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Lacking National And Supranational Policies To Deal With Weak Banks, The World Wide Financial System Will Collapse

|Includes: EUFN, SPDR S&P Bank ETF (KBE)

Blog163 reports June 7, 2010 article Global Financial Stability Report Financial Stability Set Back As Sovereign Risks Materialize relates:  ”Sovereign risks in parts of the euro area have materialized and spread to the financial sector there, threatening to spill over to other regions and re-establish an adverse feedback loop with the economy. Further decisive follow-up is needed to the significant national and supranational policy responses that have been taken in order to strengthen confidence in the financial system and ensure continuation of the economic recovery.”

The report provides a chart of the PIIGS sovereign debt spreads against that of Germany which began to increase in April 2010 as awareness of the European sovereign debt crisis started to grow on awareness of a potential default by Greece in its sovereign debt. The purchase of distressed sovereign debt by the ECB in May 2010 has helped to mitigate sovereign debt spreads from absolutely exploding. Click on chart to enlarge 

The report relates: “In part, the public bond market pressures reflect significant rollover needs. Those countries in the euro area currently experiencing significantly widened spreads to German bunds need to refinance about ?300 billion in debt maturing in the third and fourth quarters of this year (Figure 3). In doing so they will face competition from the very large rollover needs of the United States, United Kingdom, Japan, and other euro area countries amounting to a total of about $4 trillion maturing in the third and fourth quarters — beginning in July and then again in October 2010″ . Click on chart to enlarge.

“The financial stability implications of rising sovereign risks have been significant, reflecting the existing exposure of European banks to sovereign debt. Recent co-movements of European bank credit default swap (CDS) spreads with sovereign CDS spreads have intensified since our estimates in the April 2010 GFSR. This reflects the substantial holdings of sovereign debt by banks, but also the increasing risks of adverse feedback loops between the sovereign and the financial sector and the potential impact on government balance sheets, in case weak banks need support.”

“With the heightened uncertainty about the health of some banks, average bank CDS spreads are increasing in the United Kingdom, United States, and euro area (Figure 5). In part, the pressure on banks has been exacerbated by the legacy of unfinished cleansing of bank balance sheets over the last three years—a process that has been slower in the euro area than in the United Kingdom and United States—which has resulted in remaining pockets of vulnerability, overcapacity, and poor profitability for at least some types of banks.” Click on chart to enlarge

“The equity markets of Romania and Hungary and those of emerging Europe as a region were the hardest hit compared to other emerging market countries and regions (Figure 10). Mature European banks are most exposed to emerging Europe. These exposures suggest that some emerging markets may experience a renewed credit squeeze if funding strains cause European banks to withdraw their cross-border credit flows.” Click on chart to enlarge.

“The root of the problem (of destabilized financial markets is) sovereign risk— (it) must be addressed. Policy priorities include the need to (continue) ECB liquidity support for secondary bond markets.” (And the need to) ”implement credible solutions to deal with weak banks. These banks are exacerbating the current strains in funding markets, and a more comprehensive mechanism for resolving, restructuring, or recapitalizing institutions is needed. For this purpose, existing or new public mechanisms at the national level should be activated without delay. Where needed, supranational arrangements should be applied to address banking problems.”

“Forceful pursuit of the above policy measures will be necessary to underpin market confidence, reduce concerns regarding sovereign debt and banking system health, and support the euro area economic recovery.”

“In sum, recent global stability gains are threatened by a confluence of sovereign and banking risks in the euro area that, without continued and concerted attention, could spill over to other regions. Rapid implementation of the important and appropriate decisions taken by the euro area governmental authorities will be a key component in calming financial markets.”

“Further credible and swift action is needed to stabilize financial institutions. Consolidation of financial stability will be important to keep the economic recovery on track.”


The report communicated a buildup of deposits at the ECB occurred in anticipation of the expiration of the one-year long-term refinancing operation on June 30, to which I add that a fear of becoming known as a having transactions with the ECB has led to a significant decline in refinancing, which now is done on a three-month basis.

