European Credit Markets Effectively Seize Up

Tuesday, September 30, 2008

Share traders worldwide were almost jubilant on Tuesday, initiating a relief rally around the globe based on beliefs that US lawmakers would come up with an improved bailout package.
But the inflationary effect of this ultimately new load of debts has become an issue in Europe where banks are reeling to secure funds and are increasingly hesitant to lend to each other in the light of the latest European banking failure. On Tuesday, Belgium banking giant Dexia was saved with capital injection of €6.2 billion by France and Belgium. In Iceland, the government took over the helm at Glitnir bank, the third biggest bank of the remote island nation.
According to MarketWatch the overnight LIBOR (London Interbank Offfered Rate) at which banks borrow FRNs from each other, shot from 2.6875% to 6.875%, recording the biggest one-day change ever.
The Euribor, benchmark rate for interbank lending in Euros, reached a high of 5.22%, hovering almost one point above the ECB's leading overnight rate of 4.25%. And this comes on the heels of Monday's announcement by the ECB that said the central bank would stand ready to provide unspecified amounts of liquidity in ongoing special refinancing operations.
Analysts are not that optimistic. The Telegraph has a good roundup of Europe's latest banking woes, written by Ambrose Evans-Pritchard and its effects on credit markets.
Europe's credit markets have come close to seizing up as three-month Euribor jumped to a record 5.22pc and OIS spreads rocketed to 113 basis points.
"The interbank market has collapsed," said Hans Redeker, currency chief at BNP Paribas.
"We're now seeing a domino effect as the credit multiplier goes into reverse and forces banks to cut back lending to clients," he said.
Mr Redeker said the latest alarming twist is a move by banks to deposit €28bn in funds at the European Central Bank in a panic flight to safety. This has jammed the mechanism used by the authorities to shore up the financial system in a crisis.
"The ECB is no longer able to inject liquidity because the money is just coming back to them again. This is extremely serious. If monetary policy is no longer working, there is a risk that the whole system will blow up in days," he said.
On Tuesday, two voices could be heard from the ECB's governing council. President Jean-Claude Trichet headlined his speech for a ceremony where he was awarded the "European Banker of the Year 2007" with a simple "Some lessons from the financial market correction"
Some excerpts:
First, the root of the problems for many financial institutions affected by the market distress was their inability to adequately assess the risks associated with the exposures they held, either directly in their books, or indirectly, via off-balance sheet entities. Imperfections in risk management systems as well as in risk governance proved to be substantial contributing factors to the accumulation of exposures whose long-term risk characteristics were not properly identified in advance. With the reversion of the housing and credit cycles, and the drying up of liquidity in certain market segments, a substantial part of these exposures turned out to be overpriced, pressing financial institutions to book substantial losses. Clearly, risk management failed to provide accurate signals for institutions to build up sufficient cushions that could absorb losses, when materialized.
Second, financial institutions came short of addressing the flawed incentives created by the originate-and-distribute model. Recent events have revealed again that sound underwriting standards are key for preserving stability both at firm and systemic levels. Over the period preceding the market correction we had seen credit standards declining substantially across the board, triggering an unprecedented surge in delinquencies on sub-prime mortgages recently. As unfavourable events continue to unfold, with house prices declining and economic growth decelerating in many countries worldwide, financial institutions have to face further write-downs on their low quality exposures.
Third, the lack of transparency throughout the securitisation process that engineered the underlying mortgages into complex structured products made it difficult for market participants to identify where the risks were accumulating in the financial system and to assess the possible losses from these exposures. This opaqueness of the securitisation process, accompanied by investors’ over-reliance on, and poor understanding of, external ratings, seriously undermined investor confidence and continue to put strain on the financial markets.
Fourth, with liquidity strains characterising certain market segments, it became impossible for firms to properly value a range of financial assets and off-balance sheet exposures. Admittedly, the existing standards on valuation and accounting proved to be inadequate for illiquid markets.
The sources of the current turbulence on financial markets are manifold. So are the consequences. What we can see now is that financial institutions are becoming increasingly under pressure to clean their portfolios and to strengthen their capital base, reinforcing the rapid de-leveraging process already underway. These tendencies, accompanied by increasing risk-aversion and the tightening of credit standards, may have substantial impacts on the real-economy that policy makers should be aware of. In this context, regulators and supervisors have to face the challenge of finding the narrow path between giving prompt and adequate responses to current developments in the short run, and mitigating the mechanisms that may fuel the downward spiral of financial and economic contraction in the longer term. 

Austrian governor Ewald Nowotny was quoted on CNBC, saying that the situation in Europe's banking system is far more stable than in the USA.
In the light of daily failures of European banks I tend to doubt that this wave of insolvency will be over anytime soon. Nowotny had said last Friday that the ECB's economic projections released earlier this month look already too optimistic.
Central banks remain the one-trick ponies they have been since the beginning of the credit crisis in August 2007. Any sign of stress in the system was drowned in more liquidity but the problems have only grown.
Eurozone Inflation Declines Again
Another alleviation in Eurozone inflation may keep the ECB on a stable path until December. Eurostat reported on Tuesday that Eurozone inflation has declined to 3.6% in September. It was 3.8% a month earlier.

