Flatline Bounce, Then More Selling

I'm surprised that the selling has continued. I expected the bounce to persist. There is little news today, and even less conviction!

Europe persists in its apparent meltdown. Perhaps that's dragging down the euphoria today. Oddly, however, the Euro is up and the Dollar is getting trashed again. What does that say about what we (Obama) are doing?

Germany can't join the Eurobond mania without an amendment to its Constitution, and with overwhelming domestic opposition to it, I don't see any likelihood of it occurring. The European monetary union is almost certainly doomed, at least in its current form, and so is the Euro. Europe GDP is contracting, and I don't see any way out of this but pain.

ES Dips 17 Point on Disappointing Eurozone Data

from Zero Hedge:
Economic growth is faltering in all major economies with data this morning showing Eurozone and German GDP growth slowing. Eurozone GDP rose 0.2% from the first quarter, when it increased 0.8% while German GDP growth fell by more than expected in the second quarter, dropping to a derisory 0.1%. Double dip recessions involving inflation and therefore stagflation seem increasingly likely.The conditions today are far more bullish than in the 1970’s as in the 1970’s the U.S. was the largest creditor nation in the world whereas today the U.S. is the largest debtor nation the world has ever seen. Gold went parabolic in the 1970’s after a period of stagflation. Today, we appear to be on the verge of a period of stagflation.

European Debt Woes Weigh on Stocks

True Finn Party Rejects More EU Bailouts

Editorial in WSJ by True Finn Party leader Timo Soini:

When I had the honor of leading the True Finn Party to electoral victory in April, we made a solemn promise to oppose the so-called bailouts of euro-zone member states. These bailouts are patently bad for Europe, bad for Finland and bad for the countries that have been forced to accept them. Europe is suffering from the economic gangrene of insolvency—both public and private. And unless we amputate that which cannot be saved, we risk poisoning the whole body.

At the risk of being accused of populism, we'll begin with the obvious: It is not the little guy that benefits. He is being milked and lied to in order to keep the insolvent system running. He is paid less and taxed more to provide the money needed to keep this Ponzi scheme going. Meanwhile, a kind of deadly symbiosis has developed between politicians and banks: Our political leaders borrow ever more money to pay off the banks, which return the favor by lending ever-more money back to our governments, keeping the scheme afloat.

In a true market economy, bad choices get penalized. Not here. When the inevitable failure of overindebted euro-zone countries came to light, a secret pact was made.

Instead of accepting losses on unsound investments—which would have led to the probable collapse and national bailout of some banks—it was decided to transfer the losses to taxpayers via loans, guarantees and opaque constructs such as the European Financial Stability Fund, Ireland's NAMA and a lineup of special-purpose vehicles that make Enron look simple. Some politicians understood this; others just panicked and did as they were told.

The money did not go to help indebted economies. It flowed through the European Central Bank and recipient states to the coffers of big banks and investment funds.

Further contrary to the official wisdom, the recipient states did not want such "help," not this way. The natural option for them was to admit insolvency and let failed private lenders, wherever they were based, eat their losses.

That was not to be. As former Finance Minister Brian Lenihan recently revealed, Ireland was forced to take the money. The same happened to Portuguese Prime Minister José Sócrates, although he may be less forthcoming than Mr. Lenihan about admitting it.

Euro, Stocks Decline on Fresh Sovereign Debt Worries

The Finns yesterday voted in a new parliament that is expected to refuse to back Portugal's plea for a bailout. New cracks in the foundation of EU unity. It always amazes me that what has the greatest impact on the news is often obscure stories in obscure places. I have learned to expect the unexpected! One of the rules of trading is that anything can happen!

Stocks

 Euro

Survival of the (Least) Fittest

Just One In Five Chance of Survival!

from Reuters:

LONDON (Reuters) - The euro currency area has only a one-in-five chance of surviving in its current form over the next 10 years because of competitive imbalances between its members, a leading British think tank said on Friday.
The Center for Economics and Business Research said Spain and Italy would have to refinance over 400 billion euros ($530 billion) of bonds in the spring, potentially sparking a fresh crisis within the 16-nation euro area.
"The euro might break up at this point, though European politicians are normally able to respond to a crisis," said CEBR Chief Executive Douglas McWilliams in a list of 10 forecasts for 2011.
Sovereign debt crises in Greece and Ireland have rocked euro nations this year, leading some commentators to speculate that Germany could eventually lose patience with bailing out its more profligate neighbors, triggering a split in the currency bloc.
Chancellor Angela Merkel has repeatedly stressed Berlin's commitment to the euro and she said so again in her New Year message to the country on Friday.
"The euro is the foundation of our prosperity," she said. "Germany needs Europe and our common currency. For our own well-being and in order to overcome great worldwide challenges. We Germans assume our responsibility, even when it is sometimes very hard."
McWilliams argued that the deeper imbalances between the euro zone's stronger and weaker economies, which have become increasingly apparent since the 2008 financial crisis, would undermine the project in the long term.
"I suspect that what will break up the euro will be the failure of most of the countries to take the tough medicine necessary to make their economies competitive over the longer term," McWilliams said:
"We give it only a one in five chance of surviving in its present form for 10 years. If the euro doesn't break up, this could be the year when it weakens substantially toward parity with the dollar," he added.

Fresh Economic Crises Dead Ahead in Europe, U.S.

by Simon Johnson at NYT:

By SIMON JOHNSON

Simon Johnson, the former chief economist at the International Monetary Fund, is the co-author of “13 Bankers.”
Most experienced watchers of the euro zone are expecting another serious crisis in early 2011, tied to the rollover funding needs of its weaker governments. With debts coming due from March through May, the crisis seems much more predictable than what happened to Greece or Ireland in 2010.
And the investment bankers who fell over themselves to lend to these countries on the way up now lead the way in talking up the prospects for a serious crisis.
This situation is not more preventable for being predictable, because its resolution will involve politically costly steps – which, given how Europe works, can be taken only under duress. Don’t smile at the thought and think, “It can’t happen here,” because this same logic points directly to a deep and morally disturbing crisis in the United States.

