Nov 20, 2011 7:34 AM GMT
Things are about to get a lot worse before they get better. France's banks are all effectively insolvent, and now bond investors are waiting to see if Spain and Italy are spiraling the drain. This is not a good time to be holding Euros. Investors further don't trust the politicians who have overspent, and underdelivered. At some point I think those who have a large affinity to government in the US will need to consider what lessons can be learned in Europe.
Europe Fears a Credit Squeeze as Investors Sell Bond Holdings
Financial institutions are dumping their vast holdings of European government debt and spurning new bond issues by countries like Spain and Italy. And many have decided not to renew short-term loans to European banks, which are needed to finance day-to-day operations.
If this trend continues, it risks creating a vicious cycle of rising borrowing costs, deeper spending cuts and slowing growth, which is hard to get out of, especially as some European banks are having trouble meeting their financing needs.
“It’s a pretty terrible spiral,” said Peter R. Fisher, head of fixed income at the asset manager BlackRock and a former senior Treasury official in the George W. Bush administration.
The pullback — which is increasing almost daily — is driven by worries that some European countries may not be able to fully repay their bond borrowings, which in turn would damage banks that own large amounts of those bonds. It also increases the already rising pressure on the European Central Bank to take more aggressive action.
On Friday, the bank’s new president, Mario Draghi, put the onus on European leaders to deploy the long-awaited euro zone bailout fund to resolve the crisis, implicitly rejecting calls for the European Central Bank to step up and become the region’s “lender of last resort.”
The flight from European sovereign debt and banks has spanned the globe. European institutions like the Royal Bank of Scotland and pension funds in the Netherlands have been heavy sellers in recent days. And earlier this month, Kokusai Asset Management in Japan unloaded nearly $1 billion in Italian debt.
The Euro Zone's Deadly Domino Effect
Back in March, European leaders promised that all investments in Greek government bonds would be guaranteed until 2013. But, in July, they went ahead and negotiated the involvement of private investors in a Greek debt restructuring. The economic situation in the country had worsened, and the political mood in Germany had shifted. At the time, the European Central Bank (ECB) urged caution. It argued that once you go down that road, you make investors nervous. As a compromise, euro-zone leaders agreed on the following formula: The terms of the participation of private investors in a so-called debt "haircut" would not be renegotiated, and it would certainly not be extended to other states.
In the following weeks, exactly what the ECB had feared happened. The interest rates on 10-year Italian bonds rose to 5 percent. And there was worse to come. In July, European leaders broke their promises from March. In October, they broke their promises from July. The participation of private investors would now be much higher, they decided.
Following that summit, investors came to the logical conclusion that politicians have basically been lying at euro summits. They surmised that, if the economic situation in Greece and the political mood in Germany changed, then the owners of Portuguese and Italian sovereign bonds would also be asked to contribute. In the meantime, even normal individuals are now withdrawing their savings from banks across southern Europe.