100-Year Events - Now Happening Every Day

Monday, September 29, 2008

Who knows, but once the present has turned into history today's rejection of US Treasury Secretary Hank Paulson's $700 billion bailout package by Congress may be seen as the final straw that broke the back of international capital markets.
100-year events are becoming common fare these days and central banks have no other idea than to turn the spigots wide open. In a concerted action the central banks of the USA, Canada, the UK, Denmark, Norway, the Eurozone, Switzerland, Australia, Japan and Sweden expanded their FRN swap lines from $290 billion to a whopping $620 billion, the Federal Reserve announced on Monday morning.
This came after the financial crisis made further inroads into Europe.
Over the weekend ECB president Jean-Claude Trichet hammered out an agreement that Belgium, Luxemburg and the Netherlands would partially nationalize Fortis Bank and injected roughly €10 billion in order to save the bank as a going concern.
German taxpayers will remember September 29 for getting milked to the tune of €26 billion as their share in a €35 billion bailout package for lender Hypo Real Estate.
In the UK taxpayers will pick up the bill for the nationalization of Bradford & Bingley.
In the USA, Citigroup's throat got stuffed with Wachovia.
And all this happens in a matter of hours only.
Bank shares in Europe (and then later in the US) tumbled across the board as conscience gains ground that Europe will not be spared by the ongoing desintegration of the US financial system.
Wall Street's descent by some 6% was only topped by the Vienna stock exchange, where plunging real estate and bank shares led the ATX to a close more than 8% below Friday's levels. This was the second biggest plunge in the history of Austria. Austrian shares have begun to fall out of favor with investors because of their exposure to suddenly ailing East European economies which were the primary profit driver in this decade.
ECB Stays on Inflationary Course
The European Central Bank appears to try to avoid another bank failure by running its printing presses even hotter. On Monday the ECB announced more basically unlimited special refinancing operations in order to keep bids close to the official rates. This comes only 3 days after the ECB had announced more FRN repos - which were topped up again today.
As a general note I would say that central banks act like headless chickens since a year. With their boundless monetary creation at warp speed that is running into the trillions by now central banks will only be able to delay the oncoming European financial Tsunami, but the inevitable - a massive deflation of asset prices - will happen anyway.
Wall Street's deep dive today will echo around the world tomorrow. Expect Asian and European markets to open markedly lower.
In times of a true crisis gold again proved its safe haven status. In contrast to all other commodities (crude oil fell 10%) the oldest currency of the world shot up to $920 after the US congress rejected the bailout package. It may not take very long and we will see huge advances of gold once the financial wizards discover its unchallenged role as a store of value in times when all other paper assets see dramatic markdowns.

Austrian Election Results Could Bring a Nationalist Coalition

Sunday, September 28, 2008

Parliamentary elections in Austria may dramatically change the political landscape of this 8 million country in the heart of the European Union. Austrians on Sunday gave the previous so called big coalition of social democrats (SP) and conservatives (VP) a big thumbs-down with both parties descending below the 30% mark while two smaller parties, the anti-immigrant Freedom Party (FP) and the nationalist Alliance for Austria's (BZOe) gained dramatically.
According to figures released by Austrian TV station ORF the SP vote fell 5.7 percentage points to 29.7% while conservatives were told an even more compelling lesson. The VP votes sunk 8.8 percentage points to 25.6%. This is the historically worst result for the two parties that ruled Austria most of the time since WW2.
The Freedom Party under its relatively new leader Heinz-Christian Strache, 39, gained 7 percentage points and got 18% of the vote after 98% of all ballots were counted. Strache has successfully bet on a hardline anti-immigration line in his election strategy.
The biggest winner of the election was Joerg Haider's BZOe which almost tripled its vote to 11%.
The environmentalist Green Party lost 1.2 percentage points and gathered 9.8% of the vote.
Austria to Become the Nationalist Pariah in the EU?
As voters have given a definite thumbs-down to a continuation of the big coalition the new division of the 183 parliamentary seats make a coalition of conservatives and the two far-right parties the most likely outcome of coalition talks which are expected to start as soon as Tuesday.
This political earthquake in benign Austria could be a frontrunner what may happen in weaker economies like Hungary and Slovakia where nationalists have been gaining recently.
Austrian voters have projected their fears of an uncertain future. Inflation reached a 15-year high last summer while the government has scaled down social expenses whose explosive costs are based on worsening demographics, a trend that can be seen everywhere in Europe.
But a centrist to far-right coalition could land Austria in the position of a nationalist pariah within the EU. Both far-right parties had voiced strong anti-EU concerns before the election and were followed hesitantly on this path by the Social Democrats, albeit with a much softer tone.
The decider in this election may have been the populist Austrian daily "Kronen Zeitung" which pushed the Social Democrats leading candidate Werner Faymann while steering a course of xenophobic reporting at the same time, indirectly favoring the far-right winners of this election.
This is a sad day for Austria and the political climate in the EU as well. Austria had been put under a couple of EU sanctions after the vote in 2000 when the conservatives formed a coalition with the Freedom Party. I am thrilled to read the first comments from abroad.

China To Cut Its Dollar Holdings

Friday, September 12, 2008

Troubled by the weakening of the US financial sector China is seeking ways to cut its Federal Reserve Note (FRN) Exposure, reports.
China, which holds a fifth of its currency reserves in Fannie Mae and Freddie Mac debt, may cut the portion held in US dollars, according to China International Capital Corp (CICC), one of the nation's biggest investment banks.
The US government this week seized control of the two mortgage-finance companies, which account for almost half of the home-loan market in the world's biggest economy, to prevent defaults from crippling them. China holds up to $400 billion in the two firms' debt, CICC Chief Economist Ha Jiming said in a report Thursday.
"The crisis has made Chinese officials realize it's a bad idea to put all their eggs in one basket," wrote Hong Kong-based Ha. "This will likely lead to greater diversification of foreign exchange reserve investments."
China held $447.5 billion of US agency bonds as of June 2008, according to the CICC calculations using disclosures by the US Treasury. It is likely to reduce the portion of reserves in dollar assets from the current 60 percent by purchasing more non-dollar assets with new reserves, he said.
Countries in Asia have stockpiled foreign exchange reserves since the 1997-98 financial crisis to act as a cushion against a run on their exchange rates. That in turn has increased pressure on policymakers to ensure higher returns from more than $4 trillion in assets.
China will expand its investments in corporate bonds and equities, according to Ha. Treasury and agency bonds account for 50 percent and 40 percent of total dollar assets held by the central bank, he wrote.
This is an anti-dollar bell that will ring in my ears for a long time. Another blow to demand for FRN's as many sovereign wealth funds have seen their investments into troubled US companies melting away like ic e in the sun of this summer.