The euro zone needs to, and eventually will, take three steps:
Step 1: Agree on greater fiscal integration for a core set of countries. This will not be full fiscal union but some greater sharing of responsibilities for each other’s debts. There is much room for ambiguity in government accounting and great guile at the top of the European political elite, so do not expect something completely clear to emerge.
But Germany will end up underwriting more liabilities for the European core; its opposition Social Democratic Party and the Greens are pushing Chancellor Angela Merkel in this direction, calling her “un-European.”
Step 2: For the core countries, the European Central Bank will receive greater authority to buy up government bonds as needed. Speculators in these securities will be badly burned as necessary. The wild card is whether the Bundesbank president, Axel Weber, will get to take over the central bank in fall 2011 – as expected and as apparently required by Ms. Merkel.
Mr. Weber has been vociferously opposed to exactly this bond-buying course of action. So the immovable Mr. Weber will meet the unstoppable logic of economic events. Good luck, Mr. Weber.
Step 3: One or more weaker countries will drop out of the euro zone, probably becoming rather like Montenegro, which uses the euro as its currency but does not have access to the European Central Bank-run credit system. Greece is probably the flashpoint; when it misses a payment on government debt, why should the central bank continue to accept Greek banks’ bonds, backed at that point by a sovereign entity in default?
The maelstrom will probably sweep aside Portugal and perhaps even Ireland; Spain and Italy will be threatened.
It would be easy to set up pre-emptive programs for Portugal and Spain with the International Monetary Fund, but this will not happen. The political stigma attached to borrowing from the I.M.F. is just too great.
The unfortunate truth is that despite its supposed return to pre-eminence and the renewed swagger of its senior officials, the I.M.F. remains weak and of limited value. It is an effective lender to small European countries under intense pressure — Latvia, Iceland, Greece and so on. But the I.M.F. does not have the resources or the legitimacy to save the bigger countries.
At the end of the day, the Europeans will save themselves, with the measures outlined above, only because there will be no other way to avoid wasting 60 years of political unification. But one or more countries will be forced out of full euro-zone membership (although they are likely to keep the euro as the means of exchange). The costs to everyone involved will be large – and largely unnecessary.
And when the financial markets are done with Europe, they will come to test the fiscal resolve of the United States. All the indications so far are that our politicians will struggle to get ahead of financial market pressure.
There are plenty of places in Europe where you can find an easy political consensus to cut taxes and increase budget deficits. Sadly, this no longer pacifies markets. The American political elite – right and left – believes that we are different from the Europeans because we issue the dollar and therefore have some special privileges forever.
But this is not the 1950s. Asia has risen. Europe will sort itself out and become more fiscally Germanic. The Age of American Predominance is over.
Our leading bankers looted the state, plunged the world into deep recession and cost the United States eight million jobs. Now many of them stand by with sharpened knives and enhanced bonuses – willing to suggest how the salaries and jobs of others can be further cut. Consider the morality of that.
Will no one think hard about what this means for our budget and our political system until it is too late?

Europe Is Going to Get Worse!

from UK Independent:

Analysts at the credit ratings agency Moody's have issued a stark warning that even with budget deficit programmes and savage cuts in public spending across the eurozone some of the weaker peripheral nations will still default on their debts, requiring a "restructuring".

They say: "It is hard to escape the conclusion that austerity will not end the debt crisis, and that restructuring may be necessary, as Germany's Chancellor Merkel has indicated."

Arguing that Europe is the "weakest link" in the global economy, they say that the fortunes of Asia and the West will diverge further next year, and that the United States' prospects have "improved only somewhat" with the passage of the recent budget deal in Congress.

But China also represents a threat to growth around the world. Reflecting recent caution from the Bank of England on the flow of funds into emerging markets, the Moody's economists add: "Although China will continue rapid growth, it faces downside risks from inflation and a real-estate market correction. Despite these problems, our baseline outlook for recovery assumes Europe and China will go through orderly restructurings that will prevent further financial panic."

Overall, downside risks to the global outlook have increased since the start of 2010, say the analysts, adding: "Even if these risks do not materialise, growth in the world's largest economies is set to slow in 2011 before picking up in 2012."

That is the consensus view among international bodies such the IMF. But Moody's is much more gloomy about the chances of Europe being able to make it through the next few years without a major dislocation – even comparing the situation with the Argentine banking crisis of 2001, which saw riots as the value of people's savings was wiped out by 75 per cent in what was in effect a default as the country failed to maintain its link with the US dollar. Similar stresses in nations such as Greece are foreseen by the Moody's team.

In a gloomy note, Moody's states: "The largest risks to global recovery stem from Europe's sovereign debt crisis.

"The amount of austerity needed to correct Europe's imbalances may be as politically unsustainable as it was for Argentina in 2001. Even in Britain, which has not had a full-blown sovereign debt crisis, new fiscal austerity measures have sparked demonstrations by students facing higher university fees."

There is also a blunt criticism of the EU's leaders: "Both European bondholders and policymakers face problems in 2011 because officials clung too long to the belief that government austerity plus bailout financing was sufficient to handle debt overhang in periphery countries.

"The recent reconsideration of that position by German Chancellor Merkel and the ECB has come too late to avoid draconian cutbacks, higher unemployment, and declining output in the periphery countries."

Most worryingly, there is also the suggestion that the current austerity packages may not work economically even if they find political acceptance: "Europe remains the weak link, not just because of its sovereign debtcrisis but also because even its fiscally stronger states – France, Germany and the UK – are tightening fiscal policy. With growth still below potential, this could push the region's more vulnerable economies into recession. Europe might still be able to muddle through, but an orderly restructuring of sovereign debt is looking more desirable as the damage from budget cuts mounts and as high-debt countries struggle to escape recession."

Andres Carbacho-Burgos, an economist at Moody's and author of its global outlook, concludes: "Europe seems to have abandoned fiscal stimulus measures as a macroeconomic policy tool, while the US has yet to find a way to use a fiscal stimulus in a way that is debt-neutral over the long term.

"The world economy continues to diverge as 2011 begins, in ways that could produce serious side-effects."

