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As Adam Levitin remarked today (he and I are both speaking at the Americatalyst conference in Austin), the news has the same feel as of mid 2007 to early 2008, where market stresses are producing larger and larger numbers of casualties. Then it was subprime unravelling, which led to the failure of two Bear hedge funds, the freeze of the asset backed commercial paper market, the abortive Paulson SIV rescue program, the monoline death spiral, the auction rate securities market implosion, culminating in the first big crisis bailout, Bear Stearns.
Reader Swedish Lex was early to call that the crisis would turn critical when it engulfed Italy. And that point appears to be nigh. As market oriented readers no doubt noted yesterday, ten year Italian bond yields hit the new high of 6.68%, despite five ECB interventions during the day. A GoogleTranslate of LinkIvestia (hat tip Richard Smith):
Italy, rather than miss the resignation of Prime Minister Silvio Berlusconi, should be concerned by the interventions of the European Central Bank (ECB). Today the Eurotower intervened six times in the secondary market, buying Italian government bonds at 3 and 10 years, trying to bring the returns of BTP levels last Friday. The attempt has failed substantially, as shown by the curve of Italian bonds. To make matters worse, the Treasury has thought that the 18 announced that the auction of Bot (Treasury bills) to three months, originally scheduled for November 10, will not take place. Regular auctions instead of bots to 12 months and that of BTP, scheduled for November 16. The stress on the bond market continues.
The next venture is not the risk of default, as erroneously been circulating on the net. The danger is that our refinancing becomes unsustainable, causing a leak from the voluntary market. To be sure, even at these higher interest rates on Italian debt is hardly sustainable. The ten-year bond yield is stable over 6% share, despite repeated secondary market purchases by the European Central Bank (ECB). Only now the Eurotower argued Italy for six times, but it was not enough. The spread between Italian government bonds (BTP) and Germany (Bund) fell below 470 basis points for only about 20 minutes. Last speech, full-bodied, the ECB has seen the market turn against, recording the opposite effect to that intended. In fact, the spread has increased from 478 to 487 basis points within a few minutes.
Another sign of strong pressure on the Italian government bonds has been the inversion of the yield curve of government securities at 5 and 10 years. At 17:30 today the BTP with a maturity of five years was at a rate of 6.7%, while that at ten years was 6.66 percentage points. Considering that, in general, the curve should be increased by the end of the bond, the reversal of this trend is a sign of stress in the short term. In addition to the failure of the operations of the ECB, has been a fact of considerable importance.
The Italian Treasury announced that the next competitive bidding on government bonds will not be held three months. According to the Ministry of Economy the decision not to place the Bot quarterly results from the absence of “specific cash needs.”
The Financial Times echoed the worries:
Traders warned that without ECB intervention, the Italian bond markets would have seen leaps in yields that forced Ireland and Portugal to accept emergency bail-outs…
Traders noted the big rise in Italian yield spreads, which leapt to 491 basis points over German Bunds at one stage. They were also trading about 420bp over a basket of triple A rated countries. Markets consider that this is close to the area that will trigger additional margin payments on the trading of Italian bonds. Olli Rehn, EU economic and monetary affairs commissioner, urged Italy to stick to its target of implementing its budget deficit by 2013 and to carry out long delayed reforms to boost growth and job creation. EU experts are to visit Rome this week to monitor its progress, followed by an IMF delegation next week.
While other markets seem to be taking this development in stride for now, Business Insider gave a dose of black humor: GOOD NEWS: Italian Bond Yields Are Only A Tiny Bit Worse Today. As Ambrose Evans-Pritchard notes:
Rome was a seething cauldron of rumours, plots, and threats all day long as Mr Berlusconi furiously denied claims by insiders that he was about to resign and ordered “traitors” in his own party to look him in the eyes. He faces a confidence vote on Tuesda…
The escalating crisis threatens the rest of Europe through bank exposure. Mediobanca said Europe’s 20 biggest banks hold €186bn of Italian sovereign debt, led by Intesa SanPaolo (€64bn), Unicredit (€39bn), BNP Paribas (€23bn), Dexia (€13bn), Commerzbank (€9bn), and Crèdit Agricole (€8bn).
Goldman Sachs warned that Italy might start to take “unilateral decisions” such as seizing banks or clamping down on the bond market (effectively holding investors captive) if the political climate deteriorates further and authorities feel boxed in. It said the crisis has set off a “self-fulfilling dynamic” that may ultimately make it impossible for Italy to roll over debt.
The EU’s bail-out fund (EFSF) does not yet have the firepower to halt the crisis by purchasing Italy’s bonds. The fund itself struggled to raise money in a €3bn auction on Monday, paying 177 points over Bunds — up from 51 in June.
“The EFSF is basically doomed to be worthless,” said professor Giuseppe Ragusa from Rome’s Luiss Guido Carli University.
There is increasing evidence that Eurowoes are hitting the US, in this case, via a curtailment of foreign bank lending to the American market. Quelle surprise! As we and other commentators have said, the European and US economies are too deeply integrated for this not to happen. Again from the Financial Times:
The crisis in Europe has begun to spill over into US bank lending, according to the latest survey of loan officers by the US Federal Reserve.
Credit conditions have steadily eased since the end of the recession but that process almost ground to a halt in the last three months, with only five domestic banks out of 50 saying that they relaxed their standards for lending to large companies. Two banks had tightened conditions.
There was also a sharper retrenchment by US branches of foreign banks: 23 per cent of such operations tightened their lending terms, raising their interest rate spreads and cutting back on the amount and period for which they are willing to lend.
Of the foreign banks that tightened their lending conditions in the US, all nine pointed to a weaker economic outlook, while a majority said they had a lower tolerance for risk, that their own liquidity position was weaker, and that it was harder to sell loans on the secondary market.
As I too often say, this would all make for great theater if we didn’t have a stake in the outcome.