The Crisis Rolls On, Full Steam Ahead

by: Acting Man

Euro-Area Bank Stocks Crash Again

The European political authorities have become a fractured bunch. They appear completely paralyzed and are eying each other with growing suspicion. The angst and hefty debates Jürgen Stark's resignation from the ECB's board has brought to the fore in Germany speak for themselves. The EU'S leadership is unable to act in a decisive manner – it seems no longer even possible to apply ad hoc band-aids to the crisis in view of the ongoing dynamics of the process, although the ECB has continued to buy peripheral sovereign bonds to the tune of €14 billion over the past week (funny enough this is made public via so-called 'ad hoc communications'). In short, just as we suspected, the markets don't care about time tables and who went on vacation when and whether their vacation was well deserved and whether this or that parliament can't vote on some critical piece of legislation before the end of September or whatever. Instead, the markets are saying to euro-land politicians: You wasted critical time. Now you're about to get steamrollered (we should note that market participants would likely be happy if a hefty dose of inflation were thrown at the problem, in spite of the fact that this would make things even worse down the road. We currently are 'down the road' as it were).

It would be naive to underestimate the importance and potential impact of the ongoing crisis of the fractionally reserved banking system in Europe that the sovereign debt crisis has triggered. One such example of blue-eyed naivete was on display today when well known bank analyst Dick Bove argued that he sees 'no threat to US banks' from the crisis in Europe. His reasoning goes as follows:

“Rochdale Securities' analyst Richard Bove said fears of a possible impact of a European debt crisis on U.S. banks were overblown, with only Citigroup and JP Morgan Chase having a significant exposure to the crisis.

"Assuming some relatively worse case developments, it appears that Citigroup and JP Morgan Chase are at risk to the developments in Europe. No other American institution is," Bove wrote in a note.

Citing the filings from the International Financial Statistics Yearbook, released by the International Monetary Fund for the year 2010, Bove said Citigroup is at biggest risk with exposure of $12.3 billion in Italy and $10.8 billion in Spain.

JP Morgan Chase risks write downs on the $18.8 billion it loaned to Ireland, $12.2 billion to Italy and $12 billion to Spain, according to the filings.

The brokerage ruled out any risks from limited exposure to either Goldman Sachs , or Morgan Stanley and termed the exposure amount "not significant."

"The declines in the bank stock prices based on fears in this area (due to fear of financial crisis in Europe) seem to be meaningfully overdone," Richard Bove said.” [in other words, the markets are stupid, ed.]

This would all be true only if the US were an isolated island with no further connection to the euro area. Bove seems entirely oblivious to the interconnectedness of the global financial system. It may be true that the direct exposure of US banks to euro area sovereign debt is of manageable proportions, but there is much more to it than that. Euro area banks hold significant amounts of US dollar denominated assets, which in turn are funded by US dollar denominated liabilities. US money market funds have pulled back from the financing of euro area banks, but the total amount still at risk is held to be $1.2 trillion – with a 't.' The bulk of this is held in the form of short term commercial paper issued by French banks.

Below is a log chart of Societe Generale (OTCPK:SCGLY) , one of France's biggest banks, an institution that is reportedly quite dependent on wholesale funding. Similar to other French banks, it does indeed have sizable exposure to Greek government debt.

(Click charts to enlarge)

The crash in the shares of Societe Generale accelerates further. Note that on Monday alone, the stock lost yet another 10% of its value. This € 15 stock was masquerading as a € 52 stock back in February.

BNP Paribas (OTCQX:BNPQY) didn't fare any better as can be seen below.

Shares of BNP Paribas get hammered again.

Now, why is it that shareholders in these banks are so nervous? Are they all irrational? The answer is that they are facing a risk that can not be properly quantified due to the contagion issue. The default of Greece – whether it happens tomorrow or in a month or two – is by now almost a mathematical certainty. By the close of trading on Monday the yield-to-maturity of Greece's one year government note hit 117.21% – up almost 2,000 basis points on the day.