The Danger of Debt Default

John Mauldin explained the risks of EU debt default and/or restructuring in his latest newsletter:

How often did we as young kids go down the street kicking a can? "Kicking the can down the road" is a universally understood metaphor that has come to mean not dealing with the problem but putting a band-aid on it, knowing we will have to deal with something maybe even worse in the future.
While the US Congress is certainly an adept player at that game, I think the world champions at the present time have to be the political and economic leaders of Europe. Today we look at the extent of the problem and how it could affect every corner of the world, if not played to perfection. Everything must go mostly right or the recent credit crisis will look like a walk in the Jardin des Tuileries in Paris in April compared to what could ensue.
From the point of view of not wanting to so soon endure another banking and credit crisis, we must applaud the leaders of Europe. The PIIGS collectively owe over $2 trillion to European and US banks. German, French, British, Dutch, and Spanish banks are owed some $1.5 trillion of that by Portugal, Ireland, Spain, and Greece by the end of June, 2010. That figure is down some $400 billion so far this year, which means that the ECB is taking on that debt, helping banks push it off their balance sheets. For what it's worth, the US holds, according to the Bank for International Settlements, about $353 billion, or 17%, of that debt, which is not an inconsequential number.
Robert Lenzner notes something very interesting about the latest BIS report, out this week:
"What's curious, though, is that for the first time the BIS has broken out a new debt category termed 'other exposures, which it defines as 'other exposures consist of the positive market value of derivative contracts, guarantees extended and credit commitments.' These 'other exposures' - quite clearly meant to be abstruse - amount to $668 billion of the $2 trillion in loans to the PIIGS.
"So, bank analysts everywhere; you now have to cope with evaluating derivative contracts that could expose lenders to losses on sovereign debt. Be on notice!"
What did I write just last week? That it is derivative exposure to European banks that is a very major concern for the world and the US in particular. It is not just a European problem. I predicted in 2006 that the subprime problem would show up in Europe and Asia. This time around, European banks present a similar if not greater risk to the US.
A collapse of a major European bank could trigger all sorts of counterparty mayhem in the US banking system, at least among our major investment banks. And then people would want to know which bank was next. This is yet another reason why the recent financial-system reform was not real reform. We still have investment banks committing bank capital to derivatives trading overseen by regulators who don't really understand the risk. Who knew that AIG was a counterparty risk until it was? Lehman was solid only a month before until it evaporated. On paper, I am sure that every one of our banks is solid - good as gold - because they have their risks balanced with counterparties all over the globe and they have their models to show why you should go back to sleep.

Kicking the Can Down the Road

And that is why I applaud the ECB for stepping in and taking some risk off the table. We do not know how close we came to another debacle. Does anyone really think Jean-Claude Trichet willingly said, "Give me your tired, your poor, your soon-to-default sovereign debt?" Right up until he relented he was saying "Non! Non!" He did it because he walked to the edge of the abyss and looked over. It was a long way down. Bailing out European banks at the bottom would have cost more than what he has spent so far. It was, I am sure, a very difficult calculation.
I remember writing a letter not so long ago, quoting Trichet on that very topic. He was vehemently opposed to any ECB involvement in something that looked like a bailout. And then he wasn't. I do hope he writes a very candid memoir. It will be interesting reading. The reality is that there was nowhere else to turn. There were no mechanisms in the Maastricht Treaty for dealing with this situation. What I wrote the following week (or thereabouts) still stands. This was and is a bailout for European banks in order to avoid a banking crisis. Many European banks, large and small, have bought massive sums on huge leverage of sovereign debt, on the theory that sovereign debt does not default. Some banks are leveraged 40 to 1!
The ECB is now earnestly continuing to kick the can down the road, buying ever more debt off the books of banks, buying time for the banks to acquire enough capital, either through raising new money or making profits or reducing their private loan portfolios, to be able to deal with what will be inevitable write-downs. It they can kick the can long enough and far enough they might be able to pull it off.
There is historical precedent. In the late '70s and early '80s, US banks figured out that if you bought bonds from South American countries at high rates of interest and applied a little leverage, you could practically mint money. And everyone knew that sovereign countries would not default. That is, until they did.
Technically, every major bank in the US was insolvent then. I mean really toes-up, no-heartbeat bankrupt. So what happened? Mean old Paul Volker - he who willingly plunged the US into recession to vanquish the specter of inflation - allowed the banks to carry those South American bonds on their books at full face value. He kicked the can down the road. And the banks raised capital and made profits, shoring up their balance sheets.
In 1986 Citibank was the first bank to begin to write down those Latin American bonds. Then came Brady bonds in 1989. Remember those? Brady bonds were as complicated as they were innovative. The key innovation behind their introduction was to allow the commercial banks to convert their claims on developing countries into tradable instruments, allowing them to get the debt off their balance sheets. This reduced the concentration risk to the banks. (To learn more about Brady bonds, and a very interesting period, go to http://en.wikipedia.org/wiki/Brady_Bonds

and also google "Brady bonds.")
So it worked. Kicking the can down the road bought time until the banks were capable of dealing with the crisis.

Different Cans for Different Folks

The ECB has chosen a different way to kick that old can (and a large and noisy one it is!), but it is not without consequences. Trichet has let it be known that dealing with sovereign-debt default issues should not be the central bank's problem, it should be a problem for the European Union as a whole. And I think he is right, for what that's worth.
If the ECB were to keep this up, even in a deflationary, deleveraging world it would eventually bring about inflation and the lowering of the value of the euro against other currencies. That is not the stuff that German Bundesbankers are made of. So they have been pushing for a European Union solution.
At first, the political types came up with the stabilization pact in conjunction with the IMF. But this was never a real solution, other than for the immediate case of Greece ... and then Ireland. It has some real problems associated with it. It could deal with Portugal but is clearly not large enough for Spain. It is worth nothing that the political leaders of both the latter countries have loudly denied they need any help. Hmm. I seem to remember the same vows just the week before Ireland decided to take the money.
One of my favorite writers, Michael Pettis penned this note:
"Its official - Spain and Portugal will need to be bailed out soon. How do I know? In one of my favorite TV shows, Yes Minister, the all-knowing civil servant Sir Humphrey explains to cabinet minister Jim Hacker that you can never be certain that something will happen until the government denies it."
Ultimately, the EU has three options. But before they get there - or maybe better said, before there is a crisis that forces them to get there - they will continue to kick the can down the road. They are really very good at it. We will consider those options in a little bit; but first, let's look at just one aspect of the problem that will lend some context to the various paths among which they must choose. And that will take us on a detour back to our old friend Greece, where this all started.

More Debt is NOT the Solution to Too Much Debt

Greece is being forced into an austerity program in order to be able to continue to borrow money. But it has come with a cost. Unemployment is now at 12.6%, up from less than 7% just two years ago. And Greek GDP continues to slide. Let's look at some charts and data from my favorite slicer and dicer of data, Greg Weldon ( www.weldononline.com

for a free 30-day trial).
Notice that Greek GDP is down over 7% for the last 9 quarters, and there is no reason to believe there will be a reversal any time soon.

