people’s eyes so their elitist plan won’t be derailed; which is why Sarkozy and Merkel were splashed across the front pages of newspapers on Wednesday promising to keep Greece in the fold. Give me a break. The whole charade has been scripted to make sure that bankers and bondholders don’t lose money on their bad investments. This is from Reuters:
“In a report prepared for European finance ministers meeting in Poland on Friday and Saturday, senior EU officials said the 17-nation currency area faces a “risk of a vicious circle between sovereign debt, bank funding and negative growth.”
“While tensions in sovereign debt markets have intensified and bank funding risks have increased over the summer, contagion has spread across markets and countries and the crisis has become systemic,” the influential Economic and Financial Committee said.
“A further reinforcement of bank resources is advisable,” ministers were told in language that echoed an International Monetary Fund call for urgent action to recapitalize European banks….(“EU warned of credit crunch threat”, French banks hit Reuters)
Wait a minute. So the EU finance ministers knew the banking system was underwater but never forced the banks to increase their capital?
That’s called “regulatory capture”, where the banks control the political system to the extent that they can effectively block any rule that may inhibit their ability to maximize profits. Naturally, when the wolf is left to mind the henhouse, there’s bound to be trouble. The same is true here.
Geithner in Wroclaw
In a sign of how concerned the Obama administration is over developments in the eurozone, Treasury Secretary Timothy Geithner has been dispatched to a two-day meeting of EU finance ministers in Wroclaw, Poland. Geithner is expected to push for controversial and, perhaps, illegal changes to the 440 billion (euro) financial emergency fund (EFSF). The Treasury Secretary wants policymakers to massively leverage the original sum so they can purchase trillions in sovereign bonds from Italy and Spain. Here’s the story from Reuters:
“Treasury Secretary Timothy Geithner is likely to suggest to European finance ministers on Friday that they leverage their bailout fund along the lines of the U.S. TALF program, EU officials said.
“Geithner will probably insist on the importance of leverage to have more funds to ringfence the big Europeans, Italy and Spain, and to find a solution for Greece,” one EU official said.
Leveraging the EFSF, however, would not take place before the fund’s new powers of intervention on bond markets, extending precautionary credit lines or lending for bank recapitalization were ratified by the end of September, the official said.” (“Exclusive: Geithner to float idea of leveraging euro rescue”, Reuters)
So, what’s going on here?
First, the EU finance ministers are going to try to expand the powers of the EFSF so the money can be used to directly recapitalize banks. This is a clear case of bait-and-switch. The EFSF was sold to the public as a way of helping struggling nations meet their funding needs by pushing down bond yields. It was never supposed to be used to bailout underwater banks. Second, if Geithner’s recommendations are followed, then the 440 billion euros will be levered many times over (perhaps 10 or 20x), which will create a big enough mountain of money to bailout all the EU’s insolvent banks (and nonbanks!). That way, bankers will not have to writedown losses on their toxic assets or undergo painful restructuring. Geithner’s plan is like TARP and QE1 combined, a double whammy for eurozone taxpayers.
And, third, the powers of the ECB will be greatly enhanced so that the central bank can execute policy independently, basically assuming the role of “supra national fiscal authority”, much like the Fed has done in the US by invoking the “unusual and exigent” clause in its charter.
So, what does it all mean?
It means the eurozone is headed down the same road as the US, where economic policy is largely decided at the Fed and where the primary function of government is to assure that its parasitic financial institutions remain profitable.
Euro leaders are very close to making the ECB the most powerful political institution in Europe and creating their own regime of zombie “Too Big To Fail” banks which will be a perennial drag on employment and growth just as they are in the US. This weekend’s meetings should tell us a lot about the future of the eurozone.