A collapsing order will do what it takes to retain power, no matter its abuse
of law or decency. Writing in Die Zeit on August 29, 2012, European
Central Bank president Mario Draghi wrote (in German): "[I]t should be
understood that fulfilling our mandate sometimes requires us to go beyond
standard monetary policy tools. When markets are fragmented or influenced by
irrational fears, our monetary policy signals do not reach citizens evenly
across the euro area. We have to fix such blockages to ensure a single monetary
policy and therefore price stability for all euro area citizens. This may at
times require exceptional measures. But this is our responsibility as the
central bank of the euro area as a whole."
Dropping the dead fish on Berlin, Draghi reminded Germans he is not a man to be
messed with. That is why he was awarded the presidency of the ECB at such a
desperate moment. On July 26, 2012, Draghi pledged: "Within our mandate,
the ECB is ready to do whatever it takes to preserve the euro. And believe me,
it will be enough."
"Within our mandate" is defined by Draghi. He lifts restrictions on
ECB legal authority at a moment's notice. This is exactly as the bureaucrats
prefer. The sinecures in Brussels will be selling dead fish rather than dining
on prawns and apricot soufflé at Comme Chez Soi if Draghi fails. Europeans and
foreigners with securities invested in European markets should consider the
possibility of confiscation or lengthy sequestration.
European leaders, on the whole, will not object to shutting markets. Some
obvious difficulties will arise, but the alternative - a trip to the guillotine
- is more unattractive. The leaders are ignorant of the functioning of markets
so it is a small matter to shut them. They regard markets solely as instruments
of their policies: raise or lower taxes, save or shelve the national airline,
raise or lower stock markets. Federal Reserve Chairman Ben Bernanke employs
this mode of thinking. He reminded his guests of his fatuous pretensions at
Jackson Hole, Wyoming, on August 31, 2012. Praising himself for the Fed's
buying of market assets, Bernanke preened: "[Asset purchases] have boosted
stock prices.... [I]t is probably not a coincidence that the sustained recovery
in U.S. equity prices began in March 2009, shortly after the FOMC's decision to
greatly expand securities purchases. This effect is potentially important
because stock values affect both consumption and investment decisions."
There is no evidence to support his boost-the-economy contention, yet, Simple
Ben contended: "Econometric....[m]odel simulations conducted at the
Federal Reserve generally find that the securities purchase programs have
provided significant help for the economy." He really believes these
models, which produce the results he predetermined. Similarities to the final,
paranoid proclamations of superiority by the Kremlin are obvious.
Whether one prefers Mario Draghi's brass knuckles or Ben Bernanke's harebrained
approach to playing puppeteer of the masses (both received economics Ph.D's at
M.I.T.; both theses under the tutelage of Nobel prize winner Robert Sobel), it
should not be forgotten those in charge fully support such expedients. Sarkozy,
now Hollande, Merkel, and Obama have aggressively pursued criminals who engage
in markets. No, not Jon Corzine, but the widows and orphans who find it
difficult to eat on zero-percent interest rates.
Aside from Draghi's warning that he will crush anyone
in his path, Germany's position, as backstop to the euro is important and it is
clear Germany will not protect property rights. On May 19, 2010, "German
Chancellor Angela Merkel laid
out proposals to gain control over 'destructive' financial markets, after she
imposed a unilateral ban on naked short-selling that sent stocks sliding....
'The lack of rules and limits can make behavior in financial markets driven
purely by the profit motive destructive and lead to an existential threat to
financial stability in Europe and even the world,' Merkel told lawmakers in
Berlin today. 'The market alone won't correct these mistakes.'" (Bloomberg)
Merkel's attack on naked short-selling deserves a
sympathetic ear or two (though, the actions taken, and others threatened, were
designed to crush a larger carrier battle group), but the Chancellor is prone
to think closing markets will solve the euro's troubles. The Happy
Dreadnaught's public statements betray no reservations about shutting markets.
