Black Thursday

Today's mayhem was about one thing: Italian and Spanish debt. At one point in the day, as Italian bank stocks and bond yields {again} began tanking, the European Central Bank's {ECB} Chief Jean Claude Trichet, really wanted to intervene on Italy and Spain's behalf. But before he could act, he had to hold a meeting with the ECB's governing council and get their approval. It's here that something went wrong. Inside sources say that it was Germany's Central Bank {The Bundesbank} Chief Jens Weidmann who veto'd the proposal to aid Italy and Spain. The EFSF, which is a fund set up by Europe's leaders to deal with just such an emergency, has not been fully funded and has also not been approved to intervene in the secondary bond markets to help fellow EU members. The ECB actually did try and help Greece and Ireland today, but even then it was fairly meek-- and the problem was Italy anyways. It was this intervention in the secondary bond markets (as well as other markets) that needed a helping hand today. Neither the ECB or the EFSF was there when it was most needed. The markets, sensing blood, moved in for the kill. By late afternoon in Italy, the rout was so bad that the Italian stock market was shut down-- an act of true desperation. In short, Italy and Spain were essentially left outside with the wolves, who promptly torched them. Later in the afternoon, the Spanish government decided to announce that it was going to abandon a bond auction later this month due to market conditions... in the midst of a meltdown. This is rather like noticing that your roof is on fire and throwing a molotov coctail thru the kid's bedroom window.

In New York, the markets were spooked by this apparent abandonment. They realized how dangerous an Italian or Spanish full on meltdown could be... and the markets here then began a sell off. By day's end the Dow Jones had lost 512 points-- the biggest loss since the Lehman disaster. In after hours markets, there was a huge sell off of the Euro currency and purchasing of the Swiss Franc, which is {mistakenly} seen as a safe haven of sorts, as is the Japanese Yen. Today the Bank of Japan {BOJ}, in an attempt to stop people from swapping their Euros for Yen, began a very large (some estimates were $50 billion) intervention.. but the reversal engineered by the BOJ only lasted a few hours before the markets came right back to erase the BOJ's gains. 

Tomorrow will be a key day. If the ECB and/or EFSF {or someone else} don't step up and do something before the European markets open, there is a fair chance that all hell will break loose at the open. If this is the case, I look for The Fed to step in {in some fashion} to help calm the markets. I also believe that when push comes to shove, the ECB might also step in.. but only if there is a serious rout in progress. Make no mistake.. this is a dangerous moment.

Update Friday 430pm: Well the ECB finally caved this morning and reinstituted a Lehman era program called the SMP, which allows them to go into the secondary markets and purchase government bonds. This is essentially monetization of this debt, something that is specifically against the Maastricht Treaty. It also means that because of the size of the problem, the ECB, should these bonds go belly up, will need to find a way to balance the books.. and this will mean some substantial German contributions. Needless to say, Germany and Finland are far from thrilled with this. They gave no amount, essentially meaning that the ECB Council has pretty much endless authority. The ECB's intervention had the desired effect, and the markets went on to have a good day. It looks like the problem is solved-- for today anyways. I thought this last week, too.

Update Saturday Morning: ZH reporting that Germany might be backing out of any bailouts for Italy. If this turns out to be as bad as it sounds on the surface, EUtopia might be in some very serious trouble. Also, there appears to be a meeting of G7 finance ministers this weekend about coordinating central bank intervention. The ratings agency S&P also downgraded the United States-- for the first time in history. This will be another negative come Monday morning, but the downgrade was not totally unexpected. Looks like we're not out of the woods yet.