Financial Paralysis: Europe Short on Cash as Bond Fears Deepen
The euro zone is stuck in a double crisis. On the one hand, investors are no longer interested in purchasing sovereign bonds. On the other, banks with such bonds on their books are being treated with extreme caution. A massive financial crisis threatens -- and it could be worse than the last.
Josef Ackermann is a busy man this autumn. Hardly a day goes by that the Deutsche Bank chief, despite his impending departure from the bank, doesn't hold a speech on the current financial crisis that has gripped Europe. And more often than not, his talk centers on the immense problems faced by the sovereign bond market. Nobody, it would seem, wants state bonds anymore.
Germany's top banker is not alone with his concern about the problem. The entire financial world is in turmoil this autumn. Once seen as iron-clad investments, state bonds are no longer seen as secure -- particularly since the European Union agreed to a 50 percent debt haircut for Greece in October. It can, warned Andreas Schmidt, president of the Association of German Banks, earlier this week, no longer be taken for granted that countries can turn to the capital markets to finance their budgets.
The truth of Schmidt's statement became readily apparent this week. On Tuesday, Spain auctioned off three-month and six-month bonds, a sale that in normal times would be quick and easy. Interest rates of 3 to 4 percent on such sales are normal. But this week, Madrid had to pay 5.11 percent and 5.23 percent respectively, the highest it has had to pay on such bonds in 14 years -- and up significantly from the 3.30 percent it paid on six-month paper as recently as October 25. Even Greece didn't have to pay as much on a similar offering recently.
And the problem isn't just limited to indebted euro-zone countries. Banks too have run into difficulties as a result of the sudden aversion to sovereign bonds. Most of them, after all, have significant amounts of sovereign bonds on their balance sheets -- making other banks extremely wary of lending to them. Indeed, the European Central Bank said on Tuesday that 178 banks borrowed 247 billion in one-week loans from the ECB -- the most since early 2009 when the last financial crisis was at its peak.
Mistrust of EU Bonds
"There is, at the moment, a collective mistrust of European sovereign bonds and banks," said Eugen Keller, a financial market expert with the Frankfurt-based private bank Metzler.
US money market funds have long since withdrawn from the European common currency zone. American and British banks have also become extremely careful when it comes to doing business with European financial institutes. "The willingness of investors to engage in banks on the longer term is not particularly pronounced," Deutsche Bank head Ackermann said in describing the phenomenon. Were the ECB not on hand to provide banks with cheap money -- since 2008, it has been allowing banks to borrow as much as they need to overcome liquidity shortfalls -- the situation would look much worse, Ackermann added.
In an effort to win back investor faith, European banks are doing everything they can to clear their books of state bonds. According to an estimate from the US investment bank Goldman Sachs, the 55 largest European banks reduced their holdings of Italian bonds by 26 billion just in the three months between the end of June and the end of September -- roughly a 30 percent decrease. Holdings of Spanish bonds have also plunged by a similar percentage, equating to 6.8 billion. The trend is likely to have continued in October and November.
Most of the bonds shed by the banks have likely landed on the balance sheet of the ECB, which has been on a bond-buying spree since May 2010 in an effort to push down sovereign bond interest rates. But the effort has not been met with unreserved success. So far, the ECB has amassed euro-zone bonds worth 195 billion -- and the interest rate on Italian bonds still edged up to 6.8 percent on Tuesday. That is down from the highs of earlier this month, but still worryingly close to the 7 percent mark that is widely considered to be unsustainable on the long term.
Still, many feel that the ECB is not doing enough and would like to see it embark on a gigantic bond shopping spree in an effort to calm the financial markets. But the ECB has remained resistant to being turned into Europe's lender of last resort -- a position vehemently supported by Germany's central bank and by Chancellor Angela Merkel.
But the problem is not likely to disappear overnight. And the longer the double-crisis -- of state debt and bank liquidity -- continues, the more dangerous it will become for the ultimate survival of the euro. The two are, after all, dependent on each other. Countries need liquid banks to purchase their bonds and the banks need financially solid states as guarantors of the state bonds on their balance sheets. At the moment, neither half of the relationship is functioning properly.
Over the weekend, the world's largest sovereign bond buyer Pimco sounded the alarm. "This is just a repeat of what we saw in 2008, when everyone wanted to see toxic assets off the banks' balance sheets," Christian Stracke, head of research for Pimco, told the New York Times.
Keller, the analyst from Metzler, also sees parallels. "Back then, it was shoddy US real-estate loans that was causing the banks problems," he says. "Today it is the European state bonds that everyone thought were so safe."
The comparison with 2008 is frightening. Following the fall of the investment bank Lehman Brothers, the entire financial system faced collapse. And this time, the condition of the markets is, if anything, even worse: The crisis has eaten its way deep into the credit system. The entire method by which European countries access money is under threat -- and by extension, so too is European prosperity.
Keys in Berlin
It is a situation that has become unsustainable on the long term. If Europe is not able to quickly re-establish faith in European sovereign bonds, a downward spiral of fear and debt could be the result.
The key to preventing that spiral from gaining momentum lies in the hands of the German government. Germany is, at the moment, the only euro-zone country that investors continue to trust unreservedly -- which can be seen in the low interest rates that Berlin must pay on its sovereign bonds.
It is a trust that Merkel's government is hesitant to loan out, as would be the case were so-called "euro bonds" -- essentially a pooling of euro-zone debt -- to be introduced. Experts, though, think that the chancellor will soon be forced to buckle. "I think that it is only a question of weeks before we have to say: all for one, one for all," says Keller.
The implication is clear. Either Germany will have to guarantee the debts of other euro-zone countries in the form of euro bonds. Or the ECB will have to jump in and buy massive quantities of bonds from highly indebted currency zone members. A third alternative doesn't exist.
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- Pt. I: How a Good Idea Became a Tragedy
- Pt. II: How the Euro Zone Ignored Its Own Rules
Corriere della Sera
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