Shades of 2007: Funding Stresses Hit European Banks

Can you smell the napalm?

The tone of the market is beginning to feel like 2007: serious signs of danger, like interbank funding stresses, combined complacency and denial. Gillian Tett describes the disconnect between the rising panic in Washington over the debt ceiling impasse, as the formerly-disciplined Republican party is unable to rein its Tea Partiers, who are happy to throw Molotov cocktails and don’t care if a firestorm results, versus calm on Wall Street. Intrade pegs the odds of default at 60%, Tett puts them at 40%, while analysts see the probability at 10% at most, and Mr. Treasury Market views it as pretty much zero.

In 2007, investors had, in Minksy fashion, been conditioned by the Great Moderation, abundant liquidity, and the Greenspan put to believe nothing that bad could happen, and if it did, investors would be able to exit with their hides intact. Now, these reflexes have been reinforced by the Bernanke put and Geithner’s attentiveness to the needs and wishes of banks. The assumption is that even if the Congressional gridlock continues, Timmie will find a way to keep paying Treasuries, even if everyone else suffers.

The troubling bit is that the Administration has said it’s unwilling to consider any of the creative ways out of this mess suggested in op ed pages and in the blogosphere: use of the 14th Amendment, canceling Treasuries held by the Fed, or using other loopholes to have the Fed monetize the debt. But Geithner dissed those ideas. From Bloomberg:

There’s “no way to give Congress more time” on lifting the debt limit, Geithner said after meeting with Democratic lawmakers on Capitol Hill in Washington. He has repeatedly said U.S. borrowing authority will end on Aug. 2 without congressional action.

Geithner’s remarks suggested the Treasury Department is approaching the end of its efforts to shift federal cash flows to avert a breach of the mandated borrowing limit.

Normally, one might view this rigidity as a negotiating posture. But this Administration doesn’t do negotiations, it does concessions, so it lacks dealmaking skills and expertise by virtue of being good only at giving tons of ground because it never wanted to hold those positions anyhow. Now that it has finally decided to become resolute when the stakes are exceptionally high, and neither side (at this juncture) appears able to give the other needed ground, or if push comes to shove, undercut their position completely.

Even if US investors don’t seem terribly troubled, US debt gridlock can easily add tinder to the fire starting in the Eurozone. And in another repeat of the crisis, we are starting to see credit market reporting disparities. The US outlets (even Bloomberg) were way behind the Financial Times on this beat until the crisis was underway and the Journal and Bloomberg had staffed up. We see it today in the contrast between two stories on the bank funding markets in Europe. The Wall Street Journal blandly reports that Libor ain’t what it used to be:

At the height of the financial crisis in 2008, Libor was one of the most-watched indicators, as nervous investors looked at its sharp rise as a sign of waning confidence in the stability of the global financial system.

These days, however, two key Libor gauges are being suppressed because of sharply shrinking demand: Banks, flush with cash, are borrowing diminishing amounts from one another. Outstanding “interbank” borrowings have plunged 63% in the past three years, totaling $168.4 billion at the end of June, compared with $450 billion in April 2008, according to the Federal Reserve.

On Thursday, three-month dollar Libor stood at 0.24975%; the rate fell below 0.25% in June, and has failed to reflect turmoil in the bank markets amid the European debt crisis. In the 2008 financial crisis, by contrast, the rate rose to about 4.82% from 2.81% in a six-week period.

The upshot: Libor these days is less representative of banks’ health and could mask deeper problems in the credit markets, analysts say.

Now this story isn’t useless, but reading it, you’d think, “Well, so we can’t depend on Libor as a guide” but you’d not think there was any immediate cause for concern. Contrast this with a report today in the Financial Times:

Europe’s debt crisis has stoked tension in its interbank lending markets as some financial institutions find it harder to raise money ahead of bank stress tests due on Friday.
UniCredit and Intesa Sanpaolo, Italy’s two biggest commercial banks, have been asked to pay higher premiums for lending, according to brokers, as the crisis has hit Italian government bonds amid growing fears of contagion.

One broker said: “Lending is now very name specific. Banks will only lend to high-quality banks or names. Italian banks, in particular, have had difficulties this week. They can only access the markets if they pay big premiums. Other banks will not lend to them unless they pay up.”…

The key measure of credit risk for short-term bank lending has jumped sharply since the start of the month. The spread between the risk-free cost to lend overnight in euros measured by Eonia and the cost to lend for three months measured by Euribor has jumped to 29 basis points from 20bp on June 30, a rise of 45 per cent….