Note that this happened even though the so-called 'troika' of IMF/EU/ECB let it be known that it would regard the most recent additional austerity measures announced by Greece's government as sufficient evidence of goodwill to allow for the disbursement of the next bailout loan tranche. The devil is however in the details. As the WSJ reports:

Greece's creditors are expected to give the thumbs-up for the disbursement of the next tranche of its 2010 bailout pact later this month after the Greek government announced new taxes to cover a EUR2 billion revenue shortfall, said two senior International Monetary Fund officials familiar with the matter.

The IMF officials, who have direct knowledge of the talks, warned, however, that this was Greece's last chance and that the scheduled December installment would be more difficult to arrange unless budget targets are met.

The Greek government and its so-called troika of creditors – the IMF, European Union and European Central Bank–are scheduled to meet again this week to discuss the payout of the next EUR 8 billion tranche amid worries in financial markets that Greek austerity steps so far haven't met the troika's conditions. The two IMF officials dismissed speculation of an impending Greek default or exit from the euro-zone. But they said Greece nonetheless remains the biggest problem for the common currency and that it is imperative that Athens follows up on its promises to cut down the public sector and tackle tax evasion.

"The pressure in Greece has increased from all sides because it has repeatedly failed to deliver what it promises. But there is no real talk on a Greek default or an exit from the euro zone, at least not yet. Such a development would really rock countries like Italy and Spain," one of the officials told Dow Jones Newswires. "The Greeks took new measures which address the shortfall and we expect there will be agreement with the troika for the September loan tranche."

(emphasis added)

The market evidently no longer cares about whether Greece does or doesn't get the next bailout loan tranche. What it worries about is precisely the potential for further contagion once Greece keels over. It also realizes by now that it will simply not be possible for the Greek government to ever deliver on its 'fiscal targets'. Apart from the fact that the manner in which austerity has been implemented has evidently increased pressure on the economy and tax payers to the point where an unstoppable spiral of declining economic activity leading to falling tax revenues leading to more tax hikes, etc. has been set into motion, one must even strongly doubt the authority of Greece's government at this point. This is to say, its ability to enforce its latest tax edicts is fast approaching zero.

As Reuters reports:

The government on Sunday announced the new property tax to make sure it will comply with the terms and qualify for the tranche. The EU's Commissioner for Monetary Affairs, Olli Rehn, said the measure went "a long way" toward meeting the country's targets. [as we noted, we admire his sunny disposition, ed.]

But workers at power utility PPC (DEHr.AT) reacted angrily, vowing to block the tax, which the government plans to collect through electricity bills to make sure citizens will pay quickly. "PPC is no cowboy and no sheriff to put the gun at the Greek people's head," the company's labour union GENOP/DEH said in a statement.

GENOP officials said they would obstruct the issuing of bills and order PPC employees not to cut the power of customers who refuse to pay the tax.

Energy Minister George Papaconstantinou criticised the workers. "(The tax) can't be the object of cheap trade union grand-standing," he said in a statement, adding that the union had no say in how the company was run.

GENOP-DEH is seen as one of Greece's toughest unions. In the past, it has held repeated strikes to prevent the government from selling stakes or seeking strategic partners for the company.

Greece already uses PPC bills as a vehicle to collect municipal taxes and the fees of state broadcaster ERT. The state-controlled company has more than 90 percent of the country's retail electricity market.

Tens of thousands of austerity-hit families and companies are already late in paying their power bills. GENOP/DEH estimates consumers' arrears in the hundreds of millions of euros, including 135 million by the government itself. A PPC spokesman declined to comment on the figures.

(emphasis added)

So let's get this straight – not even the government itself is paying its electricity bills. Tens of thousands of families are in arrears on theirs as well. And the guys supposed to manage additional tax collections via electricity bills belong to the most militant union in the country that is prepared to strike at the drop of a hat. Said union has just issued a heartfelt 'get stuffed' to the government. Lovely combination that.