Specifically the report called for “credible and swift action coming forth to stabilize financial institutions,” and cited the need to  “implement credible solutions to deal with weak banks. These banks are exacerbating the current strains in funding markets, and a more comprehensive mechanism for resolving, restructuring, or recapitalizing institutions is needed. For this purpose, existing or new public mechanisms at the national level should be activated without delay. Where needed, supranational arrangements should be applied to address banking problems.”

I see no credible and swift action coming forth to deal with weak banks at either the national or supranational level. 

The where-with-all politically in the countries most at risk such as Portugal, Italy, Ireland, Greece and Spain to deal with weak banks is non existant as there is a total failure of national legislatures to sensibly oversee the country’s central bank-to-regional and-small-bank-relationships. The current strain in funding market for banks continues to go unresolved, and in the case of Spain, means that there is a liquidity evaporation from the banks. And I see no working mechanism for resolving, restructuring, or recapitalizing banks on the radar screen. 

The current supranational policy regarding banks is simply for stress testing;  there is no supranational policy for remedy of bank stress. 

There is an inherent strain in capitalizing banking institutions; this is a simple fact of economic life.  

Debt deflation started April 26, 2010, as the currency traders began selling the world currencies against the dollar; once debt deflation commences there is no remedy: debt deflation is like Ebola, it consumes its victim.  

Debt deflation is the contraction and crisis that follows credit expansion.  One of the most famous quotations of Austrian economist Ludwig von Mises is from page 572 of Human Action: “There is no means of avoiding the final collapse of a boom brought about by credit expansion.  The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion or later as a final and total catastrophe of the currency involved.”

Global Debt Deflation commenced on April 26, 2010, when the value shares failed to outperform the growth shares, and was interrupted by the brief June 7, 2020 to June 21, 2010 rally.

It was on April 26, 2010, the currency traders went long the yen and short the global currencies as is seen in this MSN Finance chart of FXA, FXE, FXM, FXC, ICN, FXB, FXS, SZR, FXF, BZF, XRU, FXY causing the US Dollar to rise; as can be seen in this chart from April 26, 2010 to June 7, 2010.

The age of competitive currency devaluations commenced on June 7, 2010, when the US Dollar, $USD, turned down as the Euro, FXE, rallied on news of the call for the EFSF Monetary Authority to be established (it as of yet, still has to be approved by member states).

The Swiss Franc and the Australian Dollar both were sold against the Yen on April 26, 2010; but on June 7,  the Swissie-Aussie carry trade,  FXF:FXA,  blasted out of a consolidation triangle on June 7th, as the US dollar was sold off. The long Swiss Franc and short Australian dollar carry trade has proved most lucrative to currency traders and is a defining characteristic of the current age of competitive currency devaluations which destabilizes countries and banks. 

The European sovereign debt crisis and competitive currency devaluation has created an investment demand for gold. Gold has risen as the sovereign world currency and storehouse of investment value. Currencies, sovereign debt, stocks and bonds are all headed off to the pit of investment abandon, the July 6, 2010 value of the Yen at 113.19 may be as high as the Yen goes.

The yield curve, $TYX:$TNX, which began to steepen on April 26, 2010 will continue to do so. A steeping yield curve is stimulating an investment demand for gold, $GOLD,  which is trading at $1,200, and is strongly above its breakout price of $1,140. Gold has risen to the status of a currency: it is the sovereign currency and storehouse of investment wealth.

The currency traders in having taken the Yen higher in a bull rally, has resulted in the financial sector being the worst performing sector of the S&P, leading the index in a bear rout. The bear market may have green shoots such as that which occurred on Wednesday,  July 7, but the direction of the S&P is inexorably down, down and down.

Given the lack of policy for new mechanisms at the national level or supra national level to address banking stress and deal with weak banks, the only outcome can be a world-wide financial collapse, with the European financial institutions, EUFN, and US banks, KBE, leading the way down, despite the fact that a banking rally of 11% and 5% respectively between June 7, 2010 and July 8, 2010. The current rally in the finanicals is weakly supported by a rising and following euro yen carry trade which has risen from 109.5 to 102.5; when the currency traders fail to provide continuing support, the financials will once again go back to falling in value. Chart of Banks, KBE; click on chart to enlarge.

Chart of European Financials Weekly

Symbols used in this report: KBE, EUFN

Disclosure: I am invested in gold coins