The jitters have caused problems for banks’ longer-term borrowing too. In the past six weeks, European banks have sold $19.1bn of senior unsecured debt – less than a third of the average $68.2bn they sold in the past five years during this period, according to data from Dealogic.

Heretofore, the US has looked rather smugly across the pond as European leaders have had serious difficulties crafting sensible responses to escalating financial and fiscal stresses. Now we are learning the hard way that there is no such thing as politics as usual when the economic pie is shrinking.

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  1. Swedish Lex

    A banker tried to sell me a (retail) financial product yesterday, starting the sales pitch by saying that my money would be against the equity of two of Europe’s largest banks and i.e. as “safe” as it can get these days. How things have changed, until recently you were considered a nut if you put in question the solidity of the mega banks.

    A friend is has decided to wait to sell his house because he prefers to be stuck with the house rather than with paper money that may go into the history books soon.

    A voir.

  2. Cedric Regula

    I hate to be a “I said so”, but the simple way to have avoided this debt ceiling thingy, for a while longer anyway, would have been to just let the Bush tax cuts expire as scheduled end of last year. Then O could have just hit the golf course while the Rs screamed in Congress and the clock just ran out.

    But, no. O had this odd idea that poor people make up to $250K and needed their Bush cuts preserved. Let the negotiations begin! Then we did it pork barrel style so everyone could agree on spending increases. We even got our beloved tax credits on corn ethanol extended. Oh, yes, then of course we cut employee FICA withholding ’cause there is plenty of money there already.

    And the worst part of it is after they raise the limit, we will have to do it again in 2013. Then again in 2017, then around 2021 we close the United States for real.

    1. vlade

      A kid in a playground can negotiate harder than this administration.

      What I fail to understand though is how Obama could ever be a successfull lawyer w/o any apparent negotiation skills (and you’d think some would show up in the last three years). The only way I can see for that happening is in a team where he does the opening/closing speaches, but everything else is handled by other people. Or, as Yves says (paraphrased) – if the position you want to hold is the position of your “opponent”, you don’t have to negotiate, pretending will suffice.

    2. grandiosity

      Remember the payroll tax cut? The only thing that kept us from dipping earlier in the year? Well, this came at the price of the renewal of the Bush Tax Cuts.

      The GOP is not against taxes, per se. They are just against the taxes that fall on their kind of people.

    3. Susan the other

      Capitalism is a one trick pony. It relies on growth. A particular kind of growth: population growth and an endless abundance of resources. So now that growth has disappeared, has been missing for quite some time actually, nobody knows how to think anymore: Yves, “Theres no such thing as politics as usual when the economic pie is shrinking.”

      I’m very confused about what is going to replace growth. Everyone was banking on China/Asia. But that doesn’t seem to be working out. Growth in China cannot count on an ever expanding population either.

      The banks shelled out lots of money for financal products that had nothing to do with economic growth. Because there was no profit engine running any economy anywhere in the world, revenues stopped. The banks can’t do anything else now but implode. It only seems sudden. It has been building up for 3 decades.We are in a death spiral now because we do not understand how to use the word “diminish” in an economically viable sense.

      So now what?

      1. Cedric Regula

        Find a place to hide – but I’ve been trying to figure where for a couple years now and no answer yet.

    4. Justicia

      It’s a feature, not a bug. If Obama didn’t take such obvious measures to avoid being backed into this corner, it’s because he’s part of the Washington Follies, the Grand Guignol now playing inside the Beltway to terrify the middle class and make them accept the Peterson Consensus.

  3. M.InTheCity

    The issue with European banks getting needed short-term money has been going on for a month, at least. I know of at least two British asset managers with huge cash funds (at least £2 – 3 billion each that needs to be put out for longer than overnight) that are refusing to put money in German, French, Italian or Spanish banks. That’s even on an overnight basis, much less for 3 days to a month. I can’t believe that it isn’t pretty standard proceedure in London at this point to have nothing to do with the Euro TBTF banks.

  4. vlade

    Yep, no-one wants to lend to anyone on the continent. Even if you’re reasonably sure that it won’t go belly up (say Santander is technically spanish, but most of the assets are outside Spain, and exposure to Spain’s RE is minimal), as a trader you don’t want it on your book just in case something happens (and it hurts your bonus). So, effectively, EURo banks are paying up 30bp+ more on their LIBOR – while some other banks are actually paying sub-LIBOR (you’ve got to park that money somewhere, right?).

  5. RueTheDay

    I really don’t get it.

    McConnell’s plan is bizarre by itself.

