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.