A declining GDP is just not good for the country, but it also makes it more difficult for Greece to get back into compliance with its EU fiscal deficit-to-GDP requirements. The problem is that GDP is declining faster than the fiscal deficit. Normally, a country would devalue its currency (and thus its debt), maybe restructure its external debt (or default), and then try to grow its way out of the crisis.
Let's go back and look at what Iceland did, as compared to Ireland, which is trying to take on more debt to bail out its banks, that is, to bail out German and French and British banks.
This is what I wrote a few weeks ago, and it bears repeating:
Look at how upset the UK got when Iceland decided not to back their banks. Never mind that the bank debt was 12 times Iceland's national GDP. Never mind that there was no way in hell that the 300,000 people of Iceland could ever pay that much money back in multiples lifetimes. The Icelanders did the sensible thing: they just said no.
Yet Ireland has decided to try and save its banks by taking on massive public debt. The current government is willing to go down to a very resounding defeat in the near future because it thinks this is so important. And it is not clear that, with a slim majority of one vote, it will be able to hold its coalition together to do so. This is what the Bank Credit Analyst sent out this morning:
"The different adjustment paths of Ireland and Iceland are classic examples of devaluation versus deflation.
"Iceland and Ireland experienced similar economic illnesses prior to their respective crises: Both economies had too much private-sector debt and the banking system was massively overleveraged. Iceland's total external debt reached close to 1000% of its GDP in 2008. By the end of the year, Iceland's entire banking system was crushed and the stock market dropped by more than 95% from its 2007 highs. Since then, Iceland has followed the classic adjustment path of a debt crisis-stricken economy: The krona was devalued by more than 60% against the euro and the government was forced to implement draconian austerity programs.
"In Ireland, the boom in real estate prices triggered a massive borrowing binge, driving total private non-financial sector debt to almost 200% of GDP, among the highest in the euro area economy. In stark contrast to the Icelandic situation, however, the Irish economy has become stuck in a debt-deflation spiral. The government has lost all other options but to accept the E85 billion bailout package from the EU and the IMF. The big problem for Ireland is that fiscal austerity without a large currency devaluation is like committing economic suicide - without a cheapened currency to re-create nominal growth, fiscal austerity can only serve to crush aggregate demand and precipitate an economic downward spiral. The sad reality is that unlike Iceland, Ireland does not have the option of devaluing its own currency, implying that further harsh economic adjustment is likely."
This is what it looks like in the charts. Notice that Iceland is seeing its nominal GDP rise while Ireland is still in freefall, even after doing the "right thing" by taking on their bank debt.

Greek five-year bonds are now paying 12.8%. It is hard to grow your way out of a problem when you are paying interest rates higher than your growth rate and you keep adding debt and increasing your debt burden.

Each move to deepen government cuts in Greece will result in further short-term deterioration of GDP, which makes it even harder to dig out of the hole. And Greece is a particularly thorny problem. The taxi drivers are outraged that they might have to use meters. Why? Because that means someone could actually track the amount of money they take in. Government workers are striking over 10% pay cuts. And on and on.
It is the same song but with a different verse for the rest of the countries in Europe that have problems. While Ireland is very different from Greece, assuming massive debt in a deflating economy will only turn Ireland into an ever-larger burden unless they can get on the path to growth again. Ditto for Portgual, Spain, and....

Et Tu, Belgium?

One country after another in Europe is coming under pressure. This week the debt of Belgium was downgraded, and the accompanying note from Standard and Poor's observed that:
"Belgian's current caretaker government may be ill-equipped to respond to shocks to public finances. The federal government's projected 2011 gross borrowing requirements of around 11 percent of GDP leaves it exposed to rising real interest rates."
At some point, if a country does not get its fiscal deficit below nominal GDP (and this is true for the US as well!) it will run into the wall. Credit markets will no longer lend to it. In Europe, the lender has become the ECB, but that may - and I emphasize may - change with the establishment of a new authority for the European Union to sell bonds and use the proceeds to fund nations in crisis. Under the proposal, each nation would assume a portion of the total debt risk. That may be a tough sale, as it appears there will need to be a treaty change and then country-by-country votes for such a change.
It will also mean that countries that accept such largesse will endure a very stern hand in their fiscal affairs. This is potentially a very real surrender of sovereignty. Some countries may decide it's worth the price. Others, on the funding side of the equation, may decide they have to "take one" for the good of the European team.
This fund is to be launched in 2013, which gives EU leaders some time to flesh out the idea and sell it.
A second choice is for some countries to leave the euro but stay in the EU. Not all members of the EU participate in the eurozone. Leaving would be hugely messy. It is hard to figure out how it could be done without serious collateral damage. Even if Germany were to decide to be the one to leave, which they actually could, as the new German currency would rise over time, it would also mean their exports would be less competitive within Europe.
A third choice (which could be combined with the first choice) is radical debt restructuring. Convert Greek bonds into 100-year low-interest bonds, giving the Greeks (or Irish or Portuguese ...) the time and ability to service the debt, along with real controls on their spending. Of course, that is default by another name, but it allows the fiction. Something like Brady bonds. You hit the reset button and kick the can a long way down the road.
That choice too has political and economic consequences. Someone has to cover the losses on the mark-to-market for those bonds. Who takes the hit?
Let me close with this bit of insight from one of my favorite analysts, MartinWolfe of the Financial Times (www.ft.com):
"This leads to my final question: could the eurozone survive a wave of debt restructurings? Here the immediate point is that the crisis could be huge, since one restructuring seems sure to trigger others. In addition, the banking system would be deeply affected: at the end of 2009, for example, consolidated claims of French and German banks on the four most vulnerable members were 16 per cent and 15 per cent of their GDP, respectively. For European banks, as a group, the claims were 14 per cent of GDP. Thus, any serious likelihood of sovereign restructuring would risk creating runs by creditors and, at worst, another leg of the global financial crisis. Further injections of official capital into banks would also be needed. This is why the Irish have been "persuaded" to rescue the senior creditors of their banks, at the expense of the national taxpayer.
"Yet even such a crisis would not entail dissolution of the monetary union. On the contrary, it is perfectly possible for monetary unions to survive financial crises and public sector defaults. The question is one of political will. What lies ahead is a mixture of fiscal transfers from the creditworthy with austerity among the uncreditworthy. The bigger are the former, the smaller will be the latter. This tension might be manageable if a swift return to normality were plausible. It is not. There is a good chance that this situation will become long-lasting.
"Still worse, once a country has been forced to restructure its public debt and seen a substantial part of its financial system disappear as well, the additional costs of re-establishing its currency must seem rather smaller. This, too, must be clear to investors. Again, such fears increase the chances of runs from liabilities of weaker countries.
"For sceptics the question has always been how robust a currency union among diverse economies with less than unlimited mutual solidarity can be. Only a crisis could answer that question. Unfortunately, the crisis we have is the biggest for 80 years. Will what the eurozone is able to agree to do be enough to keep it together? I do not know. We all will, however, in the fairly near future."
My only small disagreement is on whether it will be in the "near future." World champion can kickers can put off the day of reckoning longer than you might think. On the other hand, when that day does come, it will seem to have come so quickly and with so little warning. There is no way to know what the markets will do about this, so it pays to stay especially vigilant and flexible.

