Friday, July 10, 2009

Economics 10/07/2009: Don't panic, ECB is... errr... backing down

On a light-hearted side of the blog:As they say in one famous commercial: for serious press, there's Mastercard, for BJs, there's Mayo Advertiser. (Hat tip: JH)

As the Bank of New York Mellon, one of the world’s largest and, in my view lowest counterparty risk custodian banks says the markets are now seriously disenchanted with European financials.

Per FT report today, concerns about the European banking sector are at their highest level since March. Euro might be sliding.BoNYM said its data showed net outflows from German bunds for the first time since mid-March. This is at the time when our own clowns are claiming that there is now a clarity in the borrowing markets for Irish debt. Hmmm... Clarity about what? An impeding disaster that is named NAMA?

BoNY Mellon also tracks outflows from Italian, Spanish, Portuguese, Belgian and Greek bonds. Emerging European markets lead, with APIIGS, plus France, Belgium, Germany and Sweden are at the forefront of the new pressure. By the end of this round - the acronym of 'troubled' or 'exposed' states will have 27 letters in it. Per FT report, Austria, Italy, France, Belgium, Germany and Sweden, which together accounted for 84% of the exposure to Eastern Europe. FT quotes BoNYM head of currency research saying that the euro area has lost its safe haven status, and is increasingly seen as a high-risk region among international investors. Thank god someone is being realistic...

But not in the marbled halls of the ECB. Those guys are simply out to lunch. Per their latest assessment (here): "Despite the financial turmoil, the global landscape of international currencies and - within that - the share of the euro remained steady. Specifically, between end-2007 and end-2008, the share of euro-denominated instruments increased by around 1 percentage point for outstanding debt securities, around 2 percentage points for outstanding cross-border loans and deposits, and around 1 percentage point for global foreign exchange reserve holdings... The review also shows that the international role of the euro maintains a strong regional pattern. Its international use continues to be most pronounced in countries with close geographical and institutional links with the euro area."

But the ECB's rosy take on the Euro is only half a problem. ECB's Monthly Bulletin (see here: scroll to 09/07/2009) is already on the path of plotting 'exit strategies' from the current active support policies - despite giving a rather gloomy outlook for the Euro zone for 2009-2010... Go figure. A companion paper to the bulletin has another re-print of the already trite table that was first floated by the OECD back in January 2009 and then slightly updated by the Article IV paper by the IMF last month. This is:
Enjoy - our Government's contingent liabilities relating to the banking crisis are ten times greater than those of the second most-screwed up banking sector in the euro area - Belgium. Oh, we are having some fun...

But not enough, I hear you say? Here is another good one from the ECB:
Now, California is considered to be bunkrupt, given its state deficit is only $24bn through next 12-18 months (depending on the budgetary framework taken), relative to a GDP of $1.8trillion a year - less than 0.008-0.013% of GDP. Ireland? Well - depends on whether you count NAMA or not, we are pushing for some 12-30% of GDP... Spot the difference? Ok, another chart then:We are facing worse deficit than Greece, but our spreads are lower... What gives? The market is not pricing in NAMA as a state liability. Not yet.

Here is what ECB used to assess the bond spreads:
"The following empirical model is used to explain the ten-year government bond yield spreads of
ten euro area countries (inc Ireland) over Germany (spread):
spreadit=α+ρ spreadit-1+β1 ANNit+β2FISCit+β3IntlRiskt+β4LIQit+εit

In this model, ANN denotes the announcements of bank rescue packages made by individual euro area governments (this variable takes the value 1 after the date of the announcement and the value 0 before); FISC denotes the expected general government budget balance and/or gross debt as a share of GDP, relative to Germany, over the next two years, as released biannually by the European Commission; IntlRisk is a proxy for international investor risk aversion, as measured by the difference between the ten-year AAA-rated corporate bond yield in the United States and the US ten-year Treasury bond yield; LIQ is a proxy for the degree of liquidity of euro area government bond markets, measured by the size of a government’s gross debt issuance relative to Germany; εit is the unexplained residual."

For the lack of time right now, I can't re-parameterize the model to derive the values of the fundamentals-justified spread for Ireland. I shall do this over the weekend, but here are the main results for the group of 10 countries:
Good luck.


Anonymous said...

My understanding is that Irish banks are getting loans from ECB at 1% interest rate,then purchasing Irish sovereign bonds(the last medium term issue a couple of weeks ago yielded a coupon of 5.9%) ,they then repo the bonds at ECB at a discount thereby gaining cash to capitalise the banks balance sheets.

The trick here is the government gets cash to run the country through the back door as purchase of these bonds by the ECB (Quantative Easing) is prohibited by the Maastricht treaty.
Therefore the profile of Bond Investors conceals the fact there is a cleverly constructed and false closed market for many of these bonds.
There is therefore no true market price for them.

Another reason,possibly ,that nationalisaion of Irish banks is not on (according to Lenihan)is this would make it problematic to nationalise Irish bonds held by the banks or by ECB and would certainly close the door to this method of financing the States current spending.

Please also not the current treasury bill and bond auctions look more and more like the type of money lending deals done on street corners.

My own opinion is the euro has been a disaster for Ireland and we would be better outside it.If we remain in the euro and EU we will be the Luisianna of Europe,persistently in poverty and dependent on the ECB.
Better to take the pain now and go our own way.

TrueEconomics said...

Anonymous, you are pretty much right. On all points. The question I cannot answer is the following: how long can this Banks-ECB-Government-Banks carousel last before the ECB closes the window or demands that Brian Cowen cut public sepnding by, say, 15% across the board and his own salary by 50%? ECB knows that we are insolvent. Europe knows that we are insolvent. The world knows that we are insolvent. No amount of Alan Ahearne / Brian Lenihan waffle will change this reality. We know that our last trump card - the Lisbon re-Vote is comming up for a call. Once that is on the table - the bets are off. So how long can this charade last?

MK1 said...

The ECB 'quantitative easing' carousel that is spporting our banks is but another example of 'virtual money'. Credit that built up was 'fictitiuos' and virtual as our money system is a FIAT money system where money can be printed or created in an electronic account by central banks. Money is all about trust and as long as trust remains in the system it can be bouyed and used as a fiat system.

You say that we are insolvent. Correction: the WORLD is insolvent. We owe more than we have, individuals, businesses, governments, local governments. We are in NET debt.

As for Lisbon-II and the ECB, they are completely unrelated. The ECB exists as is. It was part of the Mastricht treaty iirc. Many things wil be thrown at the electorate this time that they must vote yes for Lisbon-II as look at what the EU has done for us, etc, etc, but these are all bogus claims. These are already in operation. Lisbon-II is not a vote on whether we must leave the EU or not. It is purely an organisational change, and voting should take place on those changes alone.


Anonymous said...


reference your post and mine of July 10, 2009 12:12 PM above.

The point I wanted to make regarding the quantative easing of the ECB is that this is contingent on the Irish government scaring the people into voting Yes to Lisbon.
In my opinion if there was no Lisbon 2 referendum the ECB would not presently be involved and its likely the IMF would already be here restructuring our economy.