On January 16, 2012, S&P downgraded the EFSF from AAA to AA+. On the same
day, the Financial Times reported: "Ms Merkel said she would
consider calls from her party colleagues for legislation to bar institutional
clients such as insurance companies from selling bonds when ratings were
downgraded, or fell below investment grade." Presumably, the cohort in
question were European, including German, insurance companies. When the time
comes, protestations by Fidelity or Goldman Sachs are unlikely to open markets.
Merkel was thwarted in this effort, which would have
caused untold havoc. In their corner of the world, insurance companies
prevented from selling bonds when their price was falling would have seen
prices of insurance-company stocks, bonds, credit-default swaps, and insurance
policies sinking to previously unplumbed depths.
January, 2012, turned out not to be the proverbial
Armageddon that looked so dire on January 16. The reckoning has been delayed
but not solved by eurocrats who have done so by preventing market discovery of
real prices. Such repugnant acts as proclaiming the European Central Bank
senior creditor (above private bond holders) betrays a willingness to
substitute vocabulary for legal rights.
Other subterfuges to deceive the public fall under the
heading of manipulating markets to jam their failed policy down Europeans'
throats. In August, PriceWaterhouseCoopers reported non-performing loans at
European banks have doubled since 2008, to over $1 trillion worth. Very little
of that amount has been written down. Capital as well as collateral at European
banks is a joke. That includes commercial banks, national central banks, and
the European Central bank. The latter's portfolio is quite weak since it bought
assets that even the eurocrats would not permit to be pledged as collateral.
Interbank overnight lending operates through the ECB since the banks no longer
trust each other. Why they hold the ECB in high regard is only by the latent
trust in central banks, since the ECB balance sheet has so deteriorated.
(Adding to the perplexity of today's financial discussion is the angst about
Libor when its existence as the interbank rate is extinct.)
The blatant dishonesty in European finance may be even
worse than the Paulson-Geithner-Bernanke model across the ocean. European banks
did not recapitalize to the same degree as U.S. banks after 2008. Yet, their
practices and leverage were as aggressive. In the boom, larger European banks
met capital adequacy requirements by purchasing credit-default swaps (CDS) on
collateralized-debt obligations (CDO) sold by AIG. That was reported in the
fall of 2008. Like so much else that went awry, the consequences seem to have
evaporated in the mist.
Only to reappear. A parallel to the CDS-CDO-AIG
nonsense is the current minefield of a Greek default. To pretend they are still
solvent institutions, European banks have written (that is: the bank is the
insurer) of credit-default swaps on Greek sovereign debt. (Not to be forgotten
is the North American banks - yes, Canadian banks are none too sturdy - that
have written CDS on European sovereign debt. American banks have shredded this
risk, but what remains? CDS can be traded, bundled - oh, you know the
hopelessness of bank balance sheets today.)
The deceptions run wide and deep - more evidence of
the dysfunctional European financial system. Europe seems to have bettered
Americans at cumulative weirdness. A personal favorite, from Bloomberg,
August 30, 2007: "Landesbank Sachsen Girozentrale, the German state-owned
bank ravaged by investments in U.S. subprime mortgages, had 'secret' investments
of up to 46 billion euros ($63 billion), Sueddeutsche Zeitung said,
citing Saxony's government finance committee. In addition to off-balance sheet
investments in Dublin, SachsenLB also created so-called conduits in Leipzig in
2003 under the code name 'Dublin II,' the newspaper said...." Secret
Squirrel never had this much fun.
In fact, the Landesbanken stench floated to Ireland
via Hypo Real Estate where its Irish subsidiary, Depfa Bank, is hiding (the
following is a conglomeration of estimates) between $1 to $3 trillion (with a
't') of trade receivables that are over 270 days past due. These dead loans
(over-270-days-past-due are not repaid) were somehow plucked from European
banks. This is one more layer in the dissolving European Project that will receive
its day of reckoning.