    But now, look at the deal that’s supposedly taking shape:

    Reid is starting with McConnell’s plan to get debt ceilings increased without Republicans having to vote for them and then tacking on $1.5 Trillion in spending cuts. Why is Reid tacking ANYTHING on to McConnell’s plan? What’s nect? Will Reid and Obama tack on a balanced budget amendment and a permanent elimination of the estate tax? It’s like these guys are soccer players who delight in scoring own goals. Makes no sense.

  6. Rahul

    Feels distinctly like when bear was just about to go.

    I am surprised how calmly the markets are taking it. Particularly because, we just played the same playbook 2 years ago. I would have thought the markets would have reacted much earlier – end May, mid-June. But markets still seem to hold out with dreamy eyes.

    Hold on tight and stand fast!

  7. Hubert

    Another interesting small Deja-vu from 2008: Eurodollar rates against Euribor rates. The big blow-out in 2008 happened in Eurodollar; banks “presumably” – one has to say considering the British Bankers truth in rates finding comission – could barely fund in Dollars but could get Euros in the 3 Month Interbank market. Another thing that should not have happened according to any theory.
    It took the Fed Swap lines and a few months to get the funding market back into the “presumably” (again) riskless zone.
    Now the same thing, ademittedly in a much smaller scale starts happening again: Look at the December 2011 contracts. Eurodollar funding seems to be a much bigger problem than Eurofunding and the markets seem to bet on this problem to increase slowly again ….

  8. yrtecin

    But this Administration doesn’t do negotiations, it does concessions, so it lacks dealmaking skills and expertise by virtue of being good only at giving tons of ground

    OMG, what nonsense. Your are completely blinded by you ideology.

    The only “ground” this parody of an “administration” has not “ceded” was on the Bush tax cut renewal, and one can hardly say that they did this because they “never wanted to hold those positions anyhow.” They went along because it was political suicide to do otherwise.

    (and remember when you hear them scream about the need for mew taxes that lest than a year ago when they were n the majority in the House they approved the renewal of those cuts. Nothing better shows what a cynical and dishonorable bunch of demagogues and liars the democrats are than this.)

    Ceded ground indeed. This “administration” has got almost everything they wanted. The Democrats, led by this “administration” have almost tripled the national debt in less than 3 years and has not in that time passed a budget! The looting of the nation has heretofore gone on almost unrestricted.

    Obama has refused to meaningfully negotiate altogether or to budge on inch from their “positions”. He just turned around and asked for trillions in tax hikes in these “negotiations”. He has stated that he will have tax hikes even it it “destroys his presidency”. He has thrown petulantly infantile tantrum on national TV. He has ambushed and tried publicly humiliate his opposition and has turned his lapdogs in the MSM loose on all who even show a faintest sign of opposing his will. We have not seen this sort of thing out of an American president since FDR, and this is being rather unfair to FDR. It is shocking, his behavior, but it is not as shocking as the fact that his refusal to act inside the norms and traditions–not to mention the law–of this nation does not trouble you in the slightest. If he were a republican you would be howling.

    The notion that the GOP are “intransigent” is wholly a Democrat lie spread by the MSM. So is the wildly irresponsible agi-prop that the nation will go into default if the GOP do not go along with the Democrat tax and spend, socialist agenda. It is Obama and his wrecking crew that absolutely refuse to compromise. They do this because they are hard core Marxist Leninists (with a large dash of Chavez and Peron thrown in to the mix). Do you understand that Obama got up on national television and said that he might just hold up SS checks if the GOP did not cave? This is ridiculously irresponsible; it is not true that they would not have the funds and it would be illegality for him to do so. For a POTUS to behave this way is as absurdly incompetent as it is arrogant and dangerous.

    What an astounding claim you here make. You live in a absolute dream world and are so blinkered by you loopy political agenda that I am surprised you can even find the keyhole to let yourself into your apartment. For someone of your age to behave so s shameful.

    As to the latest contretemps in the EU, well it is inevitable. We have a undemocratic set of institutions out to seize power from national parliaments run by a bunch of socialist/fascist/corporatist Tranzis, none of whom have ever had real jobs in their lives. Moreover, this crisis is built into the current structure of the EU.

    It was a timebomb planted decades ago and planted quite on purpose. The whole point is to eventually force waves of crises that would allow these would be aristocrats to consolidate power in an Europe-wide super state without the consent of the peoples of Europe and “govern” them outside of national democratic traditions and institution. They are about a complete overthrow of the advance of liberal democracy. (If you do not get this, here is a clue: it is similar to what the Democrats are trying to accomplish here, but they are less covert at this stage than are the Democrats.)

    It is all well and good to talk about technical “similarities” to 2007, but that is really beside the point.