EU Creates Permanent Bailout Fund As Moody's Drastically Downgrades Ireland's Debt

Now this is really reassuring the markets. The Euro is tanking!

 from Reuters:

BRUSSELS, Dec 16 (Reuters) - European Union leaders agreed on Thursday to create a permanent financial safety net from 2013 and the European Central Bank moved to increase its firepower to fight the debt crisis that has rocked the euro zone.
But at Germany's insistence, the 27 leaders said the long-term crisis-resolution mechanism, to be added to the EU's governing treaty, could only be activated "if indispensable to safeguard the stability of the euro as a whole".

 from WSJ:


LONDON—Moody's Investors Service Inc. downgraded Ireland's debt to Baa1 from Aa2 Friday, warning the government's financial strength could deteriorate further if economic growth were to miss its projections.
The five-notch downgrade was made as "Ireland's sovereign creditworthiness has suffered from the repeated crystallization of bank-related contingent liabilities on the government's balance sheet," said Dietmar Hornung, vice president, senior credit officer at Moody's.

Stocks Turn Bearish Before the Open

Futures have turned decidedly bearish before the open. This from Marketwatch:

LONDON (MarketWatch) — An initial rally in European shares quickly petered out Monday as a multi-lateral 85 billion euro ($113 billion) bailout package for Ireland only briefly lifted sentiment.

Several developments helped sour the mood, including a lackluster Italian bond auction and concerns that the debt crisis will not end with Ireland but spread to Spain, Portugal and other peripheral euro-zone countries.
Madrid and Lisbon led European stocks lower, while the Irish and Greek markets were the only ones managing to eke out gains.
The Stoxx Europe 600 index /quotes/comstock/22c!sxxp (ST:STOXX600 264.58, -2.02, -0.76%) opened higher but slipped into the red two hours into the session. In recent trading, it was down 0.6% to 265.03. The index lost 1.1% last week.
Of the main indexes in the region, France’s CAC-40 index /quotes/comstock/30t!i:px1 (FR:PX1 3,683, -45.93, -1.23%) fell 0.8% to 3,759.04, the U.K.’s FTSE 100 index /quotes/comstock/23i!i:ukx (UK:UKX 5,613, -55.21, -0.97%)  slipped 0.4% to 5,649.26, and Germany’s DAX 30 index /quotes/comstock/30p!dax (DX:DAX 6,767, -82.42, -1.20%)  declined 0.7% at 6,803.90.
Initially, all these indexes rallied after European Union finance ministers Sunday endorsed a bailout package for Ireland. The package includes €10 billion for immediate recapitalization measures, €25 billion on a contingency basis for the banking system and €50 billion to cover budget-financing needs.
But as Monday’s session progressed, attention shifted to the fact that some issues were still not sorted out by the measures announced.
“The news yesterday, on the whole, was more positive than negative. The obvious measure aimed at stabilizing the market was the fast-forwarding of the debt-restructuring mechanism,” said Elisabeth Afseth, fixed-income analyst at Evolution Securities.
The details of the mechanism were previously set to be discussed in mid December.
Afseth noted, however, that whether a country is deemed solvent or not will need to be a unanimous decision, and thus open to political pressures. She also said that existing bond holders “could face losses if a country is deemed insolvent in the post mid-2013 world.”
In the current context, “you’d be struggling to find anyone to put a lot of money into a fund that invests in peripheral markets. At the moment a low return from safe assets seems pretty desirable,” she said.
Auto stocks were at the forefront of the decline Monday, with shares of Daimler AG /quotes/comstock/11e!fdai (DE:DAI 50.40, -0.93, -1.81%)  down 2.1% in Germany and Peugeot SA /quotes/comstock/24s!e:ug (FR:UG 29.66, -0.80, -2.61%)  down 1.7% in Paris.
The telecoms sector also came under pressure, with Vodafone Group /quotes/comstock/23s!a:vod (UK:VOD 162.00, -3.30, -1.10%)   /quotes/comstock/15*!vod/quotes/nls/vod (VOD 25.31, -0.62, -2.39%) and Telefonica SA /quotes/comstock/06x!e:tef (ES:TEF 16.75, -0.22, -1.27%)    /quotes/comstock/13*!tef/quotes/nls/tef (TEF 65.85, -1.31, -1.95%)  both down around 1%.