What Will Happen To Lehman Over The Weekend?

Bankers and financial authorities are becoming busy bees these days. After last weekend's overtime that led to a potential doubling of US public debt for the "rescue" of Freddie Mac and Fannie Mae this weekend will be spent on a rescue plan for Wall Street's oldest firm, Lehman brothers.
Bloomberg headlined "Lehman's Fuld Races to Sell Firm as Fed Balks at Deal"
and the Wall Street Journal topped its webpage with "Lehman Races to Find a Buyer"
The WSJ opens with a meaner tone:
The investment bank Lehman Brothers Holdings Inc. spent Thursday energetically shopping itself to potential buyers -- among them Bank of America Corp. -- just a day after insisting it had found a way to patch up its massive real-estate-related losses.
According to the paper the Fed balks at a similar bailout along the lines of BearStearns, which JP Morgan was ordered to buy in the new world of capitalist socialism (if such countersubjects can ever be written side by side.) Fedization or Fed bailouts and nationalization have become the buzz words in circles who had fed off the cream of free market theoretics - while the US government's share in GDP has been soaring to new records. Keynesianism hiding under a bull's hide.
The Federal Reserve and Treasury Department have been working with Lehman to help resolve the bank's troubles, including talking to potential buyers, according to people familiar with the matter. Federal officials currently aren't expected to structure a bailout along the lines of the Bear transaction or this past weekend's rescue of mortgage giants Fannie Mae and Freddie Mac.
Let's not forget that the Bear rescue may cost the Fed $29 billion while the Treasury has earmarked $200 for the Frannie survival.
Bloomberg is a little more kind to Lehman CEO Richard Fuld.
Lehman Brothers Holdings Inc. Chief Executive Officer Richard Fuld is seeking buyers for the investment bank amid signs that the U.S. government may balk at providing the funding that enabled Bear Stearns Cos. to sell itself and avoid bankruptcy.
Fuld, who built Lehman into the biggest U.S. underwriter of mortgage securities during his four decades at the firm, was cornered into a potential forced sale after talks about a cash infusion from Korea Development Bank ended, sparking a 70 percent drop in the firm's market value during the past three days. Unlike when JPMorgan Chase & Co. took over Bear Stearns, the Federal Reserve and Treasury aren't likely to put up money for a purchase of Lehman, people briefed on the matter said yesterday.
Worse may come to worse, though. Moody's put Lehman on his watch list, saying its A2 rating may be downgraded if the firm finds no strategic partner.
As it has become a custom that bank failures are announced on Fridays while any government intervention is done during the weekend it will be most interesting to watch the wires for today's last statement on Lehman. If they don't close shop today there may be a faint chance for some kind of continuation, dressed in some innovative words.
This Will Not Be the Last Bank Failure
The WSJ finished off with observations of Lehman employees:
Outside Lehman's headquarters in midtown Manhattan, employees taking lunch breaks or a few minutes for a smoke early on Thursday afternoon discussed the firm's future. Many sounded dazed. "It's over, man...unless we get bought out in the next 24 hours, it's over," said a young man, in conversation with someone on his cellphone. He said he was a Lehman employee and declined to answer further questions.
At a fast-food vendor across the street, people waiting to order food discussed the dive in Lehman's share price this week, and the latest headlines from CNBC. Outside, a group of three men, wearing Lehman badges and walking back into headquarters, discussed the fallout for other firms on Wall Street. "At some point, where does it stop?" one said, as he headed back to the office.
I am inclined to be of the strong opinion that this credit crunch will see many more bank failures and it will not spare the behemoths of the industry as these are the institutions most entangled in a web of derivatives with a potential risk that runs into the trillions
Only yesterday Banque de France governor Christian Noyer had warned in a Reuters dispatch:
EU states will dodge the thorny question of who bails out a cross-border bank when they meet to streamline supervision this week and a bigger role for the European Central Bank seems unlikely.
Banking supervision is still done largely on a national basis and if a major bank with a multinational presence fails there is currently no mechanism for dealing with it at the EU level.
The EU's 27 finance ministers meet in Nice, France on Friday and Saturday and are due to back a simpler system for the 50 or 60 multinational banks to report to regulators from 2012.
As the ECB has no treasury standing behind it a failure of a European bank operating in several EU countries will be a new challenge for the Eurozone. While Germany has already seen a bank merger wave, other Eurozone countries may only begin to calculate the total fallout from investments in wrongly AAA-rated US MBS and their banks exposure to the looming derivatives disaster.