    They have run out of other peoples monies and confidence. They know of nothing else in this world but how to grab power. This is the beginning of their end game. They do not care if they destroy the middle classes or the liberal democratic order of that the West or the property built on this calls or this order. It is comic to watch you mince around abut their “blunders” or “market conditions” as if it local, proximate causes mattered.

    It is inevitable that it comes crashing down. The real question is are the peoples of Europe so supine as to let these monsters conclude their endgame unimpeded by national governments and the good sense, desires, hopes and aspiration of the peoples of Europe.

        1. Cedric Regula

          Maybe. When I read it fast it seemed like guy writing. But then I read this:

          What an astounding claim you here make. You live in a absolute dream world and are so blinkered by you loopy political agenda that I am surprised you can even find the keyhole to let yourself into your apartment. For someone of your age to behave so s shameful.

          That does sound kinds girly, no?

    1. RueTheDay

      “The Democrats, led by this “administration” have almost tripled the national debt in less than 3 years and has not in that time passed a budget! The looting of the nation has heretofore gone on almost unrestricted.”

      Way to play fast and loose with the facts.

      You’re counting on an uninformed reader not knowing that the government fiscal year ends Sept 30, so that you can ignore all of the spending that took place between 10/1/2008 and 1/20/2009 (e.g., the bulk of the bailouts, which took place under the previous administration) in order to get a lower baseline from which the deficit (not the debt, which you confused it with) tripled. You’re also omitting the fact that the Republicans now control the House.

      Cliff’s Notes: Everything you said was either mistaken or a deliberate attempt to mislead.

      1. citalopram

        Not that it matters anyway; both parties are on the same team.

        “It is Obama and his wrecking crew that absolutely refuse to compromise. They do this because they are hard core Marxist Leninists (with a large dash of Chavez and Peron thrown in to the mix).”

        Thanks for the laugh! This is talk radio nut jobbery at its finest.

      2. Hugh

        On January 20, 2009, the date of Obama’s Inaugural, the national debt was $10,626,877,048,913.08.

        On October 1, 2009, it was $11,920,519,164,319.42.

        On July 13, 2011, it was $14,342,954,633,916.41.

        I think the writer must have been referring to the deficit and then made the error to which you refer.

        The budget deficit for 2008 was $458.6 billion.

        The 2009 FY began on October 1, 2008 and ended on September 30, 2009. It straddled the two Administrations. However, the Economic Stabilization Act ($850 billion of which the $700 billion TARP was a part) was enacted in October 2008 (that is in the 2009 FY), a month before the Presidential election.

        The deficit for FY 2009 was $1.4127 trillion.

        The first completely Obama budget was 2010. The deficit that year was $1,2941 trillion.

        The current fiscal year has not yet ended. Through the first 9 months, it is $973 billion, $31 billion less than the $1.004 trillion at this point last year.

    2. Yves Smith Post author

      The Republicans ARE intransigent. If you don’t get that, you are badly in need of a brain transplant.

      And many of the positions the President is supporting are WILDLY unpopular even with Republican (and Peterson Institute) scaremongering (and recent visible Obama support), starting with cutting entitlements.

      The fact that their stance gives Obama air cover to move in a corporatist direction is a separate phenomenon.

      If you want to read blather that echos your views, there are plenty of other sites that do so. I suggest you frequent them instead of this one.

  9. Realist

    RueTheDay – it makes perfect sense when you consider that Obama is a conservative and/or an unprincipled highly paid servant to Big Money.

    Maybe it doesn’t make sense to you because you paid any attention to or, heaven forfend, believed anything he said.

    Same goes for his enablers on the hill.

      1. Realist

        They’re all doing what their funders tell them to do. Said funders stand to benefit in various ways from cuts on the rest of us (e.g. lower chances of them paying higher taxes; less employment means less pressure for higher wages; desperation for more people gives the wealthy that much more power; etc. and so forth.)

        Reid et al figure they have enough money to win and/or rig elections and if they lose they get lots of money in the “after market.”

        Makes perfect sense unless you get sucked into their charades. They’re playing us all for fools.

          1. Realist

            As you may know, that quote was probably propagated by cheats trying to downplay the seriousness of their offenses.

            Sadly, most “marks” of politicians are indeed honest.

            I was listening to C-SPAN this morning and a woman called in to say that she worked in the Social Security call center and that after Obama said checks may not go out, they got a lot of calls from worried recipients and that it broke her heart.

            Ironically, although he was probably just fear mongering, I wouldn’t be the least bit surprised if he actually does that. Sometimes (often?) a lie reveals the truth.

            When you consider this soberly, it makes sense that the two areas where fraud is often greatly rewarded and rarely punished – politics and finance – would attract the most crooks and the most crooked. So what we have is quite predictable when you get right down to it.