Olli Rehn has evidently transmogrified into the EU's most reliable contrary indicator. Readers may remember his fateful boast that the 'EU has managed to contain the crisis', uttered literally a few days before the yields on Spanish and Italian government bonds broke out and started their perilous journey northward. So when he says 'the new tax goes a long way toward meeting Greece's targets', you know with absolute certainty it will do no such thing.

To top things off, Greek tax collectors have now gone on strike as well due to looming cuts in their salaries (we kid you not).

As the WSJ reports:

Thousands of Greek tax collectors and customs officials walked off the job Monday in the first day of a two-day strike over plans to cut civil service salaries, the latest in a string of protests over Greek government reforms.

They were joined by taxi owners, who have called their own two-day walk over plans to liberalize taxi services, and garbage collectors in the capital, Athens, who are staging a separate 48-hour strike over local government cutbacks. "The participation rate in the strike is over 90%," said Yiannis Grivas, head of the tax collectors' union, or POE-DOY. "The workers are striking to protest the looting of their income."

(emphasis added)

You couldn't make this up. As the article also notes in connection with the latest string of tax increases:

Of more concern is opposition from the wider public who have seen their taxes rise sharply on everything from gasoline to cigarettes to personal income. Senior Greek officials say they fear that many taxpayers may simply refuse to pay.

"The biggest single concern is that we may face a outright tax revolt," said one senior official. "Those who have been paying taxes are now being asked to pay again, and there is a fear they won't be able to pay any more."

(emphasis added)

In fact, economic depressions and tax revolts tend to go hand in hand. There was e.g. an enormous tax revolt brewing in the US in the early 1930s that was only nipped in the bud by FDR's decision to end alcohol prohibition. The legal sale of alcohol opened a new source of tax revenue that obviated the need for many of the property and sales tax hikes that had caused the revolt. It is for this reason that today very little is known about this particular historical event – things never really got out of hand and the government managed to avoid the looming confrontation. This is by the way one of the reasons why we should expect the prohibition of 'soft' recreational drugs like marihuana to fall by the wayside in the course of the current economic contraction. There simply won't be enough money for the 'drug warriors' and their endless and quite evidently completely failed holy war.

With regards to the situation of the insolvent peripheral governments and the associated de facto insolvency of the banks in these countries, we must again stress that the main debate is not and never has been over avoiding the losses. It remains a debate over who shall bear them. It is a debate over whether it actually makes sense to prop up unsound credit on the backs of tax payers who were never asked whether they were prepared to take the risks that have now become manifest. Of course one must not forget that the fiat money system and the welfare/warfare statism it enables also tends to destroy the moral fiber of the citizenry by creating dependency on the State and furthering corruption. Greece is in fact a prime example of this process.

We would also point out that the threat to the fractionally reserved banking system goes well beyond its direct exposure to sovereign debt in the euro area. All the peripheral countries now facing difficulties have gone through massive credit and asset booms and the associated evils of capital malinvestment and overconsumption. There are as a result enormous amounts of debt at risk in the private sector as well.

Meanwhile In Bella Italia

Italy's government seems not to have been able to restore confidence in its fiscal and economic policies either after beginning to fiddle while Rome quite evidently burned.

An Italian short term government bills auction of about € 15 billion drew scant bids and the government had to settle for a vastly higher interest rate than at the last comparable auction.

According to Bloomberg:

Italy sold 11.5 billion euros ($15.6 billion) of Treasury bills as demand waned and borrowing costs rose amid Europe’s sovereign-debt crisis. The Rome-based Treasury sold 7.5 billion euros of one-year bills at an average yield of 4.153 percent compared with 2.959 percent the last time securities of similar maturity were sold on Aug. 10. Demand was 1.53 times the amount on offer, compared with 1.94 times at the previous sale.