Financial weaken again

While many financial stocks initially got a lift from the Irish rescue package, particularly in the U.K. and in peripheral markets, only a handful remained higher in late morning.
In France, BNP Paribas SA /quotes/comstock/24s!e:bnp (FR:BNP 47.53, -1.22, -2.50%)  fell 2.5% and Credit Agricole SA /quotes/comstock/24s!e:aca (FR:ACA 9.83, -0.24, -2.35%)  lost 1.1%. In Germany, Commerzbank AG /quotes/comstock/11e!fcbk (DE:CBK 5.74, -0.07, -1.17%)  declined 1%.
It was a more cheerful day in Ireland, where the ISEQ index /quotes/comstock/30q!ieop (XX:IEOP 2,685, +18.27, +0.69%)  rose 0.7% to 2,685.32, boosted by a 21% gain for Bank of Ireland /quotes/comstock/13*!ire/quotes/nls/ire (IRE 1.72, +0.28, +19.44%)   /quotes/comstock/30b!bir (IE:BIR 0.32, +0.06, +21.21%)  and a 8% jump for Allied Irish Banks PLC /quotes/comstock/13*!aib/quotes/nls/aib (AIB 1.03, +0.08, +8.78%)   /quotes/comstock/30b!aib (IE:AIB 0.37, +0.03, +9.36%) .
In a regulatory statement, Bank of Ireland said it would seek to raise €2.2 billion in capital by Feb. 28, via “internal capital management initiatives, support from existing shareholders and other capital market sources.”
Shares of Irish Life & Permanent Group Holdings surged 53% in Dublin trading.
In the U.K. shares of financial institutions with a large exposure to Irish sovereign debt also got a lift. Royal Bank of Scotland Group /quotes/comstock/23s!a:rbs (UK:RBS 38.70, +0.01, +0.03%)   /quotes/comstock/13*!rbs/quotes/nls/rbs (RBS 12.03, -0.04, -0.33%)  , in particular, was buoyed by the rescue deal, gaining around 1%.
In Spain, the IBEX 35 index /quotes/comstock/20r!i:ib (XX:IBEX 9,397, -150.20, -1.57%)  lost 1% to 9,448.60, as Banco Bilbao Vizcaya Argentaria SA /quotes/comstock/13*!bbva/quotes/nls/bbva (BBVA 9.62, -0.70, -6.78%)   /quotes/comstock/06x!e:bbva (ES:BBVA 7.39, -0.16, -2.16%) fell 1.6%.
Portugal’s PSI 20 index /quotes/comstock/30t!i:psi20 (XX:PSI20 7,489, -92.65, -1.22%)  slumped 1%.

European Debt Crisis Threatens to Engulf Even Germany

from UK Telegraph:

Credit default swaps (CDS) measuring risk on German, French and Dutch bonds have surged over recent days, rising significantly above the levels of non-EMU states in Scandinavia.

"Germany cannot keep paying for bail-outs without going bankrupt itself," said Professor Wilhelm Hankel, of Frankfurt University. "This is frightening people. You cannot find a bank safe deposit box in Germany because every single one has already been taken and stuffed with gold and silver. It is like an underground Switzerland within our borders. People have terrible memories of 1948 and 1923 when they lost their savings."

The refrain was picked up this week by German finance minister Wolfgang Schäuble. "We're not swimming in money, we're drowning in debts," he told the Bundestag.

While Germany's public and private debt is not extreme, it is very high for a country on the cusp of an acute ageing crisis. Adjusted for demographics, Germany is already one of the most indebted nations in the world.
Reports that EU officials are hatching plans to double the size of EU's €440bn (£373bn) rescue mechanism have inevitably caused outrage in Germany. Brussels has denied the claims, but the story has refused to die precisely because markets know the European Financial Stability Facility (EFSF) cannot cope with the all too possible event of a triple bail-out for Ireland, Portugal and Spain.
EU leaders hoped this moment would never come when they launched their "shock and awe" fund last May. The pledge alone was supposed to be enough. But EU proposals in late October for creditor "haircuts" have set off capital flight, or a "buyers' strike" in the words of Klaus Regling, head of the EFSF.
Those at the coal-face of the bond markets are certain Portugal will need a rescue. Spain is in danger as yields on 10-year bonds punch to a post-EMU record of 5.2pc.
Axel Weber, Bundesbank chief, seemed to concede this week that Portugal and Spain would need bail-outs when he said that EMU governments may have to put up more money to bolster the fund. "€750bn should be enough. If not, we could increase it. The governments will do what is necessary," he said.
Whether governments will, in fact, write a fresh cheque is open to question. Chancellor Angela Merkel would risk popular fury if she had to raise fresh funds for eurozone debtors at a time of welfare cuts in Germany. She faces a string of regional elections where her Christian Democrats are struggling.
Mr Weber rowed back on Thursday saying that a "worst-case scenario" of triple bail-outs would require a €140bn top-up for the fund. This assurance is unlikely to soothe investors already wondering how Italy could avoid contagion in such circumstances.
"Italy is in a lot of pain," said Stefano di Domizio, from Lombard Street Research. "Bond yields have been going up 10 basis points a day and spreads are now the highest since the launch of EMU. We're talking about €2 trillion of debt so Rome has to tap the market often, and that is the problem."
The great question is at what point Germany concludes that it cannot bear the mounting burden any longer. "I am worried that Germany's authorities are slowly losing sight of the European common good," said Jean-Claude Juncker, chair of Eurogroup finance ministers.
Europe's fate may be decided soon by the German constitutional court as it rules on a clutch of cases challenging the legality of the Greek bail-out, the EFSF machinery, and ECB bond purchases.
"There has been a clear violation of the law and no judge can ignore that," said Prof Hankel, a co-author of one of the complaints. "I am convinced the court will forbid future payments."
If he is right – we may learn in February – the EU debt crisis will take a dramatic new turn.

Escalating Europe's Bailout Bonanza

from WSJ:

BERLIN—The euro zone's sovereign debt crisis escalated Friday as the market homed in on Spain as another potential weak spot, leaving officials scrambling to quell investors' fears.
Spanish Prime Minister Jose Luis Rodriguez Zapatero moved to dispel the growing anxiety surrounding the country's fiscal position Friday, saying there was "absolutely" no chance the euro zone's fourth-largest economy would seek a bailout from the European Union. But his attempt to calm the markets had little effect, with the euro tumbling and the selloff in Spanish and Portuguese sovereign bonds continuing.
"If we continue to see the recent trend in Spanish bond yields then the crisis is going to be taken to a completely new level, as Spain accounts for approximately 11.7% of euro-zone [gross domestic product] which is pretty much double the figure of Ireland, Portugal and Greece [combined]," said Gary Jenkins, head of fixed-income research at Evolution Securities.
Sparking Friday's markets turmoil was a report in Friday's Financial Times Deutschland, which quoted unnamed German finance ministry officials as saying an aid package for Portugal would reduce the chances that Spain would also need a bailout.
The Portuguese and Spanish governments, the European Commission and Germany's finance ministry all denied the report, saying pressure wasn't being placed on Portugal to seek help. "It's absolutely, completely false—every reference for an aid plan for this country. It has neither been asked for and neither have we suggested it. It is absolutely false," said European Commission President Jose Manuel Barroso, a former Portuguese prime minister.
But the report still caused the euro to tumble against the dollar to $1.3252 from $1.3355 late in New York Thursday.
The yield premium that investors demand to hold 10-year Portuguese sovereign bonds rather than German bunds rose 0.3 percentage points to 4.35 percentage points, according to Tradeweb, while the spread between Spain's 10-year bonds and bunds spread rose to a fresh euro-era record high of 2.67 percentage points. The spread later recovered to 2.59 percentage points, still 0.07 percentage points higher than Thursday.

