Belmont Club


The New York Times reported yesterday that non-continental banks were preparing ‘contingency plans’ for the breakup of the Euro.

Banks including Merrill Lynch, Barclays Capital and Nomura issued a cascade of reports this week examining the likelihood of a breakup of the euro zone. … Major British financial institutions, like the Royal Bank of Scotland, are drawing up contingency plans in case the unthinkable veers toward reality, bank supervisors said Thursday. United States regulators have been pushing American banks like Citigroup and others to reduce their exposure to the euro zone. In Asia, authorities in Hong Kong have stepped up their monitoring of the international exposure of foreign and local banks in light of the European crisis.

But banks in big euro zone countries that have only recently been infected by the crisis do not seem to be nearly as flustered. Banks in France and Italy in particular are not creating backup plans, bankers say, for the simple reason that they have concluded it is impossible for the euro to break up.

Yet that impossible event loomed ever larger as a certainty in most banker’s minds. Therefore the Europeans, while denying the possibility of a Euro breakup were working frantically behind the scenes to prepare for it.

Peter Taberner at New Europe says US financial authorities are examining ways to help the stricken continent, probably knowing that the “impossible” was more than likely. The options being considered ran the gamut from the liberal Brookings proposal to lend to ECB and push China into let the EU sell more to it to Manhattan Institute’s suggestion that the US should cut its own debt to avoid falling into the same hole that swallowed Brussels.

Domineco Lombardi, a senior fellow of global economy and development at Brooking’s Institute, believes that there are a number of measures that are in process and directions that could be implemented to confront the situation.

“The Federal Reserve has already been lending to the ECB so as to ease pressures from those euro area banks unable to access the USD inter bank market and to facilitate the settling of US dollar obligations from those banks. The United States can facilitate a stronger financial position of the IMF which the international community could leverage on as soon as the Europeans finalise a ‘fundable’ strategy.”

He added: “Finally, the US should try to push China on the current account rebalancing agenda so as to compensate the loss of net exports to Europe with increased exports to China. Yet, based on how the latest G-20 summit in Cannes went, it seems unlikely. The problem remains that the US economy is exposed to a systemic crisis from the euro area.”

Alternatively, conservative think tank the Manhattan Institute took a more rigid view of the US’ finances, pointing to the unsustainability of borrowing 40 cents in every dollar that the federal government spends.

“If we are to protect ourselves from the situation in Europe and to avoid a similar scenario to them then we must look at the large entitlement programmes like health care that President Obama has tried to bring in, but with an election next year I cannot see any proposals put forward that could be a solution,” said Furchtgott-Roth, a senior fellow at the institute.

Quite naturally, it was the liberal view that prevailed. The Wall Street Journal reports that the Fed has established a facility to ensure that selected central banks have access to dollars to prevent short-term illiquidity. “The European Central Bank borrowed another batch of dollars from the Federal Reserve during the week ended Nov. 23, the New York Fed reported Friday.” So far the amounts drawn have been relatively small; but an uptick in amounts flowing through the facility would indicate that serious trouble was at hand.

The Fed established currency swap lines to ensure the Bank of Canada, Bank of England, Bank of Japan, European Central Bank and the Swiss National Bank have access to dollar liquidity. Sovereign debt problems prompted the creation of this program as fears rose about European banks’ ability to access short-term funding.

At the height of the 2008 financial crisis, these central bank borrowings totaled hundreds of billions of dollars through this facility as financial institutions scrambled for dollar-funding.

The facility was reintroduced in May 2010, but was little used before euro-zone fears perked up again this summer. Many market participants look to the program as a barometer of broader financial stress, and if borrowings were to shoot substantially higher, it would be a signal of trouble.

If nothing else the application of a financial transfusion provided vital data on whether the patient was taking a turn for the worse. Bloomberg says that “the premium European banks pay to borrow in dollars through the swaps market is at the highest since the collapse of Lehman Brothers Inc. in 2008”.

It’s a measure of the “true euro-zone liquidity crunch,” said Conor Howell, head of ETF trading at Christopher Street Capital in London. “It’s hardly a positive that it has reached -150 basis points.”

But the Fed could hardly be counted on to do it alone. Therefore the Europeans, despite their denials that Enemy was at the Gates could be observed digging trenches everywhere and dragging streetcars across the major avenues to stop the attack that officials confidently say will never come.

In response to the liquidity crisis the ECB is considering extending 2 or even 3 year financing to European banks “to try to prevent the euro zone crisis precipitating a credit crunch that chokes the bloc’s economy,” according to a Reuters source. The article went on to say the loan facility was being considered as an alternative to intervening in the bond market.

To date, the longest term it has offered funds is one year.

As the sovereign debt crisis has worsened, the ECB has been coming under increasing pressure to intervene on a larger scale by buying state bonds but is reluctant to make such a commitment.

It does, however, have the freedom to lend banks trillions of euros and could use this firepower to indirectly support governments trying to issue debt.

The ECB has flagged the possibility of longer-term loans to banks, sources familiar with the matter told Reuters, in a move that could be aimed at gauging their interest ahead of a launch.

The possibility of lending over a longer time horizon was raised at a meeting last week between the ECB and a group of banks including Goldman Sachs, Barclays Capital and Morgan Stanley, according to one person familiar with the matter….

There has, however, only been lukewarm interest, suggesting that more ECB cash may not be the answer to a creeping credit freeze.

Why lukewarm? Part of the banker’s reluctance may come from the realization that taking on the loans might amount to their ‘nationalization’ by the ECB, until such time as the shareholders could pay the loans back, a process painfully illustrated by Northern Rock.

A sovereign default would not only trash the asset portfolios of the banks but force them into nationalization to pay for the liquidity crisis to boot. Of course over the course of the settlement, the banksters might convince the financial authorities to let them keep the “good bank” while the bad loans are sucked up by the government, i.e. passed on to the taxpayer. In every bailout involving socialized losses and privatized gains it is  always the taxpayer who winds up holding the bag.

And what a bag it is! As the financial cherry bomb’s fuse burns down to its last inches there is an increasing scramble to pass the smoldering infernal machine around. The game is now to frantically hand the hissing explosive around in the hopes that when it finally blows it will be far enough to result only in the loss of a financial limb or two instead of total destruction. That is what ‘contingency’ planning may mean; that is all the banks are now hoping for; to survive no matter how, no matter who else gets it.

Fearless forecast: the taxpayer will “get it”.  Like the Red Shirts in a Star Trek away expedition, doom is the taxpayer’s role in life.

Storming the Castle at Amazon Kindle for $3.99
No Way In at Amazon Kindle $3.99, print $9.99
Tip Jar or Subscribe for $5