Until recently, the concern about Europe has been mostly theoretical–a potential train-wreck that would occur if/when the world’s lenders decided that the continent’s problems extended beyond the basket case known as Greece and cut lending to Europe’s “core.”
Well, that concern is no longer theoretical.
The world’s lenders are increasingly deciding that it’s better to be safe than sorry, and they’re pulling their money out of Europe.
As a result, the borrowing costs of many European countries are rising fast. And so are inter-bank lending rates, because the second huge problem with the Euro-train-wreck is that Europe’s banks have Euro debts coming out of their ears.
(When bond yields rise, the market value of existing bonds drops, so any bank that owns the debt of any European country is suffering huge embedded losses. The banks don’t mark these losses to market, so you can’t see them on the balance sheet, but they’re there.)
Last week, Italian borrowing costs soared over 7%, which has been viewed as a sort of Rubicon level. Spanish yields hit nearly 7%. And French “spreads” over German bonds expanded sharply.
Nelson Schwartz in this weekend’s New York Times has some other details:
- The Royal Bank of Scotland and pension funds in the Netherlands have been heavy sellers of European sovereign debts in recent days.
- Kokusai Asset Management in Japan unloaded nearly $1 billion in Italian debt this month.
- Vanguard let a $300 million CD with Rabobank expire earlier this month and pulled the money out of Europe
- European banks like SocGen and BNP Paribas cut exposure to Italy by 26 billion euros in Q3
- American money-market funds have cut their exposure to European bank paper by 54% ($261 billion) since May
And so on.
The interbank-lending problems, by the way, are exactly what happened in the United States in 2007 and 2008.
If the run continues, for banks and countries and companies that live on borrowed money, the effect will be similar to the oxygen being sucked out of the room.
And because of the absurd opacity of bank balance sheets, there’s no way to tell when or if some critical threshold will be breached and banks and insurance companies (think AIG) will suddenly have to start handing over tens of billions of dollars of “collateral” to counter-parties, blowing huge holes in their balance sheets.
Importantly, once runs like this get started, they can accelerate fast. Recall how quickly Bear Stearns and Lehman Brothers went from angry denials and “exploring options” to bust. Recall how quickly, a month ago, MF Global went from confident to flailing to broke.
Check out these two charts of the “TED Spread,” which shows the difference between LIBOR (London Interbank Offered Rate) and US T-bills.The first shows the sharp rise in the TED since the summer. The second, which extends back 5 years, shows how quickly the spread exploded in 2007 and 2008. As the latter chart illustrates, you can go from “concern” to “crisis” overnight.
Right now, Europe’s leaders are still denying that there’s a problem, and market pundits are still talking about possible solutions.
But most of the possible solutions are still focused on the ultimate fate of the Euro–which, increasingly, is the least of the world’s worries.Whether the Euro survives, and how, is something that will likely take several years to work out.
The much more immediate crisis–and the way this week went, it may be a VERY immediate crisis–is whether the Eurozone can stave off a full-blown bank and sovereign debt panic.
The temporary solution that everyone is focused on is for the European Central Bank to step in and buy hundreds of billions of dollars of European sovereign debt to get rates down and keep them down.
Importantly, this solution it would not be easy or problem-free. It also wouldn’t be permanent. It might not even be possible. The Germans, and the ECB, are adamant that this solution is not even a possibility. And even if the ECB could marshal the support to start buying, it would have to keep buying, day after day, month after month, and display total resolve in its public statements. It would have to keep buying until the Euro-zone’s problems are sorted out, which could take years. It would have to figure out how to deal with the “moral hazard” of funding the deficits of most European countries and, therefore, removing any incentive for the countries to get their deficits under control. And, eventually, it would have to deal with the extreme inflation this “money printing” would likely produce.
In other words, if the situation continues to deteriorate–and barring some miracle, it will–the only way to stave off disaster looks less like an inevitable move and more like a Hail Mary pass.
The next few months, as the Chinese might say, are going to be interesting.
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