The Treasury also sold 4 billion euros of 3-month bills. The yield was 1.907 percent, up from the 1.034 percent the last time such securities were sold on March 10. The bid-to-cover ratio was 1.86, compared with 2.42 at the previous sale.

(emphasis added)

Not surprisingly, the crash in Italian bank stocks continues as well. The best thing we can say about these stocks at the moment is that their distance to the very strong support at zero has shrunk so much that there's no longer very much left to lose for their shareholders.

The share price of Unicredito (OTC:UNCIF), Italy's largest bank, crashes by another 10% on Monday. At only € 0.69 Unicredito's shares are trading at a 2.17 : 1 ratio to a packet of Kelly's potato chips.

The share price of Italy's second largest bank Intesa Sanpaolo (OTCPK:ISNPY) is in a similar death spiral.

We would point out here that when we recently said that 'European stocks look cheap', we neglected to mention that they mainly do so if one includes financial stocks in the calculation, so one has to carefully analyze things on a case-by-case basis if wondering whether one should prepare to eventually buy the 'dip'.

Italy faces debt rollovers of € 75 billion for the remainder of this year and must sell altogether € 80 billion of bonds to finance both the redemptions and the budget deficit. In the remainder of the month of September alone, another €46 billion in debt mature and need to be rolled over. This sounds like a fairly tall order, alas, a white knight just appeared on the scene (see further below).

European Stock Markets Get Pummeled Again, CDS on Banks Soar

The weakness in bank stocks infected the whole tape, and European stocks swooned once again on Monday, ending at new lows for the move. Once again it didn't really matter much where a bank is located. Similar to previous trading sessions, German bank stocks came under great pressure again as well.

Shares of Deutsche Bank (NYSE:DB) are in free-fall.

Shares of Commerzbank AG (OTCPK:CRZBY) are among the worst performing in all of Europe over the past six months, and that is really saying something.

Further illustrating the growing worries about the banking system, our proprietary index of CDS on euro-land banks (an unweighted index of 5 year CDS spreads on BBVA, Deutsche Bank, SocGen, BNP Paribas, Intesa SanPaolo, Unicredito, and Monte dei Paschi di Siena) continues to go ballistic. After rising by 10% on Friday, it added another 38 basis points or roughly 11% on Monday. It is now finally more than twice as high as during the height of the Lehman crisis. This is yet another data point that hammers home how serious the situation actually is.

Our index of CDS on seven euro area banks is going 'parabolic.'

A long-term chart of this index of CDS on euro-land banks shows that insuring the credit risk they represent now costs more than twice as much as during the 2008/9 crisis.

Dollar funding continues to be problematic – euro basis swaps, which under normal market conditions should oscillate around the zero line, continue to fall off a cliff. For readers not familiar with what these swaps represent and what they are telling us, here is a link to a brief explanation by Natixis (pdf).

Three month, one year and five year euro basis swaps – falling off the proverbial cliff in unison now. Note that both prices and price scales are color-coded – they are not in fact all trading at the same level (see the legend as well). The three month swaps are the ones that have fallen the furthest into negative territory, so the problem is mainly one of near term needs for dollar liquidity.

Below you can see the charts of four representative European stock indexes – all of them have plummeted to new lows again on Monday.

Germany's DAX continues to confirm our interpretation of the chart – the main question is now whether the current phase of the decline is a fifth wave or a third wave decline. If it is the latter, it should eventually exceed the initial crash wave in percentage terms. Normally that would not seem terribly likely, but we are not in a normal situation. If it is a 5th wave, then an extended upward correction should begin fairly soon.

The CAC-40 in Paris gaps below its previous low – ouch.

Italy's MIB index: hurrying toward its 2009 low, which is now only about 1,300 points away.

The Athens General Index also keeps falling. This bear market is now more or less equivalent to the 1929 to 1932 bear market in the US. In short, it is now one of the worst bear markets in all of market history.

Charts by:,, Bloomberg