ECB tenders


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The ECB raised its day tender rate to 2.75% today and got far fewer tenders, as USD market rates had gone below that in anticipation of lower rates.

But that should just mean the USD ‘market rates’ will rise to over that level and the USD borrowers will come back to the ECB in big size as it’s just a game of musical chairs


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UK’s Brown- Right action for wrong reasons


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Brown set to borrow more (FT)

By George Parker and Norma Cohen

Gordon Brown on Monday insisted the government would spend its way through the downturn. Mr Brown said Britain’s debt-to-gross domestic product ratio of 37.6 per cent was lower than main competitors – the eurozone average is 56.4 per cent – and could sustain higher borrowing. “It is because we cut the national debt over the past few years that we are able to do what is the right thing.” The £37.6bn half-year borrowing figure is the highest since the second world war in nominal terms, although relative to the size of the economy it is below that of the 1993/4 fiscal year, when John Major’s Tory government was fighting a recession. Treasury estimates of growth in tax receipts are far short of those forecast at the start of the fiscal year, rising at only 1.9 per cent year-on-year instead of the 5 per cent rate that had been expected.


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Re: The first weak link to be probed?


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(email exchange)

Good read, thanks, passing it along.

>   
>   On Thu, Oct 16, 2008 at 8:22 PM, wrote:
>   
>   Even though Hungary is not a member of the euro zone, this analysis
>   suggests that this could be the weak link which shatters the whole euro
>   project. Is the ECB now going to be able to secure swap lines from the
>   Fed to deal with the problems in eastern Europe? Interested to hear
>   your thoughts.
>   

ECB Agrees to Lend Hungary as Much as 5 Billion Euros

The European Central Bank has announced that it will lend up to 5 billion euros to Hungary’s Central Bank. The move aims to stop Hungary’s financial crisis from spreading, a goal that overrides its drawbacks.

Analysis

The European Central Bank (ECB) announced Oct. 16 it will lend as much as 5 billion euros ($6.75 billion) to the Hungarian Central Bank to help head off a local liquidity crisis. The ECB is attempting to nip Hungary’s potentially destabilizing problems in the bud, for if the Hungarian economy tanks, far more than one small Central European country will be affected.

International Economic Crisis

Hungary’s mortgage system is locked up in the carry trade with the Swiss franc; many mortgage loans are denominated in Swiss francs rather in the local currency, the forint. Since 2006 in fact, nearly 80 percent=2 0of all Hungarian mortgages have been granted in Swiss francs. As the forint falls versus the Swiss franc (it fell 7.1 percent Oct. 15 alone) the cost of servicing those mortgages for the average Hungarian homeowner will increase proportionally (even before things like teaser rates are taken into account). All told, approximately 40 percent of Hungary’s mortgages are directly affected, along with approximately 40 percent of all consumer debt. The ECB move today to inject 5 billion euros into the country is designed to head off a plunge in the forint. At about 4.8 percent of gross domestic product, this represents proportionally the same amount of money as the entire U.S. bailout package.

At present, how critical the Hungarian situation is to the Europeans remains somewhat murky, but we do know that most of the Swiss franc-denominated loans were granted by Austrian banks. So as the forint falls and Hungarians begin defaulting on their mortgages en masse, we could see broad and deep failures in the Austrian banking sector, which is already in trouble due to the global liquidity crisis. Should that happen, the next step in the chain is the Swiss banks that lent the Austrian banks the francs needed to fund the Hungarian mortgages in the first place. Switzerland remains one of the world’s most critical financial nodes. Problems there would have global implications, with the epicenter at the heart of Europe. Switzerland is completely surrounded — culturally, economically, figuratively, financially and literally — by EU states, but is not a member.
Budapest has seen this problem coming, and has worked aggressively to get its budget deficit — which stood at 9.2 percent of GDP in 2006 — under control. Last year it was brought down to 5.5 percent, and now the government is redoubling its efforts and hopes to get that number down to 3.4 percent this year and 2.9 percent in 2009.

Highly contractionary move but necessary to keep the currency up and comply with ECB entrance requirements.

But it may be too late for that. The government has discovered that there is no appetite at home or abroad for additional government debt issues,

I haven’t been watching this, but that reads like the problem is a fixed FX policy, as they try to fit it to the Euro.

raising the prospect that government financing could simply freeze up. The government already has taken the precautionary step of seeking a standby agreement with the International Monetary Fund (IMF) for emergency financing. Preferring to avoid the embarrassment of having one of their own going hat in hand to an international institution that normally helps manage economic basket cases, the European Union jumped in Oct. 16 with that 5 billion euro loan both to (hopefully) nip the problem in the bud, and in the longer term avoid the embarrassment of having the IMF taking one of their own into receivership. Hungary now stands as the only European country to receive direct emergency aid in the history of the European Union, and Hungary is not even a member of the eurozone.

