Wednesday, June 16, 2010

Spain Plays High-Stakes Poker Game With Germany

¹²Spain Plays High-Stakes Poker Game With Germany As Borrowing Costs Surge

AXA Fears 'Fatal Flaw' Will Destroy Eurozone

Spain has upped the ante in a high-stakes poker game with Germany, pushing for the release of EU stress test results for major banks in a move that risks precipitiating a dramatic escalation of Europe's financial crisis.

By Ambrose Evans-Pritchard | 15 June 2010

Jobseekers line up at an employment office in Madrid, Spain.

"We're not afraid of transparency," said the Spanish Banking Association (AEB), saying the full truth would put an end to rumours battering Spain's instutitions. El Pais reported that the government backs the initiative, putting it on a collision course with Germany which insists on secrecy. Josef Ackermann, head of Deutsche Bank, warned last week that it would be "very dangerous" to publish the results of each bank, fearing that it would trigger flight from weak lenders and set off a chain reaction.

The Spanish authorities have little to lose by publishing the data given the near paralysis in the country's debt markets. Funding is frozen for much of the private sector. Spain was pummeled yet again on Tuesday as credit default swaps (CDS) measuring bond risk on Spanish debt jumped to 245 basis points, approaching an all-time high. An auction of Spanish debt yesterday underlined how fast the situation is deteriorating. Yields on one-year debt reached 2.45% compared to 0.9% as recently as April, suggesting that the markets do not view the EU's €750bn 'rescue shield' as credible.

Francisco Gonzalez, chairman of BBVA, stunned investors earlier this week by admitting that "the majority of the Spanish companies and financial groups are shut out of the international capital markets". He said the country's external debt had reached €1.5 trillion or 147% of GDP, much of it on short-term maturities. "This debt has become our most overwhelming problem, since €600bn falls due this year," he said.

Analysts say the call for release of the stress test results is a veiled attack on Germany, retaliation for German media reports— fed by sources in Berlin— claiming that Spain is about to tap the EU's bail-out fund. Spain's two heavyweights, Santander and BBVA, are well capitalised, though there are concerns that Spain's accounting rules mask the full horror of bad debts in the property sector. The problem lies with savings banks or cajas that are not part of the EU test. These are being kept afloat by the European Central Bank, with loans equal to 20% of their balance sheets.

By contrast, some German banks may look very ugly. An internal memo last year by the regulator BaFin feared that write-offs might reach €800bn. German banks have accumulated a double set of loses from both US subprime and the Club Med debt crisis. They have the lowest risk-adjusted capital ratios in the world after Japan and have not exploited the global rally to rebuild their base.

Jose Garcia Zarate, credit strategist at 4cast, said Madrid is powerless at this stage. "There is absolutely nothing the Spanish government can do to get their message through. They have lost all market credibility and nobody is listening to them any longer," he said.

Mr Garcia said the country is in a "Catch-22" situation. Madrid has slashed public wages by 5% this year in a show of discipline, only to find that the markets have now moved the goal posts and, moreover, fear austerity will choke recovery. "My view is that it would be suicidal for Madrid to use the rescue fund. The moment they pick up the phone and start talking about this, it is the end of any remaining hope for the single currency. Spain's government just has to put on a brave face, pay the higher yields, and hope for the best," he said.

Elsewhere in European financial markets, default insurance for Greece rocketed after Moody's downgraded it to junk on Monday, forcing bond indexes to sell up to €20bn of Greek debt. Ireland and Portugal also jumped sharply, with mounting credit stress in Belgium following the electoral triumph of Flemish separatists.


¹²AXA Fears 'Fatal Flaw' Will Destroy Eurozone

Analysts at the French financial group AXA see a serious likelihood that the eurozone will break in half or disintegrate, dismissing Europe's €750bn (£623bn) rescue package for Club Med debtors as a 'stop-gap measure' that misdiagnoses the problem.

By Ambrose Evans-Pritchard | 14 June 2010

A riot policeman's clothing catches fire during protests in Greece. Photo: AP

"The markets are very nervous because they can see that there is a fatal flaw in the system and no clear way out," said Theodora Zemek, head of global fixed income at AXA Investment Managers. "We are in a very major crisis that has even broader implications than the credit crisis two years ago. The politicians have not yet twigged to this."

Ms Zemek said the rescue had bought a "maximum" of 18 months respite before deeper structural damage hits home, with a "probable" default by Greece setting off a chain reaction across Southern Europe. "It would be the end of the euro as we know it. The long-term implications are at best a split in the eurozone, at worst the destruction of the euro. It is not going to end happily however you slice it," she said. The warning came as Spain's authorities were forced to shoot down German media reports that Madrid was preparing to tap the 'rescue' facility after ructions in the inter-bank market.

Carlos Oocaña, Spain's treasury secretary, said smaller Spanish banks are struggling to roll over debts but denied that the country is seeking outside help. "The rumour is false," he said. Spanish banks increased reliance on funds from the European Central Bank to a record €86bn in May.

Berlin said Spain "does not meet the conditions" for the aid package in any case, even though the socialist premier Jose Luis Zapatero has already provoked a general strike by cutting public wages by 5%. It is becoming clear that German demands for austerity across EMU are nearing the limits of political tolerance, and may prove self-defeating as 1930s-style wage deflation sets off a vicious circle. Greece's woes increased further as Moody's downgraded Greek debt to junk status, saying the "macroeconomic and implementation risks associated with the programme are substantial".

The move is largely symbolic at this point since the European Central Bank has suspended its rating requirements for the use of Greek debt as collateral for loans. Greece is almost entirely shut out of the capital markets. Private investors are believed to have offloaded €25bn of Greek debt on to the ECB as it steps in to shore up the market, shifting the credit risk on to tax payers.

AXA said there was "no chance" that the EU's €750bn "shock and awe" shield will succeed since it treats Club Med's debt trap as a short-term liquidity crisis. In the case of Greece, the joint IMF-EU policy will increase Greek public debt from 120% to 150% of GDP by 2014, arguably making matters worse. A number of ex-IMF officials have said the policy is doomed to failure since there is no devaluation or debt relief to offset the ferocious fiscal squeeze, and may endanger the credibility of the Fund itself.

The IMF had floated the idea of a 'debt restructuring' [[which usually involves some kind of partial default: normxxx]] but this was blocked by Brussels. The strategy assumes that voters in Greece and other Club Med democracies will endure [[endless?: normxxx]] years of pain for the sake of foreign creditors. "It's a pipedream," said Ms Zemek.

Contagion from a Greek default would be harder to control than fallout from the Lehman collapse. "This has huge implications for banks. These bonds didn't just disappear; they went somewhere, allegedly into French money markets and insurance companies, or on to French balance sheets," she said. The Bank for International Settlements said French and German lenders have $958bn (£650bn) in exposure to Greece, Ireland, Portugal and Spain, mostly in mortgage and company debt rather than sovereign debt.

The distinction has become meaningless in Greece. The ECB has lent Greek banks €85bn, mostly in exchange for collateral in the form of Greek government bonds. This has kept Greek lenders alive as they suffer a slow bank run, losing 7% of their deposit base since last June as wealthy Greeks shift their funds abroad. The ECB support is equal to 20% of their non-equity funding, according to Lombard Street Research.

AXA said the America's currency union is successful because Washington has over-riding legal powers over the 50 states. "It is a precondition for the system to work but it doesn't exist in Europe and the bond markets are starting to figure this out. We are looking at a noble experiment on the brink of failure," said Ms Zemek.

No comments:

Post a Comment