Sunday, June 19, 2011

EU Interbank Lending

"The Depression may have started with a stock market crash, but what hit the general economy was a disruption of credit. Credit availability has the ability to build a modern economy. But lack of credit has the ability to destroy a modern economy-- swiftly and absolutely. The inability to stock store shelves, buy spare parts and seed for farms, purchase houses and nearly everything else is what made the Depression so awful for the people of this country. If you do not act boldly and swiftly, we will replay the Depression of the 1930's.. only this time, it will be far, far worse. If you don't do this, you won't have an economy on Monday" Ben Bernanke, September 18th 2008.

What Bernanke was so terrified of was the freezing of the credit markets; the inability of everyday businesses to access the credit needed to continue their daily operations. At the very heart of the credit markets is inter-bank lending, which is where banks loan to each other for short periods of time. This inter-bank lending is measured by a few different measurements; the most widely known of these is the LIBOR (London Inter Bank Offer Rate), which is the interest rate banks are charging to one another. Another one that I don't have a terrific understanding of is the OIS spread. During the crisis of 2008, banks became very nervous about unsecured loans to each other (and to anyone else) because they were afraid they'd be lending to a failing institution. In short, it's a matter of confidence. When there is some sort of scare, the LIBOR rate soars and banks essentially stop lending. There hundreds of measurements of the economy: GDP numbers, the Stock Market performance, Bond markets, inflation reports, unemployment reports, and on and on. By leaps and bounds, the one measurement that has the ability to terrify entire nations and governments more than any other is the interbank lending measurements.

Last Friday the OIS spread, one of the interbank lending measurments, began spiking. Also China's interbank lending measurement, called the SHIBOR, began spiking. Today, an article in the UK's Guardian newspaper shed light on the pulling back of some of Britain's banks from lending to other EU banks: "Senior sources have revealed that leading banks, including Barclays and Standard Chartered, have radically reduced the amount of unsecured lending they are prepared to make available to eurozone banks, raising the prospect of a new credit crunch for the European banking system. Standard Chartered is understood to have withdrawn tens of billions of pounds from the eurozone inter-bank lending market in recent months and cut its overall exposure by two-thirds in the past few weeks as it has become increasingly worried about the finances of other European banks. Barclays has also cut its exposure in recent months as senior managers have become increasingly concerned about developments among banks with large exposures to the troubled European countries Greece, Ireland, Spain, Italy and Portugal"

There are few things scarier than this for us econo-nerds. While this is not on a grand scale as yet, this is how the 2008 Meltdown began in earnest and forced Bernanke to give the above speech to a group of US Congressional leaders as he pleaded with them for the $700 billion TARP bill. 

All of this is coming about because of the mess in Greece. After hours Friday began well enough: there appeared to be an agreement between the ECB, France and Germany on the outline of a new bailout plan. The IMF also agreed to cough up a $12 billion loan to Greece, despite their political mess and resistance to more austerity measures. The agreed upon plan was a victory for the ECB and France, who were against any sort of restructuring.

But today came an article from Der Spiegel which refutes this agreement. "It's no longer on the table". Germany wants private creditors to take a haircut; the French and ECB are worried (especially the ECB, which has vast exposure to Greek debt) that any such forced haircut would be seen as a form of default. Any form of default may have the ability to actually make the ECB itself insolvent. The German public, who are sick of endless bailouts of nations who lost control of their own finances, have handed Chancellor Merkel several defeats in recent small elections. In particular the retirement age of Greek civil servants is 50 years old, whereas in Germany it's 64. This has yet to change, and the Germans are (not unreasonably) upset at having to (again) bail out a nation where this overgenerous retirement plan exists. 

Later in the day came this: "European governments weighed withholding half of Greece’s next 12 billion-euro ($17.2 billion) aid payment, seeking to keep the country solvent while maintaining pressure on the government to slash the debt that pitched the euro area into crisis. Euro-area finance ministers may authorize only a 6 billion- euro loan to tide Greece through bond redemptions in July, while further aid hinges on Greek budget cuts, Belgian Finance Minister Didier Reynders said"

In short, this Friday's calming news was blown up even before the markets have opened in Asia. This is not how to calm credit markets. The Eurocrats are like the gang that can't shoot straight. While I don't think it's a serious matter as yet, continued inaction and indecision will weigh on market confidence. As we speak the Greek government is debating a vote of confidence on PM Papandreou's government; the vote is expected next Tuesday nite. Should he fail, the markets will certainly react badly. These politicians are playing hot potato with a hand grenade here and need to come up with a solid and plausible plan for Greece. In the end, I actually believe they'll get a deal done and Greece's indentured servitude will be extended again, but as each day passes I get more scared that their dithering and confusion will blow up in their faces.