Argentina, Brazil Abolish Dollar in Bilateral Trade

Thursday, September 11, 2008

The dollar begins to fall out of favour in Latin America.
Argentina and Brazil are the next 2 countries that reduce their exposure to Federal Reserve Notes (FRN). According to a report by,
Brazilian and Argentine presidents Lula da Silva and Cristina Fernandez de Kirchner signed on Monday an agreement which officially launches the use of their countries currencies for bilateral trade instead of the US dollar.
Both sides said that bilateral trade would save forex costs especially for smaller businesses. Bilateral trade between the two countries reached $25 billion in 2007 and is expected to soar another 20% to $30 billion this year. The agreement will be effective from October 1. Brazil sees the move as a first step towards more monetary cooperation in the Mercosur area that other countries could join as well.
"We’re giving a crucial step for a future regional monetary integration” said Lula da Silva during the official reception. "We are going to abolish the dollar as a currency in our trade" he added.
Lula da Silva pointed out that he wanted Brazil and Argentina's trade balance to be more balanced. Argentina had a 2.7 billion US dollars trade deficit with its larger neighbor Brazil in the first half of the year.
"The trade balance should be a two-way street," he said. "There has to be certain balance: one can have a small difference, one year a trade deficit and the next a surplus."
Brazil’s Central Bank said in a release that it had signed with the Argentine Central Bank an accord which establishes the rules for the Local Currencies Payments System, SML between the senior members of Mercosur.
Brazil Raises Basic Rate
On Thursday the Brazilian Monetary Policy Committee (Copom) of the Central Bank (BC) raised the base interest rate (Selic) by 0.75 percentage point, from 13% to 13.75% a year. This is the fourth consecutive hike in Selic and the highest is almost two years.
The Copom vote apparently was 5-3. Dissenters favored a 0.50 percentage points increase. In a statement the Central Bank said it was raising rates “to promote the conversion of the inflation to the target trajectory in a timely fashion”.
Even with falling commodity prices that pushed inflation lower in August to 6.17% from a three-year high of 6.37%, the orthodox central bank seems intent in insuring demand growth does not outpace supply and keeps to the original inflation target of 4.5% for 2008. Concerns were heightened when earlier data showed the economy expanded at 6.1% in the second quarter.
The Copom after raising the Selic rate by a larger-than-expected 0.75 percentage point in the previous meeting July 23 used the same language to express their goal of bringing inflation back to its target in a “timely fashion”.
A central bank survey of 100 economists anticipates the Selic rate will further increase to 14.75% by the end of the year.

Trichet Warns of Sustaining Risks in Banking System in EU Parliamentary Hearing

Wednesday, September 10, 2008

ECB president Jean-Claude Trichet warned EU parliamentarians on Tuesday that inflations risks were still to the upside. In his crusade against inflation Trichet repeated his warnings already covered after the ECB council meeting last Thursday.
In a new twist the ECB president emphasized the possibility of serious disruptions in the financial system, implicating the wave of liquidity problems could swamp more financial institutions. He restated that bank credit was still easily available, a hidden hint that the ECB will keep the taps open but stressed that there is no room for any complacency in an environment of unexpected balance sheet changes, meaning more losses may be in the pipeline.
Trichet's own words:
Let me now turn to the developments as regards financial stability. Recent developments suggest that the balance of risks in the ECB financial stability assessment remains tilted towards the downside. This is because the persistent, although moderating, decline in US house prices is leading to a rise in loan delinquencies and losses, and commensurate further declines in mortgage backed securities prices. Also in the euro area, economic growth has slowed down and credit risks could have increased in some housing markets and related corporate sector loans. At the same time, however, there is little evidence to suggest that the availability of bank credit in the euro area, as a whole, has been until now significantly affected by the financial market tensions.
That said, as we already emphasised, the persistence of the financial market tensions may have made the financial system more vulnerable to the crystallisation of other pre-existing risks. These include the possibility of a more broad-based turn in the global credit cycle, disorderly developments owing to global imbalances, and the financial stability implications of volatile energy prices.
More generally, the outlook for euro area and global financial stability will increasingly depend on the interaction between macroeconomic developments and the financial system, and on how banks respond to a challenging operating environment. The financial market correction could be gradually changing its nature and scope and evolve into a more traditional credit-cycle downturn. In such circumstances, it is more likely that the adjustment process will not abate as key participants in the financial system continue their efforts to strengthen their liquidity and capital positions. In an environment where balance sheet conditions change unexpectedly, there is no room for complacency.
Central Banks Meet Bi-Monthly at BIS
According to the ECB chief central bankers from both sides of the Atlantic are rubbing shoulders significantly more often since the beginning of the solvency crisis in August 2007.
As I already mentioned before, central bank staff and Governors of industrialised countries as well as of emerging countries meet every two months under the auspices of the Bank for International Settlements in Basel. Presently, I happen to be the Chairman of the Global Economy Meeting and I can tell you that this meeting in particular is important for all central banks. In a very frank and direct fashion and with a high degree of mutual confidence we compare notes, exchange all necessary information so as to be duly enlightened on the analysis and diagnosis that other central banks are making of their own domestic economies and on their perception of the global issues.
Against the backdrop of the serious market correction recorded since summer 2007, monetary authorities on both sides of the Atlantic have been cooperating to help ensuring a smoother functioning of inter-bank markets and help alleviating liquidity drying up in some market segments.
Euro member states are certainly happy to see the recent reversal in Federal Reserve Notes (FRN) as it may help to buffer exports in the Eurozone. It is also welcome by all holders of FRN debt who may at least book currency revaluation "balance sheet changes" in the current quarter, to paraphrase Trichet. But as we are only talking about the different speed both fiat currencies are debased at this is a competition of relative weakness, not strength.