        1. Valissa

          Ahhhh… the charades of Versailles on the Potomac…

          “The whole aim of practical politics is to keep the populace alarmed and hence clamorous to be led to safety by menacing it with an endless series of hobgoblins, all of them imaginary.” — H.L. Mencken

  10. Slim

    Good thing Citi was just allowed to release some of the reserves it was holding and declare massive profits! I was really worried that Pandit and the boys might not get their bonus. And why not, if the reserves are really needed, the US taxpayer will pick up the tab.

    Let it all blow-up, better than being bled by leaches.

    1. Cedric Regula

      Ya, this bad loan thing is moving right along I hear, and should be right behind us soon (again). They still had a little miss vs expectations (why they didn’t reduce loss reserves to hit the number?????) but the stock went up 3% so that’s working for them too.

      NEW YORK (AP) — Citigroup says it has turned a profit for the sixth straight quarter as losses from failed loans declined.

      The New York bank says losses from bad loans fell 35 percent during the quarter to $5.4 billion. That allowed the bank to release $2 billion from its loan loss reserves and count it as income.

      Net income rose 24 percent to $3.3 billion, or $1.09 cents per share, on revenue of $20.6 billion. That compares to net income of $2.7 billion, or 90 cents per share, during the same quarter last year. The earnings per share was adjusted to account for a reverse split, where 10 Citi shares were exchanged for one this May.

      Analysts surveyed by FactSet had predicted Citigroup Inc. would earn 96 cents per share.

      Shares of Citi are up over 3 percent at $40.43 in premarket trading.

      1. Cedric Regula

        Whoops. They did beat. $1.09 cents vs. 96 cents expectation.

        back to the coffee pot

        1. Slim

          Bonuses all around! I’m going to spend my on something frivolous that I don’t even need.

          1. Slim

            Guys – stress tests are out, and guess what!?!? Everything is cool! Seriously, only like 8 or 9 banks fail. It’s awesome! Being able to mark your shitty real-estate backed “assets” to some fantasy number is. the. best. Seriously, help yourself to some bonuses.

          2. hermanas

            “Bonuses all around!”
            But they’re all wearing ankle bracekets aren’t they?

  11. Stephen Neumeier

    “Intrade pegs the odds of default at 60%”

    I looked on Intrade and cannot find the odds of default. They have a contract on the odds of the debt limit being raised and state govt defaults. Where did the writer get this information?

    1. Yves Smith Post author

      Tett is mapping that from the debt ceiling discussion. I need to recheck her article, since I might have overstated her point (she cited various odds and may have mixed failure to raise the debt ceiling, which WOULD create a technical default, with actual failure to make Treasury payments).

  12. arby

    “Every dollar raised from Wall Street is a bullet fired into the dying body of the US middle class.”

  13. monday1929

    Total and utter complacency. Huge spike in U.S. when “deal” is made and ceiling lifted, could last 1 hour, or one year.
    Europe will follow the U.S. lesson and make a really big announcement, multi-trillion dollars. Same spike, same collape.
    I buy cheap puts from the delusional, profits will go to feed the needy AND, to buy justice. Can one go to jail for bribing a prosecutor to do her job?

  14. Hugh

    There are too many balls in the air. The juggler’s hands are getting tired and his/her attention is wandering. Instead of letting one or two go, the juggler is eager to add more balls into the mix. We know this can only end badly but the juggler isn’t listening.

    The analogy with the world economy is incomplete however. In the real world, there is no downside for the kleptocrats. They will loot until there is a crash, and then they will loot the crash.

  15. TC

    Thanks for the heads up! I would expect graduates from the “Alan Schwartz Academy” will be turning up the volume, then.

  16. Jim

    Political Psychology

    Our Democracy has partially been built on the impotent hatred that has existed between the political parties and their members.

    Such partisanship has tended to result in great agitation and great immobility.

    Both parties excite the desires and will of their members in an extreme way and frustrate them in just as an extreme way.

    Party members see themselves correctly as omnipotent since ultimate power supposedly rests on their will but they are also powerless since their will is often shackled, limited or checked by the will of the other party.

    A democracy supposedly learns to live with this tension.

    If we do away with this tension( hateful impotence) will we still have a democracy?

    Democracy is also dependent upon the acceptance of the tension which is a consequence of this importent hatred.

  17. Skippy

    Napalm in the morning, nay, more like Fuel Air Bomb / MOAB / Massive Ordnance Air Bomb.

    Skippy…one ignition source is all that is needed, the game of whom is it, is which we play.

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