Running Out of Money
Research for Online Investors

6/22/12

The Leaders of France, Spain and Italy met this morning with Angela Merkel of Germany in Rome to forge an agreement before European leaders meet next week in Brussels.  The leaders endorsed the idea of a “Growth Package” of one-percent of eurozone GDP, without any explanation of how it would work.  Christine Lagarde, head of the IMF, attended a meeting of Eurozone Finance Ministers in Luxembourg yesterday.

Lagarde wants the European Central Bank (ECB) to cut interest rates and extend aid directly to banks rather than offering bailouts only through governments.  The IMF believes the eurozone should consider a banking union “as an immediate priority” while working for greater fiscal integration and issuing joint debt.

Spanish 10-year bond yields traded higher this morning at 6.66%.  The Spanish government received the requested independent bank audit.  Auditors reported the banks would need $78 billion dollars to protect them from financial shocks.  This was less than the $125 billion the eurozone was willing to loan the government to bail out their banks.  Spain is expected to request funds by Monday.

German bonds are falling in price as yields increase as the market prices in expectations the government will have to take on more debt to rescue Spanish banks.

Greece’s new government will be under the gun next week.  Inspectors from the “troika” of the European Commission, ECB and IMF will be in Athens on Monday to inspect the government’s books and progress on austerity promises made by the previous government.  The Greek Treasury will need an infusion of cash by mid-July.  The next trache of bailout funds is approximately $1.9 billion.  We expect negotiations on timelines and severity of cuts to be made by Greece.  This can’t go well.

Mario Monti of Italy has been very vocal about the eurozone buying sovereign debt either through the EFSF or the ECB.  He believes they could suppress the rise in interest rates so Italy and Spain could avoid requesting a bailout.  The problem is the size of the problem.  Gavyn Davis writes in the Financial Times that the EFSF (and ESM once it is authorized) only have $625 billion dollars available to rescue troubled economies.

Davis believes it could take as much as $2 trillion dollars to rescue Spain and Italy.  Germany is unwilling to increase the ESM which means the ECB would have to print euros to buy sovereign debt at issue or in the secondary market.  Germany is against the ECB engaging in quantitative easing.  Gavyn Davis paints a bleak picture as he reviews the credit that may be required in the near future.

The ECB announced an easing of collateral requirements this morning.  The ECB will now loan money against auto loans, mortgage backed securities and other Asset Backed Securities (ABS).  The ECB also lowered the credit rating on securities available for collateralization.   You can read the ECB press release.

It appears to us the eurozone is running out of money.  There are a multitude of liabilities to cover and limited credit to pay the piper.  Germany understands this, the others do not.  We agree that growth can help budgets improve, but inflation covers up all the mistakes.  Eventually, the ECB will be forced to create euros as borrowing is not affordable if available.

The market is struggling to hold onto gains this morning after a washout yesterday.  We have plenty of game-changing meetings next week.  It is tempting to go into those short as the likelihood of any meaningful action will be minimal, we think the better play is to exit shorts if you are a trader and start anew next week.  Headline risk over the weekend would favor good news.

Quote:
Power tends to corrupt, and absolute power corrupts absolutely.—Lord Action

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