Europe Continues In Disarray, Stocks, Euro Plunge

Stocks have given back 100 points of Wednesday's misguided gains

The Euro sinks to a new low

Headlines from FT:

Germany Rejects Larger Bailout Fund
The German government has rejected any suggestion of an increase in the size of the €440bn European financial stability facility – the eurozone rescue fund established by European Union finance ministers in May to help debt-laden members of the common currency zone.

“It really is a non-issue for the German government right now,” said Steffen Seibert, the government spokesman. “We have never been approached in any way about this. All conversations are taking place within the framework of the existing facility.”

Berlin’s approach - and that of the European Central Bank - to handling the eurozone crisis has come under strong attack from Peter Bofinger, economics professor at Würzburg university and an independent adviser to the German government. Without a profound change of strategy there was a “major risk of an unraveling of the euro area,” he has said.

A “dangerous” adjustment process is being forced on eurozone countries he told a Financial Times/Credit Suisse conference in Frankfurt. The weakest spot is Greece, which faces rising unemployment and debt levels. As a result, political opposition to euro membership would grow, according to Prof Bofinger. “Sooner or later we will have a discussion in Greece: ‘why not leave the euro?’” A new currency could then be devalued and much of the government’s debt cancelled out. Once Greece had left, others would follow.

IT'S GETTING WORSE, NOT BETTER:

Europe’s proposed “permanent crisis resolution mechanism” is aptly, if rather ironically, named. Trying to resolve a permanent crisis seems to be what the continent’s leaders have been doing all year and will no doubt be doing for some time yet. (One presumes they really mean a permanent mechanism for crisis resolution – the final language may well be different).

Whatever the final shape of the mechanism, designed to allow eurozone countries to default in an orderly manner, Europe seems little closer to resolving its debt crisis. To the financial markets, bail-outs for Greece and now Ireland are clearly insufficient, no more than plasters placed over gushing wounds.


U.S. Munis Sink Still Lower


Investors withdrew another $2.3bn from funds that buy US municipal bonds in the latest week, capping a sell-off that has taken about $5.4bn from the sector, according to Lipper, the fund tracker owned by Thomson Reuters.
The latest outflows from mutual and exchange traded funds for the week ended November 23 follow redemptions of $3.1bn in the previous week, the largest outflow since Lipper began compiling weekly data in 1992. The combined weekly outflows accounted for 1.5 per cent of the assets managed by the muni funds that Lipper follows.
Investors have cashed out of muni bonds this month after a rise in yields on benchmark US Treasuries and against a backdrop of warnings that the financial problems of local governments and municipalities will lead to a rise in defaults. The selling also came amid record amounts of new issuance into the end of the year.
The latest round of outflows from funds occurred even though the $2,800bn municipal bond market, where states, cities and other public entities raise money, had rebounded in the last few days.

The Fuse Is Burning In Europe

Finland Opposes Aid Too

European Union In Meltdown

It seems odd that the Euro is holding its own tonight despite the turmoil.

from UK Telegraph:

Spain's central bank governor, Miguel Angel Ordonez, lashed out at Dublin on Monday, calling on the Irish government to halt the panic and take the "proper decision" of activating the EU-IMF bail-out mechanism.

"The situation in the markets has been very negative due to the lack of a final decision by Ireland. It is up to Ireland to take that decision, and I hope it does," he said.

The outburst reflected suspicion at the European Central Bank that Dublin is holding the eurozone to ransom, allowing the crisis to fester until it extracts a pledge from EU officials that it will not suffer a loss of economic sovereignty or be forced to give up its 12.5pc corporate tax rate under any deal.

from Montreal Gazette:

The euro is facing an unprecedented crisis after another country indicated on Monday night that it was at a "high risk" of requiring an international bail-out.
Portugal became the latest European nation to admit it was on the brink of seeking help from Brussels after Ireland confirmed it had begun preliminary talks over its debt problems.
Greece also disclosed that its economic problems are even worse than previously thought.
Angela Merkel, the German Chancellor, raised the spectre of the euro collapsing as she warned: "If the euro fails, then Europe fails."
European finance ministers will meet in Brussels on Tuesday to begin discussions over a new European stability plan that is expected to result in billions of pounds being offered to Ireland, Portugal and possibly even Spain.
David Cameron said he was thankful that Britain had not joined the euro, but indicated his displeasure that taxpayers in this country face a pounds 7?billion liability in any bail-out package.
The veteran Conservative MP Peter Tapsell warned that the "potential knock-on effect" of the Irish crisis "could pose as great a threat to the world economy as did Lehman Brothers, AIG and Goldman Sachs in September 2008".
Ireland has resisted growing international pressure to accept EU financial assistance amid concerns that this would lead to a surrender of political and economic sovereignty.
However, the German government is expected to signal that Ireland may have to accept a pounds 77?billion bail-out, along with a loss of economic and political independence, as the price of preserving the euro.
Mrs Merkel said that the single currency was "the glue that holds Europe together".
Her words came as fellow eurozone members Portugal and Spain rounded on Ireland. They fear that international concerns over the euro will lead to so-called market contagion spreading to them.
Fernando Teixeira dos Santos, the Portuguese finance minister, said: "There is a risk of contagion. The risk is high because we are not facing only a national problem. It is the problems of Greece, Portugal and Ireland. This has to do with the eurozone and the stability of the eurozone, and that is why contagion in this framework is more likely."
Mr Teixeira dos Santos added: "I would not want to lecture the Irish government on that. I want to believe they will decide to do what is most appropriate together for Ireland and the euro. I want to believe they have the vision to take the right decision."
He later sought to clarify his comments, insisting that Portugal was not preparing to seek assistance.
Greece had earlier added to the growing uncertainty when it said it would breach the conditions for the bail-out it was granted by the EU earlier in the year. The Greek government said its debt problem was far worse than previous dire forecasts.
Eurostat, the EU statistics agency, said Greece's 2009 budget deficit reached 15.4 per cent of gross domestic product, significantly above its previous figure of 13.6 per cent.
George Papandreou, the Greek Prime Minister, said new European-wide taxes may now be needed to fund bail-outs.
"We need a mechanism which can be funded through different forms and different ways," he said. "My proposal is that taxes such as a financial tax or carbon dioxide taxes could be important revenues and resources for funding such a mechanism."
Irish ministers continued to insist publicly on Monday that they did not require a European bail-out to help meet the cost of repaying the country's debts. However, reports suggested that it may require help to shore up its banks.
Jean-Claude Juncker, the head of the Eurogroup of finance ministers, said the eurozone was indeed ready to act "as soon as possible" if Ireland sought financial assistance. But he stressed that "Ireland has not put forward their request".
Ireland suffered the worst recession of any major economy and has amassed government debts of more than euros 100?billion (pounds 84?billion). It has an unemployment rate almost twice as high as Britain at 13.2 per cent and has a record deficit equivalent to 32 per cent of its gross domestic product.
Senior figures at the European Central Bank lined up on Monday to insist that the Irish accept international help to reassure investors that the euro was secure.
Miguel Angel Fernandez Ordonez, the Bank of Spain governor and a member of the ECB's governing council, said: "The situation in the markets has been negative due in some part to the lack of a decision by Ireland. It's not up to me to make a decision. Ireland should take the decision at the right moment."