The only reason for that kind of financial assistance is to support the local currency at a pegged rate. Also sounds like a ‘managed peg’ of some kind as per the mortgage problems above stemming from currency depreciation.

As for the other end of this daisy chain of potential chaos, the normally stolid Swiss are filled with fear more appropriate for a former Soviet republic=2 0that has just fallen under the shadow of a resurgent Moscow. On Oct. 16, the two largest Swiss banks, UBS and Credit Suisse, received government capital injections worth $6 billion as Bern assembled a fund to buy up $60 billion (both of the packages are denominated in U.S. dollars) in questionable assets held by the banks. And this is on top of the 6.5 billion euros ($8.7 billion) gleaned from the banks’ own recapitalization efforts. The ECB is also working with the Swiss National Bank in a very big way to bolster liquidity in each others’ markets. The Swiss see a storm coming, and when the Swiss get nervous about financials, everyone should take note.

As of the time of this writing, Hungary is holding. The forint has risen 3.8 percent versus the euro since the ECB’s announcement, mitigating yesterday’s 5.4 percent fall. To prevent the collapse from going regional and perhaps even global, the ECB needs to keep the forint as locked into its current value as possible. That means the ECB probably will de facto draw Hungary into the eurozone. This is because if the forint/euro exchange rate can be frozen, homeowners will be able to keep up with their payments, the mortgages will not go into foreclosure and there will not be a domino effect. It would be better yet to freeze the forint versus the Swiss franc, the currency the problem loans are denominated in. But the ECB controls the euro, not the Swiss franc, and must work with the tools at its disposal.

This is a highly inflationary policy as it will take more and more euros to support the local currency that seems to have its own inflation issues.

Again, I haven’t followed this one.

Thanks for the heads up!

Warren

In the long run, essentially extending euro membership to Hungary on crisis terms is a horrible decision. Normally, states spend years working themselves to the bone to qualify for the sort of perks and stability that euro membership grants, so the political and economic fallout of what began Oct. 16 will damage the euro’s credibility for years. But these are exceptional circumstances. The ECB, and the European Union as a whole, realizes full well that without dramatic action far more than Hungary is at stake.


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ECB extending collateral (to almost anything)


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And this includes the ‘appropriate collateral’ for the unlimited USD loans as well.

ECB extending collateral (to almost anything)

ECB extending collateral (to almost anything) and introducing more longer dated repos with full allotment. Significant points: acceptable ratings down from A- to BBB- (except for ABS) syndicated loans included, also wider range of currency. Quid pro quo is higher haircuts but fair enough. So virtually no excuse for any bank to run out of money. Also pretty positive for corp spreads.

As you predicted. The US taxpayer, via the Fed, is basically the dumpster receiving all of this toxic crap from Europe. That’s got to be dollar bearish longer term.

Until the the ECB is driven to sell euros to pay back the USD it borrowed from the Fed.

And no doubt there will be continuous politically driven responses that could tilt the outcome in any direction.

Our leaders are in this way over their heads.

All they needed to do was declare a payroll tax holiday- none of this had to happen.


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Total euro CB offerings (update1)


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The total is now up to $354 billion including $100 billion in overnight funds added by the ECB.

Haven’t seen overnight funds by the Bank of England or Swiss National Bank.

Haven’t seen any Bank of Japan numbers.

ECB Leads Push to Flood Banks With Unlimited Dollars (update1)

Oct. 15 (Bloomberg) — The European Central Bank, Bank of England and Swiss National Bank loaned financial institutions a combined $254 billion in their first tenders of unlimited dollar funds, stepping up efforts to ease strains in markets.

The Frankfurt-based ECB lent banks $170.9 billion for seven days at a fixed rate of 2.277 percent. The Bank of England allotted $76.3 billion and the Swiss central bank $7.1 billion at the same rate, also for a week.


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Fed to lend to CBs in unlimited quantities (day 2)


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I’m keeping an eye on crude prices rising a lot more than the USD is falling; so, I suspect the great Mike Masters inventory liquidation has run its course.

Inventories are at record or near record lows.

If there has been net demand destruction, it hasn’t yet showed up in OPEC or Saudi production numbers.