Those who hold European securities (U.S. money-market
funds were large investors) own (to what degree is it "ownership"?)
paper floating in a sea of chaos. As the financial institutional framework
cracks, the informal - and, non-taxpaying - economy replaces it. The Mafia is
now Italy's biggest 'bank,' according to James Mackenzie at Reuters.
Mackenzie reported this non-bank bank is "squeezing the life out of
thousands of small firms.....Organized crime now generated annual turnover of
about 140 billion euros ($178.89 billion) and profits of more than 100 billion
euros," which equals 7 percent of Italy's national output. Here we see the
legitimacy of the eurocrats as well as local government authority flickering
before the final gale.
The Troika (European Union, or, more particularly,
European Commission, ECB and IMF) has thus far forestalled panic in the markets
by changing rules, a process that has degenerated as the preventive measures
grow more desperate. We are closing on a day when non-government investors, as
well as the masses, say: "Enough." With any luck, that will be ahead
of a general sequestering of their assets.
Tracing the deterioration of collateral is an avenue
to clarity. From Bloomberg on June 25, 2012: "Residential mortgage
backed-securities and loans to small and medium-sized enterprises rated at
least BBB- by Standard & Poor's will now be accepted with a valuation
haircut of 26 percent.... In the case that the ECB Governing Council [approves]
this, 'it would reduce the widely criticized influence of Standard and Poor's,
Moody's and Fitch,' one euro zone central bank source who spoke on condition of
anonymity said. 'On the other hand, this could also expand the shrinking pool
of collateral which banks in troubled countries have available.' The ECB
declined to comment." This story is a prime instance of institutional
confusion. First, "the ECB declined to comment," yet a "euro
zone central bank source" was extensively quoted. Where does he work? In
the ECB's pâtisserie? Second, as much as the rating agencies are widely
criticized, the obvious ploy to include dead-fish securities as proper
collateral makes a sham of the ECB.
The trustworthiness of collateral can only be
manipulated so far. It is a point of observation in human inertia that trust
has not already been extinguished, but, it required a trigger with Bear Stearns
and Lehman Brothers.
A few more changes to acceptable collateral that were
publicly announced and duly reported:
(Bloomberg, June 28, 2012): "ECB to accept
certain mortgage-backed securities, car loans... leasing, consumer
finance-backed securities, as collateral. Measure to come into effect when
adopted in legal act June 28."
Andy Lees (AML
Macro Ltd.), July 31, 2012: The ECB is considering unsecured
bank debt as collateral.
Bill King (The
King Report) wrote on June 20, 2012: "The EU put on its
clown shoes and stated that it would no longer use rating services and would
issue its own ratings."
June 22, 2012: Not to be outdone, IMF synchronized
swimming champion Christine Lagarde put on her clown shoes, whinnying "for
the ECB to be more inventive" in aiding the eurozone to beat the debt
crisis. The currency union needs a "creative and inventive" monetary
policy." This criticism was uncalled for. The Draghi ECB may lack many
attributes, but creativeness and inventiveness are its forte.
There is a limit. However much investors are willing
to accept the EU clown court, after the solvency of a financial institution is
past slavation, heroes are not rewarded for tossing a lifeline. Recent examples
of vaporizing trust were Bear Stearns and Lehman Brothers. A clearinghouse
survives by retaining trust. LCH.Clearnet, the largest clearinghouse in Europe,
served notice on June 4, 2012, that it might require additional collateral on
Spanish government debt held by banks. On June 20, the clearinghouse raised the
margin requirements for Spanish sovereign debt used in short-term funding
(repos) from 13.6% to 14.7% on certain maturities (it varies). This looks like
a compromise. Clearnet raised the percentage, but not enough to upset the
distribution of Spanish bonds. To retain confidence, the clearinghouse may be
forced to act decisively, in the not too distant future.
In the not too distant past, LCH.Clearnet announced it would accept unallocated
gold as collateral for margin cover purposes (starting on August 28, 2012). The
CME announced that it, too, would start accepting gold as collateral for margin
requirements on August 28, 2012. Markets are racing back to the nineteenth
century faster than central bankers can destroy their credibility in the
twenty-first.
