ECB success and folly

Yet another interesting night in Europe.  Spain managed to over sell as it latest auction with €6.03 billion sold versus €3.5 billion targeted which in the current environment is seen as a good result. Medium term paper had lower yields and lower bid/cover ratios, while longer term paper had higher yields but better bid/cover.  Given that the markets are on edge and are therefore hyper-senstive about these preceedings this is a good result, with Spain paying 5.545% on 10 year issuance.  The big question is whether the latest night’s auction result was spurred on by the new ECB long term repo operation Swhich could be encouraging spanish banks to purchased their nations sovereign bonds and then front up to the ECB. This would make sense because the spread between the ECB’s refinance rate and euro-sovereign bond yields is very wide which means it is a profitable transaction for the private banks, although I would expect to see this result further towards the short term paper.

If this is the case, then this is obviously a positive for struggling sovereigns because the ECB liquidity operations are providing a small sovereign backstop. This is a good thing for the Spanish government in the short term, but it doesn’t help solve the issue that the private sector will continue to deflate as banks attempt to repair their balance sheets after the fallout of the housing boom:

Repossessed houses in Spain are worth 43 percent less on average than the valuations assigned on the mortgages for the properties, according to Fitch Ratings.

Price declines range from 20 percent to 58 percent, analysts Juan David Garcia and Carlos Masip in Madrid wrote in a report analyzing 8,235 properties funded by loans from banks including Banco Santander SA (SAN) and Bankia SA. The mortgages are in asset-backed securities with high loan-to-value ratios.

“Fitch does not expect lending to recover in 2012, as financial institutions are more focused on optimising their balance sheets, while their access to funding is limited,” the analyst wrote. “Lending is likely to remain concentrated on existing high-quality borrowers and on potential buyers of banks’ repossessed properties.”

With Spain’s private sector continuing to struggle and the government promising more austerity I am not sure the LTRO is going to be enough to save the Spanish banking system. Just don’t tell Mario Draghi, who continues to live on a planet detached from Europe’s economic realities:

Europe’s top central banker said on Thursday that euro zone governments are on the right track to restore market confidence but reminded them that an emergency program to buy their bonds was “neither eternal nor infinite”.

Mario Draghi’s comments came after a smooth Spanish bond auction eased fears of an accelerating slide in European markets following a summit last week that failed to reassure investors the single currency area is closer to resolving its debt crisis.

The European Central Bank chief said in a speech in Berlin that the 17 euro zone governments “are now on the right track and they are right in implementing budgetary consolidation resolutely.

“The unavoidable short-term (economic) contraction may be mitigated by the return of confidence,” he said.

To mitigate risk aversion rife in markets, Draghi said more policy clarity was necessary, and he urged politicians to “speak unambiguously”, then “deliver”.

I’m not going to go through this again, you can read my followups to Draghi’s last press conference ( here and here ). In summary the new fiscal compact is a recipe for deflation which will be anything but short-term, and everything else Draghi said he learned from the unicorns.

In my opinion Christine Lagarde has a far better grasp on the situation, even if she does work for an organisation that is part of the problem:

The European debt crisis is growing to the point that it won’t be solved by one group of countries, Christine Lagarde, the managing director of the International Monetary Fund said today.

Lagarde said that if countries don’t work together, the world will face a situation similar to the 1930s, before the world slid into World War II.

“There is no economy in the world, whether low-income countries, emerging markets, middle-income countries or super- advanced economies that will be immune to the crisis that we see not only unfolding, but escalating at a point where everybody would actually have to focus on what it can do,” Lagarde said.

If the international community doesn’t work together, “the risk from an economic point of view is that of retraction, rising protectionism, isolation,” Lagarde said. “This is exactly the description of what happened in the ‘30s and what followed is not something we are looking forward to.”

The trouble with that statement is we already know that the US is finished helping the Europeans until they start helping themselves and the contribution from other nations is likely to be as subdued, even if the Russians have promised to do more. Most of the world is telling the ECB to provide more assistance to Europe or they aren’t going to bother, meanwhile the ECB is telling Europe that deflationary policy is bound to lift investor confidence so there is no need for additional action. Let’s hope actions speak louder than words.

In other news Merkel’s coalition party is falling to pieces  which is not her only domestic problem , and let’s not forget the banks as well and the Eurozone continues to contract , although at a slightly slower pace.

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Comments

    • Well this can go on for a long period of time , because the US Fed is supplying USD liquidity for Euro banks that are still solvent that have Euro capital available to swap in USD but cannot find a willing counter-party for the swap at a tradable cost.

      Although foreign currency liquidity is important to Euro banks because they issue bonds in foreign currency it is a different issue to the one I discuss above.

      What we are seeing in the European banking system is a degradation of asset quality, which leads to a loss of capital. No amount of liquidity is going to solve that problem because it is one of solvency.

      That is why we are seeing on-going issues with Commerzbank and more lately credit agricole even though there is unlimited liquidity available on demand.

      • Sorry I’ve been in mining financing meetings most of the day. No attacks please as I’m not a mining bot…

        Thanks DE for clearing that up as I’d seen conflicting statement in the US. FT Alpha had a good post on Target2 so I get where this is at.

  1. I would not presume to be prescriptive regarding the EU situation, but I find the Gavekal analysis at FNArena, enlightening.
    http://www.fnarena.com/index2.cfm?type=dsp_newsitem&n=3A4A1BE6-0269-06FA-128F1681C599656C
    The link to the BBC’s “Top economists reveal their graphs of 2011” in today’s Chart-of-the-day post, is also informative. Surely, the EU’s (and the global) predicament is summed up by Richard Koo’s appraisal that most OECD countries are in a “Balance Sheet” recession, post GFC1?

  2. Where does the Russian WTO deal fit into this picture. What is it a quid pro quo for exactly? These things are not given without something in return.

    This may seem off topic but this whole Euro mess is tied in with French delusions of grandeur and the desire for Europe (ie a French vision of Europe) to be the World Power it deserves to be (in the twisted minds of French Bureaucrats that is). Sort of the Divine Right of France. Witness the foot stamping about France getting downgraded before Britain. Oh the joy, the joy!

    How come most French people are so nice and French bureaucrats are so deluded? One of life’s mysteries there.