OPEC Sets $100 Floor for Crude Oil

The surprising announcement of a 520,000 barrels per day (bpd) production cut for 40 days by OPEC embers led to a sharp reversal in crude oil prices which had dropped to a 10-month low as $98.89 overnight and traded above $103 again.
The cut brings production back in line with a 28.8 million bpd limit oil exporters had set a year earlier. OPEC ministers said the cut was aimed to reduce a current oversupply.
It certainly was a strong sign that crude producers want to keep prices in the three-digit area.
At $100 oil OPEC countries rake in $86.4 billion in monthly oil revenues.
From Bloomberg:
Crude oil jumped in New York as OPEC President Chakib Khelil called on members to stop producing more than the group's set quota after prices fell to almost $100 a barrel.
The Organization of Petroleum Exporting Countries is pumping about 520,000 barrels a day more than their 28.8 million-barrel limit, Khelil said. The group kept its output quota unchanged after adjusting for the departure of Indonesia and including new members Angola and Ecuador, according to Bloomberg data.
"It's definitely a defensive measure to keep prices above $100,'' said Jonathan Kornafel, a director for Asia at Hudson Capital Energy. "They don't want to see us go back to $140 or $150 but they want us over $100. It's a bit of a shock to the market and that's why we're up.''
Bloomberg also cites from a study that says speculators sold $39 billion in oil futures between the July peak at $147 and September 2. Limits on traders would cut oil to $65/70, it is believed.
Commodity index investors, blamed for record oil prices, sold $39 billion worth of oil futures between their July record and Sept. 2, causing crude to plunge, according to a report to be released today.
The work by Michael Masters, president of the Masters Capital Management hedge fund, blames investors who buy and hold an index of commodities for driving prices to records, and for their subsequent drop. It comes a day before the U.S. Commodity Futures Trading Commission is set to discuss its own study of energy trading with a congressional committee.
Masters testified three times before Congress this year, arguing that limits on traders would cut oil prices to $65 to $70 a barrel. He has been cited by lawmakers who introduced at least 20 measures to curb speculation. Congressional pressure on the CFTC to step up enforcement and restrict anonymous trades has pushed index traders out of their positions, Masters said.
New upward pressure may come from hurricane Ike which is expected to make landfall in Texas.
Hurricane Ike started to strengthen as it entered the Gulf of Mexico and headed in the direction of Texas, after leaving more than 170 people dead when it lashed Cuba and Haiti.
Ike's eye was 100 miles (165 kilometers) north-northeast of the western tip of Cuba and moving west-northwest at 7 miles per hour at 2 a.m. Miami time yesterday, according to the U.S. National Hurricane Center. Ike's winds strengthened to 80 miles per hour from 75 mph earlier.
The storm is forecast to make landfall between Corpus Christi, Texas, and Houston, according to a chart from the Hurricane Center.

Find the US short term oil outlook from the Energy Information Administration here.
Gold followed oil to a new 2008 low around $763.

New ECB Rules Designed to Restrain Lending - Or Is It Only Window Dressing?

Tuesday, September 09, 2008

Having been a little off-guard during the European Central Bank's (ECB) press conference I have to come up with a postscript as new rules on collateral valuations were silently put on the website while ECB president Jean-Claude Trichet only talked about it at the end of the Q&A session on Thursday.
In its biennial review of its risk strategy the ECB created a new fifth category for ABS and established significantly higher haircuts (markdowns) towards the valuation of category 4 and 5 of so called tier 1 assets. According to the press release,
the risk control measures applied to marketable assets, a new liquidity category for marketable assets will be introduced (see Table 6 of the “General Documentation”). This new category IV will be composed of credit institution debt instruments (other than Jumbo and traditional covered bank bonds) that were previously part of category III. Old category IV will be renamed category V.
In numbers it means that all ABS except for German jumbo Pfandbriefe and covered bank bonds will undergo a haircut of 12% when taken on the books of the ECB. Using such collateral has become more expensive too. Check the latest details for all maturities and risk categories here and compare them with the earlier framework from July 2003 and the initial framework from 2000.

Haircuts and Markdowns
The new rules are a clear sign that the ECB will no longer accept shoddy collateral in bank funding. In addition to higher haircuts the ECB will also adopt a general 5% markdown before the haircuts are applied, said Trichet:
  • "As regards ABSs, we have decided to apply to asset-backed securities a uniform haircut of 12% for all residual maturities and all coupon types. So 12% across the board. I have to mention that we are not, then, increasing haircuts for all ABSs, because we had already applied a 12% haircut to some ABSs – ABSs with a fixed coupon and a residual maturity of more than ten years. And for ABSs with a zero coupon and such residual maturity – the haircut so far has been 18%. But it is true that for ABS with lower residual maturity, the Eurosystem is now increasing haircuts.
  • Still on the ABSs, we have decided to apply a haircut add-on to ABSs that are theoretically valued, in the form of a valuation markdown of 5%. The valuation markdown is applied to the theoretical price before the application of the 12% haircut. The total discount on the price is then exactly 16.4%, when you compute first the 5% and then the 12%.
  • On bank bonds, we have decided to apply a haircut add-on of 5% to unsecured bank bonds.
  • As regards close links in ABS transactions, we have decided to prohibit the submission as collateral of any ABS by a counterparty when this counterparty - or any third party that has close links to it - provides support to that ABS by entering into a currency hedge with the issuer or guarantor of the ABS or by providing liquidity support of more than 20% of the asset-backed security’s nominal value.
  • We have also introduced a new decision on the ratings, and we want higher rating disclosure standards. With regard to the External Credit Assessment Institutions, the so-called ECAI sources, the credit assessment must be based on a public rating. For ABSs, ratings must be explained in a publicly available credit rating report, being a detailed presale or new issue report, including inter alia a comprehensive analysis of structural and legal aspects and a detailed collateral pool assessment. So this involves the External Credit Assessment Institutions. Moreover, we would ask the External Credit Assessment Institutions to publish rating reviews for ABSs at least on a quarterly basis.

