Thin Ice

Wed, Nov 16, 2011 - 8:36am

I’m not surprised that the halo effect of political changes in Italy and Greece had a very short half-life. Why would it? Nothing has changed.

I’m not surprised that the contagion has worked its way to France. After all, the ECB intervention policy insures that France becomes a target. “If you can't sell Italy, sell France”, is the market’s response.

But I’m absolutely blown out by the pace of things. France’s bonds are being devalued on a daily basis. Italy has been functionally shut out of the new issue market. Market liquidity has dried up. What were once routine transactions are now difficult to price. E100mm bond transactions for France and Italy were normal; today E25mm is a market amount.

What is becoming scarily clear is that there is no more announcements coming that are going to make a difference. All the news is out on expanding the EFSF. The only thing that could reverse this tide is an agreement to “federalize” the debts of Europe. This would leave Germany (massively) on the hook. There is zero chance of this happening.

The central question that the market will ask and answer in the next few weeks is whether France can withstand the onslaught. The ECB will not intervene in the French market. Will debt capital continue to move out of France? Two charts. One says France is probably okay. The other says we are headed for a hard landing.

These numbers (CIA) are a year old but they tell the story. Italy had .1T of public sector debt (119% of GDP) while France had only .8T of debt (82% of GDP). Looking at this it’s understandable why Italy is in trouble. But it does not explain why France should have a problem. This chart is the reason that there could be an issue:

On this basis France has double the debt of Italy. I call this the Money Center Bank Syndrome. The banks have debt outside their borders (they have assets too). This debt is getting sucked into the French government bond market as world investors trim exposure to the country (“If you can’t reduce exposure to the banks, sell government bonds”).

Italy and France have an average debt maturity of ~7 years. There is a total of T. The market value of this stock of debt has fallen by about 0b since October 1st. This is not a loss that will be recorded on anyone’s books (except the likes of MFG) but it does cause a strain on funding as the repo value has fallen.

Remember that all night conference by the EU deciders on October 26th? Central to that meeting was the commitment that the EU banks would undergo a recapitalization of E106b (0b) by June 30 2012. The EU banks have had their assets impaired by at least that amount in just the past two months.

That all night meeting was just a joke! Anyone who trusts these people are making a mistake.

The Merkozy’s of Europe will be making “calming” statements over the next few days. We are dangerously close to a death spiral, and they know it. But they have nothing on their shelf but words. I don’t think this will prove to be enough.


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Bkrasting [at] gmail [dot] com ()