from WSJ:

Greece's prime minister lashed out Monday at Germany—its chief euro-zone benefactor—for tough talk on government-debt defaults, making clear the widening strains inside the 16-member euro-zone as the currency bloc wrestles with a teeming sovereign-debt crisis.
Addressing reporters in Paris, George Papandreou said the Germans' view—long-held, but recently reiterated—that private bondholders could suffer losses as part of a future bailout was intensifying government-debt woes.
The German position "created a spiral of higher interest rates for countries that seemed to be in a difficult position, such as Ireland or Portugal," Mr. Papandreou said. He added that the spiral could "break backs" and "force economies toward bankruptcy."
The sharp words reflect the severe difficulties the euro zone faces as it tries to shepherd its weaker members through an unstable period in which their access to borrowing from private markets is sharply curtailed.
Many in Europe—particularly in Germany—are wary of simply replacing that market financing with a blank check from other euro-zone taxpayers, hence the German insistence on finding others to take some of the losses. German leaders also believe that the tough-love approach will, in the long-term, give countries the incentive to live within their means.
"Our task is to anchor a new culture of stability in Europe," German Chancellor Angela Merkel said in prepared remarks for a party congress Monday.
A spokeswoman for Ms. Merkel said Monday the German chancellor's call for investors to bear a share of the burden in case of a euro-zone default in sovereign debt was made in reference to European Union discussions about new strategies for financial-crisis management that would not be implemented before 2013.
At the same time, the very fact that some countries are facing borrowing difficulties is spreading the problem to others and weakening the euro. That makes a speedy solution imperative.
Ireland, the country most acutely in crisis, is facing pressure to accept a bailout in order to stem the contagion, and a Portuguese minister speculated over the weekend that his country—another weak spot—may be forced to leave the euro zone.
In a bit of odd timing, Mr. Papandreou's remarks came as his own country released revised government-finance figures that made it more likely Greece would be unable to get out from under the crush of its own debt pile.
Greece said Monday it would miss a target to reduce its government deficit to 8.1% of gross domestic product this year, which was set after Greece took a €110 billion (€150 billion) bailout from euro-zone countries and the International Monetary Fund. (Germany put up €22 billion of that total.) As recently as last month, Greece said it would beat its target and report a deficit of 7.8%.
Instead, it now says the deficit is likely to be 9.4% this year, and that government debt would total 144% of GDP at the end of 2010. Citigroup economist Giada Giani said Greece's debt could reach 165% of GDP in 2013. At the time of the bailout, Greece agreed that its 2010 debt would be 133%, rising to 150% in 2013.
The bigger debt burden will increase Greece's annual interest tab. "A significantly higher debt profile inevitably makes the fiscal situation in Greece even more unsustainable than before," Ms. Giani wrote in a research note.
The revisions are in part the fruit of an effort to revamp Greece's poor record of making economic estimates and compiling government statistics. The 2009 deficit—also adjusted Monday from 13.6% of GDP to 15.4%—has been revised a half-dozen times. Greece now says it has finally seen the end of statistical revisions.
But the changes to the numbers also reflect a more fundamental problem: Greece is straining to bring in enough cash to close its budget gap sufficiently. Data from the Greek finance ministry show that revenue is up just 3.7% in the first 10 months of 2010, against the same period a year ago. The deal Greece inked in May as part of its bailout calls for full-year 2010 revenue to be up by 13.7%. That's now all but impossible, and Greek authorities have responded by imposing additional spending cuts to compensate. Analysts say Monday's new figures mean Greece will have to cut again.
—Alkman Granitsas, Amelie Baubeau, William Horobin and David Crawford contributed to this article. Write to Charles Forelle at charles.forelle@wsj.com

EU Enters New Era of Crisis

from Bloomberg:

The life-support system for Greece, Ireland, Portugal and Spain is now under threat. The highly indebted nations of the euro area can’t survive the deficit crisis without access to central-bank credit.
Last month’s Franco-German agreement at Deauville, France, and the statement of European leaders on Oct. 29 have changed the ground rules for euro-area debt.
All 27 member states have now signed up to the need for a revision of the Lisbon Treaty in exchange for a permanent crisis-resolution mechanism. The key new element is that Europe’s leaders have specifically said that future rescues might involve private creditors.

Ireland's Debt Downgraded -- Again -- Worries Europe!

Standard and Poors has downgraded Ireland's debt for the third time this year, and it is sending fresh ripples of worry through Europe.

Economist Sees Greek Debt Default Soon, Urges Investors to Carry Cell Phones On Vacation

Greece will eventually default on its debt because the country is highly indebted and the euro zone's approach towards saving it is the wrong one, Carl Weinberg, chief economist at High Frequency Economics, told CNBC Friday.

A restructuring of Greek debt could happen as soon as August, when the Balkan country is due to receive another tranche of funds from its lending agreement with the International Monetary Fund (IMF) and the European Union, according to Weinberg.

"You can't take a country that's over-borrowed and make it more creditworthy by lending it more money," he said. "They're throwing Greece further and further and further in the hole by not addressing the problem directly and properly."Asked when a Greek default could happen, Weinberg answered: "at High-Frequency, we are advising people to take their cell phones on their August vacation." He said a Greek default would be "harsh" for the euro.