The Saudis only pump on demand, at their price, so as swing producer it’s their production that should fall, not anyone else’s.

However, there can be 90 day type lags; so, October Saudi production could be down but not be reported until early November.

___________________________________________________________________________________________________________________

This latest swap line expansion should be a target of Obama and McCain, but neither are touching it.

It’s a financial blunder, potentially of epic magnitudes.

It’s also an oversight issue of epic magnitudes that could dwarf the subprime issue at the first ECB USD auction tomorrow.

The $620 billion swap lines currently in place could swell to well over a trillion USDs.

It will reduce eurobanks cost of USD funds, bring down LIBOR, and normalize bank liquidity.

And the reduction of bank credit risk is bringing in credit spreads which makes room for equities to appreciate as well.

But that’s an empty victory that changes the lack of aggregate demand very little, if any.

And it adds a new element of systemic risk.

Unrestricted/’currency secured’ international USD lending has been tried before in the emerging markets.

Yes, this type of initial lending reduces financial stress, but then it must be sustained and increased to avoid a subsequent collapse, which then becomes inevitable.

Remember Mexico and the rest of Latin America?

It took a growing level of external USD debt to hold it together, until the number got too large and the controls impossible. And then it all fell apart.

All of these ‘top down’ measures that carry the hopes and anticipations of markets should continue to be let downs as no one addresses demand.

This happened in Japan after the banks were recapitalized and ‘healthy’ and nothing happened regarding lending.

Obama and McCain have a window to jump on this opening but don’t seem to be. McCain as the watchdog and Obama as the reformer are both letting us down. Again, as they show no insight and instead keep to their canned rhetoric.

Bush and congress missed a historic opportunity to move the US away from ‘materialism’ after 9/11.

I got a call from Congressman Gephart at the time, and I said this is an opening to show a different kind of leadership as people had turned ‘inward,’ with the following type of statement:

A nation is not richer because people sleep in hotels instead of staying at home. A nation is not richer because we eat out rather than have family meals at home. And now that we have become more introspective on life itself, we can continue this enlightened change of course, back to our real core values, and steer our efforts to educating our children and improving our health care service, etc. etc.

But instead, our leadership telling us:

“Get out of Church and get into the shopping malls!” in order to ‘save the economy’, etc. etc. Gephart didn’t do it. And we went back to the malls.

This go round was also an opportunity to make a fundamental change away from a lending based model to a more cash based model which seems to me has proven more stable over time and a lot more beneficial to human peace of mind.

We could have let most of our lending institutions go by the wayside and kept the banks that would be allowed to make more conservative home loans, installment loans, checking and savings accounts, and not much else. And the housing agencies operating a bit like the old savings and loan’s used to do, but this time with sustainable, matched treasury funding.

And rather than relying on lending for aggregate demand, which is inherently unstable, we could have supported aggregate demand with a fiscal package to provide sufficient income to buy our output and sustain growth and employment.

But instead we are first ‘fixing’ the lending institutional structure, without addressing aggregate demand.

It’s unlikely that costly (in terms of lost output and employment) credit bubbles will be reduced by first supporting the lending institutions and then supporting demand.


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Germany to insure all bank deposits?


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(an email exchange)

Right,

If everyone in Germany tries to take their funds out of the banks they won’t get it, with or without the backing of the German government.

German government insurance can buy them some time, maybe even enough time to make it through if aggregate demand wasn’t falling off so fast.

In the U.S., U.K., Japan and any nation with its own currency and fiscal authority behind the deposit insurance you can get all the funds you want on demand.


>   Finally, the Germans seem to get it. This might be the best news of the
>   weekend. But they need to take the final step. Problem is there
>   is no EU treasury or debt union to back up the single currency.
>   The ECB is not allowed to launch bail-outs by EU law.

>   Each country must save its own skin, yet none has full control of
>   the policy instruments. How do they change this in a hurry?

With great difficulty!

Germany draws up contingency plans for state rescue of banks

By Bertrand Benoit

The German government was last night drawing up a multi-billion euro contingency plan to shore up its banking system, which could see the state guarantee interbank lending in the country and inject capital in its largest banks.

The contingency draft, closely modelled on the British initiative announced this week, marks a dramatic political U-turn for Europe’s largest economy after Angela Merkel, chancellor, and Peer Steinbrück, finance minister, both ruled out a sector-wide state rescue for banks this week.

A senior government official said Ms Merkel and Mr Steinbrück would decide on Sunday which of the measures to implement after consultation with their European partners. Once a political decision was made, he said, the plan could be implemented in the following days.