All this may be window dressing only, though. Let's take a look at the latest categories of so called tier 1 eligible assets.
  • Category 1: Central government securities and debts issued by central banks
  • Category 2: Local and regional government securities, Jumbo Pfandbriefe, supranational and agencies securities.
  • Category 3: Traditional Pfandbriefe, 
  • Category 4: bank securities, corporate securities
  • Category 5: All other ABS

These changes are designed in order to restrain banks from relying on ECB funding which has dramatically grown since the beginning of the credit crunch on August 9, 2007. But then again the bigger problem is the rating of all these securities. It was AAA-rated subprime MBS that created the ongoing market turmoil in the first place.

The ECB's Tap Is Still Wide Open
Ironically the ECB announced the unchanged continuation of its long term facilities at the same time as the new collateral rules. There will come another supplementary €125 billion with maturities in 2009, according to the release. In simple words, the ECB will continue to inflate until...
But they still do the anti-inflationary talk. ECB chief economist J├╝rgen Stark did a good reminder of what the ECB is supposed to do in this interesting speech from last Friday, hinting at increasing political interventions:
In the current challenging environment, maintaining price stability is both more demanding and more important than usual. Siren voices from various quarters ask that we subordinate this duty to other considerations. Such voices are becoming ever more voluble. In this context, the principles embedded in our monetary policy framework have been, I think, instrumental in ensuring that we stay the course.

A look at the weekly financial statement of the ECB shows it is high time to reduce the monetary expansion that is running lengths ahead of the contracting economy in the Eurozone. Trichet and his fellow Eurozone governors may have been spared an inflationary blow-off situation because of the strong correction in oil prices. But with producer prices running at an annual rate of 9% in the Eurozone, currently benign headline inflation of 3.8% can be strongly expected to pierce the 4% record mark soon again.
Given the geopolitical tensions this may have been a summer break only. Russia can be expected to tighten the thumbscrews if the European Union gets too cozy with the USA and its ideas of a missile ring around energy-rich Russia.
To round off my postscript on the latest actions of the ECB I want to point readers to Edward Hugh's excellent spaineconomywatch blog.
Scrutinizing central bank borrowing on a national level Edward alerts the world to the worrisome fact that Ireland's borrowing is actually ten times that of Spain when comparing the size of the two economies. In his own words:
...when we look at how this money lent by the ECB has been allocated, then even more eyebrows may be raised on learning that lending to the much castigated Spanish banks has been "only" running at around 49 billion euros (as of July), while lending to Irish banks reached 44.1 billion euros according to data from the Irish central bank in Dublin.
While all this leads to the conclusion that the recent weakness of the Euro has a very fundamental reason I nevertheless would not favor FRNs or Yen as an investment alternative. The dollar is broken and sees only a dead cat bounce these days. I note with pleasure that gold is slowly decoupling from all fiat currencies and even withstood the correction in oil prices. Remember the term "flight to safety?" 

The Prudent Investor Joins Wikinvest

Monday, September 08, 2008

It did not take Wikipedia very long to become the standard online encyclopedia that has blossomed in 23 different languages.
Having joined a new grassroots service for investors by invitation I hope that Wikinvest will soon equal its successful model in popularity.
The new non-commercial service aims to establish itself as the premium provider of investment and economic knowledge and relies entirely on volunteers like me.
Wikinvest differentiates between specific company information and concepts that cover economic terms or issues. Equal to its big brother all articles can be edited by all registered users which should ensure unbiased information. Wikinvest has special bulls and bears categories for more opinionated contributors. This should prevent stock touting pretty effectively, I hope, being glad to have joined at a very early stage of Wikinvest.

Am I Dreaming? Capital Markets Welcome Fannie, Freddie Nationalization

Gosh, boys, we truly must be in a mess of epic proportions. Sometimes it pays to watch CNBC, and if it is only to preserve my humour in a time when we see daily exemptions from hailed free market principles for troubled financial enterprises. Only 2 hours after star investor Jim Rogers reminded viewers that the government's nationalization of Fannie Mae and Freddie Mac potentially doubled US public debt overnight, US Treasury Secretary Henry Paulson sat in CNBC's studio to calm investors, repeating his statements from the weekend.
You can guess the official stance: Taxpayers will be protected, the housing market will stabilize etc. Oh, and he also said, "this is not something we wanted to do."
He was followed by the world's best investor and richest man, Warren Buffett, who said the Treasury's plan to inject $200 billion into the two companies was the best that could be done. Freddie Mac shares are coming from a 52-week high at $65.88 and were being quoted at $1.50/70 in pre market hours on Monday. 
At that point of time Paulson's predecessor John Snow came on air, providing viewers with a good laugh when he said congress should have done something already in 2004 and 2005. That was the time he ran the Treasury. Readers of this blog may remember that former Fed chairman Alan Greenspan had warned about looming problems of Fannie and Freddie in May 2005 and September 2005.
International stock markets rallied in what will probably soon be seen as a bear market rally as this nationalization certainly does not qualify as a solution to the world's multitude of problems. I wonder if the Dow future can hold onto his pre market 250-point gain for the rest of the day.
Shifting the corporate risk and rewards from private investors shoulders to the big belly of government that has now been running on borrowed fuel (i.e. public debts) since 2001 is definitely not a move to curb moral hazard on management boards.
Something is here fundamentally wrong: Capitalism, the frontier fighter for free markets welcomes nationalization???
A look into history should sober up everybody. The last time US banks were nationalized was in the great depression of the 1930s. European governments had ended up with numerous bankrupt banks after WW2 that were nationalized in order to keep a financial base for the rebuilding of the war-ravaged continent. Nationalization happened even earlier in Russia: During the communist revolution in 1917 banks were the first enterprises the Bolsheviks took control of. With that control bundles of industrial company shares fell into the country's new rulers hands.
As the USA has been marching on an unprecedented path of monetary expansion since 1987, throwing freshly minted Federal Reserve Notes (FRN) on every problem that came along, this weekend's biggest nationalization in history raises fears that big government will continue on this deceivingly dangerous path that will further debase FRNs. Fed chairman Ben Bernanke, always ready to flood the world with more FRNs, said in a statement,
"I strongly endorse both the decision by FHFA Director Lockhart to place Fannie Mae and Freddie Mac into conservatorship and the actions taken by Treasury Secretary Paulson to ensure the financial soundness of those two companies. These necessary steps will help to strengthen the U.S. housing market and promote stability in our financial markets. I also welcome the introduction of the Treasury's new purchase facility for mortgage-backed securities, which will provide critical support for mortgage markets in this period of unusual credit-market uncertainty."
What comes next? The world is aware that the big three car manufacturers are de facto bankrupt. Will they be put under conservatorship too? After all they are as vital to an economy as are ailing airlines. Will the fading expenditures of cash-strapped consumers finally lead to whole malls being run by the government as it tries to follow the inflationary rule that all debts can be written off in the long term as long as the fiat money system is accepted by the public?
The cost of the bailout of Fannie and Freddie is virtually zero to the government as it will inevitably be borne by taxpayers. Add a few million more in hush-money handshakes for Fannie and Freddie executives to the potential trillion disaster because no official wants to see the true story become public ever. Bloomberg TV reported that $1.47 trillion in GSE swaps will be unwinded.