Another limit was noted in June by the
Bank for International Settlements (the central banker's central bank). The BIS
warned of "asset encumbrance," that is, the current need for European
banks to pledge so large a portion of assets for collateral is weakening banks'
liquidity needs.
These limits are a reason ECB President Mario Draghi
has served notice the ECB will decide whether "irrational fears....
require exceptional measures." The world awaits the German Constitutional
Court's decision, scheduled for September 12, 2012, of whether Germany can
participate in the ESM's (European Stability Mechanism) bailout of countries.
Since Germany is already the "transfer
union" of funds to the rest of Europe (TARGET2 - not discussed here), its
participation will be fundamental. Draghi muscles opponents into Jimmy Hoffa's
locker so may not wait for, or possibly ignore, the court's decision. In any
case, the €500 billion ESM (which does not exist) is not large enough to hold
Spanish and Italian sovereign bond premiums to a ceiling of 200 basis points
above German government bonds. That is only one of the current mandates shouted
from the balcony of the Palazzo Venezia and Draghi knows this. Merkel, Monti,
and Hollande know it, too. Thus, the hope the ECB will call the
non-existent ESM a "bank" to leverage the €500 billion into bank
loans. Bank lending to companies in the eurozone has fallen 43% this year, so
the wonders of fractional-reserve lending would not seem to apply.
Market participants are heading to the exits. As
alluded to above, U.S. money market funds have sold European securities. How
much, and how the funds would post a daily price if assets are frozen, are
question that lead to a slew of other questions.
Europeans, too, are transferring money. On July 31,
2012, Reuters reported outflows from Spanish banks at €41.3 billion
($50.6 billion) in June and €163 billion from January through May: an
accelerating pace. To fill the void, Spain's banks borrowed €50 billion euros
from the ECB (that is: Germany) in June, and a total of €204 billion between
February and June.
Shell "is cutting back its exposure to European
credit risk in the worst-hit economies and putting a higher price on doing
business with the region's peripheral nations...[T]he Anglo-Dutch oil major
would rather deposit $15bn of cash in non-European assets, such as US
Treasuries and US bank accounts." (Daily Telegraph, August 6, 2012)
U.S. banks "are telling counterparties and borrowers to restructure
contracts or find another bank as they prepare for the potential exit...from
the eurozone. Using hedges, such as credit-default swaps [Yikes! - FJS], U.S.
banks have reduced their net exposure to troubled eurozone countries. But they
are also engaged in more work behind the scenes to ensure that if a country
leaves the eurozone they will not have to receive payment in a devalued drachma
or peseta." (Financial Times, August 6, 2012) Some companies are
"sweep[ing] cash out of euros nightly to reduce foreign-exchange exposure,
while others are looking at alternative payments in case customers flee the
euro or run out of cash." One company "has been preparing a version
of the company's pricing list in pounds...." (Wall Street Journal,
August 14, 2012)
The counterattack is mounting. In fact,
nationalization of assets has recent precedent. When its banking system
collapsed in 2008, the Icelandic government "ring-fenced domestic accounts
and shut out international creditors. Iceland's central bank prevented the sell
off of krona through capital controls, and new banks were created that were
controlled by the state. Then the government and the state-controlled banks
agreed that amounts in excess of 110% of home values would be forgiven on
mortgages." Iceland is not a euro participant, has a population of
300,000, so did not endure complications that European renegades will face.
A boatload of restrictions on money flows have washed
across Europe over the past three years. Many are petty and simply an excuse
for bureaucrats to collect a paycheck, but the mandarins in Madrid locked
Spaniards in chains in late June (recall the acceleration of money fleeing, above)
by instituting a minimum fine of €10,000 for taxpayers who don't report their
foreign accounts and the prohibition of cash transactions greater than €2,500
for individuals and firms. Looking at flow data in Spain, this does not seem to
have accomplished its goal, but simply reading numbers, without context, can be
misleading.
All in all, LCH.Clearnet and the CME are ahead of a
mad rush.
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