“We are considering all the options at present to the exception of a massive state acquisition of toxic assets,” the official said. “Whatever we do will be done in close co-operation with our G7 and European partners.”

France announced last night that it was planning an emergency European Union summit tomorrow.

Speaking in Washington ahead of a meeting of Group of Seven finance ministers, Mr Steinbrück said the time had now come for “a systemic solution . . . I am convinced that case-by-case solutions are no longer helping. They are now exhausted.”

The official said Ms Merkel was in daily contact with Nicolas Sarkozy, French president, suggesting that the plan, if approved, could be launched as a joint initiative.

Ulrich Wilhelm, the government spokesman, said: “It is the duty of the federal government to be prepared and to review all options . . . As of now, no political decision has been made.”

Under the draft, Germany could issue a state guarantee for interbank lending worth more than €100bn and provide direct lending to the banking sector. Berlin is also contemplating offering several dozen billion euros of capital to the banks in exchange for equity and may take entire ownership of some institutions.

As an additional option, the government is considering extending the blanket guarantee it issued last Sunday for account deposits to money market funds, which have experienced a steep outflow of savings lately. Fund managers have had to divest considerable quantities of assets to cover the withdrawals.

Bankers said the interbank lending market in Germany had reached near-gridlock.


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End game for the euro


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Europe is even worse off than I thought.

And it looks to me like the Fed’s loan (via swap lines) to the ECB is noncollectable:

  1. Seems Eurozone got caught short USD much like AIG got caught short credit. Now the squeeze is on as the euro falls vs the USD rises. It’s an old fashioned external currency debt problem.
  1. The ECB has borrowed perhaps over $400 billion from the Fed via swap lines, secured by euros, to lend to its banks. Functionally, this is unsecured borrowing. And the amount approved by the Fed grows with each FOMC meeting. To pay it back the ECB has to sell euro and buy $400b, which might be problematic, at best.
  1. National budget deficits are now rising rapidly due to falling revenues and rising transfer payments. They will soon have their hands full funding themselves and will be incapable of funding the needs of the banking system.
  1. Should a run on the banks force the euro payments system to close; the question is how it re-opens.
  1. Reopening the ECB in euros will mean the national governments will have to repay the Fed $400 billion.
  1. If the national governments abandon the ECB and euro, the ECB’s debt to the Fed debt is noncollectable. The Fed’s debt is only with the ECB and not the national governments.
  1. This gives the national governments a powerful incentive, and perhaps no other choice, but to abandon the euro should the payment system fail.
  1. It will also likely mean the national governments will technically default on their euro debt, as they convert the debt to a new currency (or currencies).

 
Their only hope is a large enough US fiscal package that restores demand for world output.

Like my proposed payroll tax holiday that immediately adds maybe 5% to US GDP.

But the odds of that are not promising.

And the US economy continues to weaken rapidly.

(I own some German credit default insurance and wish I had bought a lot more.)


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FT: Fed’s first foray into unsecured lending


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Fed’s first foray into unsecured loans.

As per my proposal over a year ago.

Fed’s first foray into unsecured lending

by Krishna Guha
Oct. 6- The Federal Reserve is working with the US Treasury on plans for a dramatic move into unsecured lending in the hope that this extreme step could help bring credit markets back to life.

As well as unsecured lending to banks, this could lead to the Fed directly purchasing commercial paper or funding a special purpose vehicle set up to do this.

Any unsecured lending would be a radical departure for the Fed. Central banks the world over almost never make unsecured loans, and the Fed has never done so in its history.

Wrong, the swap lines to foreign commercial banks seem to me to functionally unsecured lending.

The Fed has loaned over $400 billion on this basis to the ECB so far.

It would allow the Fed to address two key problems in the financial system directly: the freezing of the term interbank money market, which covers all but overnight borrowing, and the rapid contraction of the commercial paper market.

However, the US central bank does not believe it has the legal mandate to make unsecured loans on which there is a reasonable likelihood of some loss. So it needs the Treasury to guarantee losses on the loans, probably under new authorities granted by Congress last week with the passage of the $700bn (€518bn, £402bn) Paulson plan.

The Fed and Treasury are working together on how that might work but were not ready to announce it ­on Monday.

It is awkward for the Treasury to pivot to supporting a big unsecured lending programme when the core of its pitch to Congress was the plan to purchase troubled mortgage-related assets.

There remains some chance that the US authorities are not be able to reach agreement. But the urgency of the situation – and the fact that the Fed referred to unsecured lending in a press release on Monday – suggests that it will happen.