Is the USA Ready for a New Deal?
Remembering last Friday's new record unemployment rate of 6.1% it appears as if the current administration has not been on a path of progress since it took office. Disregarding the official GDP figures because of the ridiculous 1.2% deflator we can confidently put the USA on the list of countries in recession - where it meets numerous European countries where the economy appears to fall off the cliff nowadays.
Historical comparisons shine a light on the fact that countries in recession have always had the doubtful joy of growing government intervention.
What is a bit different these days is that it is conservative governments - the former free market advocates - who embark on a socialist path. And BTW, why is nationalization in the USA ideologically "good" while it is "bad" in countries like Venezuela? After all shareholders will get nothing in both places when the state's arm reaches out.
Considering the crumbling infrastructure in the US and a withdrawal from formerly public services (community services e.g. waste, jails, roads) the worsening economic situation could lead to a new New Deal.
Concluding that this nationalization is a stopgap for the current occupiers of the White House, all these pressing issues - and two wars going bad - will be left to the next president anyway. Not exactly a friendly outlook.

Having Tea at the Dovish ECB

Thursday, September 04, 2008

The governing council of the European Central Bank (ECB) seems to have had a very sanguine meeting, leaving the key interest rate as expected unchanged at 4.25% in an unanimous vote.
I am actually blown away by the dovish tone expressed in the introductory statement and the following press conference. 
Not only that the ECB has for the first time failed to mention "being vigilant" - a standard phrase in the past - but now starts to blame wage effects for the surge in inflation it has so far missed to address appropriately with a more decisive rate policy.
Currently the ECB is wide off the mark
Inflation is almost double the target rate of 2% and ECB analysts predict a figure between 3.4% and 3.6% for the full year 2008.
With regard to price developments, annual HICP inflation has remained considerably above the level consistent with price stability since last autumn, standing at 3.8% in August according to Eurostat’s flash estimate, after 4.0% in June and July 2008. This worrying level of inflation is largely the result of both the direct and indirect effects of past surges in energy and food prices at the global level. Moreover, wage growth has been picking up in recent quarters, at a time when labour productivity growth has decelerated, resulting in sharp increases in unit labour costs.
Looking ahead, on the basis of current commodity futures prices, the annual HICP inflation rate is likely to remain well above levels consistent with price stability for quite some time, moderating only gradually during the course of 2009. Consistent with this view, the September ECB staff projections foresee average annual HICP inflation at between 3.4% and 3.6% in 2008, and between 2.3% and 2.9% in 2009. The higher inflation projections for 2008 and 2009 mainly reflect higher energy prices and, to a lesser extent, higher food and services prices than assumed previously.
Money supply points to upside risks for price stability too, the ECB acknowledges. M3 is still running at more than double the target rate of 4.5%.
The monetary analysis confirms the prevailing upside risks to price stability at medium to longer-term horizons. In line with our monetary policy strategy, we take the view that the sustained underlying strength of monetary and credit expansion in the euro area over the past few years has created upside risks to price stability. Over recent quarters, these risks appear to have become manifest as inflation has trended upwards.
Not least in the face of the ongoing tensions in financial markets, the monetary analysis helps to support the necessary medium-term orientation of monetary policy by focusing attention on the upside risks to price stability prevailing at medium to longer horizons. While the growth of broad money and credit aggregates is now showing some signs of moderation, reflecting the policy measures taken since 2005 to address risks to price stability, the strong underlying pace of monetary expansion points to continued upside risks to price stability over the medium term.
The currently flat yield curve has given rise to a substitution from longer maturity assets into monetary instruments, which offer similar remuneration but greater liquidity and less risk. This substitution has led the current headline rate of M3 growth to overstate the underlying pace of monetary expansion.
Remembering the single mandate of the ECB - to hold inflation below 2% and M3 around 4.5% - I would consider the inactivity of the ECB as a dangerous precursor for more inflation down the road. This could soon turn into a "too little, too late" situation where the ECB will be behind the curve.
The hesitancy to give markets a sign of decisive hawkish commitment probably has a political background too. The ECB lowered its staff forecast for growth in the Eurozone:
Taking into account all available information, the euro area economy is currently experiencing an episode of weak activity characterised by high commodity prices weighing on consumer confidence and demand, as well as by dampened investment growth.
This outlook is also reflected in the September 2008 ECB staff macroeconomic projections for the euro area. The exercise projects average annual real GDP growth in a range between 1.1% and 1.7% in 2008, and between 0.6% and 1.8% in 2009.
I am quite confident that a lot of politicians are frequently pounding on the doors of their central banks, fearing a continually worsening of economic growth in case of more hikes that will be unavoidable in the medium term if the ECB wants to retain its credibility an an inflation fighter.
Their fears are unfounded as long as the ECB describes credit availability quite unrestricted:
In particular, the pace, maturity and sectoral composition of borrowing from banks suggest that, at the level of the euro area as a whole, the availability of bank credit has, as yet, not been significantly affected by the ongoing financial tensions.
Eurozone citizens though, plagued by high food inflation, have turned cautious on long term financial commitments as the downtrend in private lending still continues, according to the ECB and also observed in declining retail sales.
The surprisingly complacent impression the ECB left on markets pushed the Euro to a new seven-month low of $1.4333. Oil and gold weakened accordingly, displaying their negative correlation with Federal Reserve Notes.

