As our overly-long headline tells you, Wednesday was a really bad day in credit land. Not only has the reality of the severity and seeming intractability of the Eurozone mess started sinking in, but US investors seem finally to be facing up to the fact that a full blown crisis would not be contained and will engulf American banks. If you thought September-October 2008 events were nasty, they could look like a mere trial run for what may be in the offing.
The Financial Times coverage on the failure of the Bund auction is suitably grim:
The worst-received bond sale by Germany since the launch of the euro fuelled market fears that the continent’s debt crisis was now affecting Berlin…
The bond auction only managed to raise two-thirds of the amount targeted..
The euro, which has held up relatively well despite the turmoil in the bond markets, suffered one of its biggest one-day falls against the dollar this year, while eurozone government debt was sold off across the board…
But as fear spread across trading floors, Germany started to trade like a risk asset with Bund yields, which have an inverse relationship with prices, rising roughly in line with French, Italian, Spanish and Belgian yields. However yields on short-term German debt went into negative territory, meaning that investors effectively are paying to hold the bills because they see Berlin as a safe haven..
A senior trader at a US bank said: “We are now seeing funds and clients wanting to get out of anything that is denominated in euros and that includes Bunds because they don’t know what will happen to monetary union. It is not helped by the year-end with most banks not prepared to buy anything.”..
The so-called failure also comes against a trend of poor auctions. It was the ninth auction that failed to meet its target this year, according to the German debt agency. However, demand was significantly weaker this time round.
It is true, as the quote alludes, that liquidity and trading volumes fall at year end. But this is a little early to see that pattern playing a big role. It may also be true that the very low yield on this particular auction was a deterrent to buyers. But even if there are logical explanations as to why this bad auction means less than it seems, appearances of weakness have a nasty way of becoming reality.
And on the US banks:
Investors paid record amounts to protect themselves against the risk of default by Bank of America on Wednesday…
“There is again broad risk-averse sentiment stemming from Europe,” said Otis Casey, an analyst at Markit. “We still don’t have a solution there.”…
CDS protection on European financials also rose to fresh highs on Wednesday..
Italian banks were among the hardest hit, with CDS levels reaching “stratospheric” levels, according to Markit’s Mr Casey. Protection on UniCredit, Italy’s biggest lender, rose 43bp to 622bp, a fresh record. CDS on Intesa Sanpaolo rose 57bp to 580bp, while CDS on Banco Popolare jumped 63bp to 925bp..
Signs of broader stress across US financials have also been flagged by three-month dollar Libor, the interbank lending rate, rising to its highest setting since July 2010. The benchmark reference rate for banks lending to each other rose to 0.50611 per cent on Wednesday, double this year’s low of 0.2450 per cent set in June.
Another barometer of bank counterparty risk, two-year interest rate swap spreads rose to their highest level this week since May 2010. Swaps reflect the credit quality of banks that trade the derivative and widen over Treasury yields during periods of banking stress.
To make a bad situation worse, the banks are in precisely the same mess they were in in late 2008: under credit market pressure, with stock prices too low to make equity issuance an attractive way out. For a garbage barge to sell a lot of equity in a risk-off market is a tall order. Yet no one is pillorying bank managements or regulators for getting their balance sheets in better shape in 2009 or 2010. The banks continued their overly generous pay practices, failed to retain enough earnings, and couldn’t be bothered to sell more stock.
The most troubling sign of the day, however, is that the officialdom seems unwilling to take the steps needed to keep the looming crisis from spinning out of control. As we’ve indicated, the minimum needed measure is for the ECB to signal that it is willing to intervene aggressively. That is not a sufficient as a solution; the underlying problem, that of internal imbalances (meaning Germany’s addiction to running big trade surpluses) needs to be dealt with. But you don’t tell a patient in the throes of a heart attack to lose weight and start jogging. You stabilize him first, and then when he has recuperated enough, start addressing the underlying pathology. Of course, what we did in the US was keep the patient receiving costly hospital care, and allowed him to order in gourmet meals, so he is now 50 pounds heavier.
Despite the continuing refusal by the Bundesbank and Chancellor Angela Merkel to consider eurobonds or other measures that would have the ECB de facto act in a fiscal capacity by monetizing debt, quite a few members of the NC commentariat continue to argue that the Eurocrats will come around in a crisis, just as the US did. I would not be so optimistic.
First, even though I deplore many of the actions taken in the US during the crisis, and the fact that this disaster was permitted to happen in the first place, you do have to give Paulson, Bernanke and Geithner credit for going into crisis mode. I don’t see the European leadership as willing or able to spend weeks in marathon sessions to cobble emergency responses together (which could just as well be nationalizations rather than rescues). They still seem to be in very deep denial that the situation is decaying as rapidly as it is, and decisive intervention is needed. And do not forget we have deep cultural biases at work. If you try telling a German that having the ECB print is actually a pretty decent idea, particularly given the risk of deflation in Europe, they react as if you’ve recommended deliberately contracting HIV as a cure for cancer.
Second, and related, is that even if the Eurocrats do wake up and become more unified in their responses, they may be too late. Market timetables are faster than political ones.
Third is that the complexity of the Eurozone mess is greater than the situation in the US during the crisis. As we noted in our post yesterday:
There are a ton more moving parts than in the US in 2008: more institutions at risk, multiple domestic banking regulators and national legislatures, Maastrict treaty rules. Anyone who has worked with networks knows that more nodes and more communication lines between those nodes means more points of failure. The odds of things ending up badly if the markets go critical are far greater than the last time around, and that’s before we factor in the caliber of Eurozone emergency responses thus far.
As I too often say, it would be better if I were wrong. While it is probably too early to tell whether the dismal results of the Bund auction have served as a wake-up call to Germany’s leadership, if we don’t see a shift in posture very soon, with sovereign and bank bond yields continuing to escalate, the Eurozone may well pass beyond the event horizon. And the worst is that everything evidently continues to seem normal even as you go pat the point of no redemptinn.