The core of the problem in the interbank market is the lack of availability of term unsecured loans. Banks can get some term funding, but only on a collateralised basis, which helps explain the extreme demand for Treasury securities used for collateral purposes. Unsecured borrowing rates for any significant period of time – such as the three-month Libor (London interbank offered rate) – are sky high. In practice, most financial institutions are now unable to get term loans without collateral, and are funding themselves heavily in the overnight market.

This reliance on overnight money is dangerous for the financial system. It makes banks vulnerable to short-term market dislocations or loss of confidence, increasing the likelihood of failures and firesales of assets.

There are two reasons why banks cannot obtain term unsecured loans from the private market. There is a classic financial-crisis co-ordination problem, characterised as: “I won’t lend you money for a month if I think that everyone else will only lend you money for a day, allowing them to pull out tomorrow and leave me stranded.” This “roll-over” risk is a form of liquidity risk. The second reason is the credit risk of lending to banks, which has been elevated by the financial and economic turmoil .

The Fed’s existing liquidity operations – ramped up again on Monday – reduce liquidity risk by providing a large backstop source of funds. But they are imperfect substitutes for unsecured borrowing, as they are only available on a secured basis. Unsecured term loans – for instance at 100 or 150 basis points over the federal funds rate for three-month money – would provide a near-perfect substitute.

The unsecured Fed term loan rate would act as a ceiling for Libor. Banks would be able to use these loans to reduce their reliance on overnight borrowing, making the system more stable.

Moreover, banks would in theory become more willing to lend spare funds to each other, reviving the private interbank market, since the borrower or lender could turn to the Fed for unsecured loans if it suddenly needed additional liquidity.

The Fed is also actively considering using unsecured lending to shore up the collapsing commercial paper market, in which many corporations as well as financial institutions raise funds.

The US central bank could either buy commercial paper (a form of unsecured debt), or support a special purpose vehicle that would buy this debt with a liquidity line from the Fed and credit support from Treasury.

Another option under consideration is for the Fed to loan money to money market mutual funds to finance their holdings of commercial paper. The Fed is exploring this, but most money funds are wary of leveraging up and worry that this could lead to investors remaining in a fund being exposed to increasing risk. That is why the authorities are having to explore the radical option of buying commercial paper themselves.


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Eurozone on the Brink


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Hi Joseph,

Agreed, and this attitude continues this morning, with comments like ‘Europe needs this slowdown to bring down inflation’ as their opinion leaders argue against a rate cut (not that a rate cut would actually help demand as they think it would, but that’s another story).

It seems they are actually welcoming this weakness, probably out of fear unemployment was getting far too low to ‘discipline’ the unions, as wage demands were anecdotally featured in the Eurozone news.

France’s proposal for a 300 billion euro wide fund to calm bank depositors was immediately shot down by Germany (not that it would have or could have been sufficient to stop a run on the banking system, but that too is another story).

It is also becoming more clear that effectively major euro lending institutions have found themselves massively ‘long’ euros and ‘short’ dollars. The Fed’s swap lines have grown to over $600 billion, mainly with the ECB. This means the ECB is borrowing USD from the Fed to lend to its banks. This represents the same kind of external debt that has brought down currencies since time began. Running up external debt to sustain your currency is highly unlikely to succeed.

Ultimately, their only exit is to sell euros and buy the USD needed to cover their net USD needs. The resulting fall in the currency can spiral into a serious run on the banking system. Unlike Americans who run to high quality securities in their local currency when they get scared, Europeans and their institutions tend to flee the currency itself.

While the national governments will attempt to contain any such run, they don’t have the capability, as they are all limited fiscally by both law and market forces, with the latter the far stronger force. Only the ECB can write the check of the size needed, no matter how large, but they are currently prohibited by treaty from making such a fiscal transfer.

I have serious doubts the Eurozone can get through this week without entering into a system wide banking crisis that will end with the payments system being closed down until it reopens with bank deposit insurance at the ‘federal level’- in this case from the ECB itself.

The Eurozone would have been ‘saved’ if the US has responded with a fiscal response in the range of 5% of GDP, and continued to increase imports and keep the world export industries alive.

But that didn’t happen, and, by design, that channel was cut off when Paulson, supported by Bernanke and Bush, managed to convince foreign central banks to stop accumulating USD reserves.

This both killed the goose laying the golden eggs for the US (imports are a real benefit and exports a real cost), as US exports have boomed and real terms of trade fell, and also triggered the looming collapse of the Eurozone as exports fell off and domestic demand remained weak.

Good morning!


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