ECB Will Hold Rates Steady Based on Recent Economic Data

Wednesday, September 03, 2008

Comfortably cushioned by recent economic data the European Central Bank (ECB) will most likely leave its leading overnight interest rate steady at 4.25% at its governing council meeting on Thursday. ECB president Jean-Claude Trichet can be expected to point to improvements in both inflation data and money supply M3. According to Eurostat inflation has leveled off slightly to 3.8% in August, after an annual CPI of 4% a month earlier. A year earlier inflation had just reached the ECB'S upper target level of 2%.Money supply M3, supposedly the other policy target of the ECB, has continued its retreat below the 10% mark and stood at 9.3% in August (July: 9.5%.) The ECB has a formal M3 growth target of 4.5% which it has overstepped since the introduction of the common European fiat currency in 2001.
Expect Trichet to keep the ECB's stance that inflation will moderate in the medium and long term. This is not backed up by producer price data, though. Latest PPI figures from July show an annual increase of 9% (June 8%) in the category "total industry excluding construction." Eurostat does not publish an overall PPI.While there had come some hawkish tones from two ECB council members last week, rapidly worsening economic indicators will guarantee steady rates too.
Recession in Q2 2008
Eurostat published a first estimate for Q2 2008 GDP data that show a decline of minus 0.2% MOM. Expect the PIGS (Portugal, Italy, Greece, Spain) to take the lead in a further economic contraction.
Add in further proof from a continuing decline in retail sales, which fell 0.4% MOM in July and combine it with gas prices that did not decline equally with crude oil. Europeans have no spare cash that could boost the economy. A good part, though not as many people as in the USA, are saddled with the same problem: Rising market rates for mortgages and the threat of negative home equity have yet to grow into a financial disaster rivalling the chaos in the USA.
Looking at forex markets I don't expect American Federal Reserve Notes to rise further after the announcement of the ECB. The 10% correction against the Euro is IMHO merely technical. But never forget that the whole world wants to get rid of FRNs. 

Weird Dichotomy in Gold and Silver Prices in Europe

Having read a growing number of reports on a physical silver - and now gold too - shortage with dealers unable to guarantee delivery time, here come some additional observations from the German language area in Europe. The dichotomy between the so called global spot price for the two precious metals and prices paid on ebay Germany has never been wider than these days. 
A lot of 100 one oz. silver Maple Leafs was sold for €1,267 or $18.25/oz Tuesday evening. This is a markup of 40% to the then current spot price of $13.10. It appears as there is a seller's strike as there are hardly any sizable silver lots on offer.
The gold market shows the same: Offers have dropped to mere 100 gram (3.21 oz) bars which are sporting minimum bids of €2,100 or $ 3,045 which translates into $948/oz. This is a markup of 17% to the so called global spot price.
A desirable 50 gram (1.6 oz) Rothschild gold bar - which are not produced anymore - is listed for another 6 days and has already drawn a bid of €895 or $1,298; this is 10% above spot.
Having read reports that South Africa's biggest refinery has been unable to fill a 5,000 oz. order I can only arrive at the conclusion that these so called global spot prices which are derived from COMEX paper prices have nothing to do with the world of truly physical deals. Come on, that's a $4 million purchase - and now they are finished.Has ebay already established itself as a competitor to precious metals exchanges? 
The loud uproar in the gold and silver investing community about falling futures prices - while demand is still up - seems to be a correct alert to market authorities that appear to sit on their hands with closed eyes.
The fundamentals for the metals could not be better. Western central banks remain with the tactic to shower more fiat money while betraying the public with false statements about their vigilance on inflation. Inflation is here and it will not go away for geopolitical reasons. Russia is the strong man that controls the biggest part of energy supplies to Europe. Rumours have it that Putin will raise natural gas prices by 20% later this year. Prices at European gas pumps have not come down with crude oil prices, suggesting the market is still tight, despite what is said officially.
Both gold and silver will see another formidable fall season where "official" prices will soon catch up with actual prices paid by investors. Especially silver is poised for a meltup, considering the COMEX shorts. And don't give too much about short term charts these days. As the market is manipulated, charts lose any power of predictability.

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