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Sunday, July 22

22nd Jul - Weekender: Euro Crisis

Spain is broke. ECB suggested that bank bond holders could be burned. This translates to either negotiation tactics (do as we say or prepare to die) or possibly means what it says. In that case any bailout measures will not save everyone and everything – and this is making markets nervous, as it is unclear what will be saved in the end. Also, if a really lousy bank is burned in the process and some others get in trouble because of this, who will foot the bill for these additional rescues? Not Spain, because Spain is broke.

1) Spain 10y, last five years
Spain’s regions are now already applying for bailouts, and markets were definitely not happy with the Eurogroup’s Memorandum of Understanding that was published on Friday. At the same time riots and demonstrations against austerity, real economy tanking deeper than officially expected, bond auctions went badly, govvie yields increasing and shorter maturities increasing even faster (yield curve inversion is always a sign of very, very bad things ahead). What worries me are the non-performing loans of the Spanish banks – the total number increases each month at a linear rate. This implies the data is fabricated, and there are a lot of losses that the banks are simply hiding. If the banks are doing it, everyone else, from regions to central government, are also doing it. Did I already say Spain is broke?

2) Spain 10y, last three months
ECB’s Draghi said in an interview that the bank could do more if it were given the powers to do it. This is easy to translate: the euro crisis is moving beyond the capacities of the existing defense mechanisms and new ones are needed. The only thing left in the toolbox is for the ECB to start quantitative easing, i.e. buy massive amounts of periphery bonds, with stated intention to hold them for a very long time – and even be prepared to take losses and print the losses.

ECB also states Greek government bonds are not good collateral anymore, and this leaves Greece with only ELA financing. This is blackmail (do the cuts and reforms you have agreed to do, or the flows stop), and the Greece and the Troika are now back to a game of chicken. Just when I was finishing this, Mish noticed that IMF is supposedly saying they will stop funding Greece. Italy is also moving very much into focus, and it is a good candidate for euro exit politically as well. 

3) Spain 10y vs 2y, last twelve months
And now a word on the charts. 1) The ten-year Spanish bond yield clearly shows the two spikes (last summer, followed by ECB's bond purchases and last Christmas, followed by ECB's 3-year LTRO). This is the third one. Nothing but ECB can solve this any longer. 2) The same bond yield a little bit closer, and I believe the range breakout is clearly visible. To be honest I was not expecting this yet. 3) The relative performance of the Spanish two-year bond yield versus the ten-year yield. Right after the euphoria of the last LTRO in March, the short end started increasing and has outpaced the longer end. That is even worse than just increasing yields. The curve flattening means banks that took LTRO loans are struggling with losses, while the risks (default, renomination etc.) are seen happening soon rather than later.

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GENERAL
Euro exit and depreciation would bring economic gainsThe Telegraph
In an exclusive extract from his updated book, Roger Bootle explains why allowing a country such as Greece to leave the euro is not as hard as critics think.

Disunited states of EuropeThe Economist
As the euro zone struggles to pull together, Britain is trying to pull away

IMF loses all faith in the euro projectThe Telegraph
The IMF is the leader of the Eurosceptic camp now.

The Lion in the GrassJohn Mauldin / The Big Picture
Topics: Europe and Japan. Very good

Finland will not hang itself to the euro at any cost…”alphaville / FT
JP Morgan: In this narrow sense, there is a first mover advantage for a core country exiting.

A summer lull?MacroScope / Reuters
The ECB may cut interest rates further but it seems very reluctant to create more money or buy government bonds unless the euro zone crisis needle hits critical again, although if we do get a summer onslaught from the markets, it remains pretty much the only game in town, given the euro zone’s ESM rescue fund won’t be operational before September .

Should the eurozone be mutualised?bruegel
Investors worldwide need to know what is the safe euro asset. For America they know what it is—the Treasury bond—and they are stockpiling it in spite of their doubts about the soundness of American public finances. For the euro zone they thought they knew what it was—all euro-zone government bonds—until they paid a price for this wrong belief.

Bank bondholders: Burning sensationThe Economist
Taxpayers should not pay for bank failures. So creditors must

Back to the brinkFree exchange / The Economist
But while they resist the policies that could make a real difference in solving the problem—real sovereign risk-sharing, real euro-zone-wide bank guarantees backed by the ECB, and higher inflation in Germany—each new intervention will buy a bit less time. And the capital flight from the periphery will continue and peripheral recessions will deepen. And then, one day, it may all come apart in a flash.

Gallo Says Spain and Italy are Still `Very Vulnerable' (Audio)BB (mp3)

ECB
Interview Mario Draghi: Interview with Le MondeECB
“We stand ready to do more, if our powers were to be strengthened.”

Short-term crisis management and long-term vision: how Europe responds to the crisisECB
Speech Benoît Cœuré, presentation slides here

SPAIN
Death Spiral in Spain; Six Spanish Regions Seek Aid; Bankrupt Spain to Bail out Bankrupt RegionsMish’s (see also Reuters and BB)
There are 17 Autonomous communities of Spain of which at least six have applied for or are expected to apply for aid. Eventually most, if not all of those regions will request aid. Spain itself needs a bailout (which it still denies but the market is going to force any time now). The plan in place now is for the bankrupt to bail out the bankrupt.

Market Response To Schrodinger SpainZH
Eurogroup statement text and market reaction charts

'Black Friday' Blame-Game Escalates As Spain Is Out Of Money In 40 DaysZH
"the money will last [only] until September", and "Spain has no 'Plan B".

Spanish yield curve flattens, along with Europe’s fortunesMacroScope / Reuters
The more pressure you put on the front end … it is saying that the near-term risk of default is going up through the roof. It’s exactly the dynamic you saw in all of the other curves before they went into a bailout. You actually saw things like the Greek curve invert.

How Spain went from quiet to crisis in two daysWonkblog / WP
Recession to continue, regions asking for help, and accepted bailout package too little, too late.

Spain's 5-year spread outpacing the 10-yearSober Look
not only have the chances of Spain's failure gone up but also the time to default has been shortened.

Demand for Spanish Bonds Collapses; "No Money Left to Pay Services" says Treasury Minister; Massive Protests Over Austerity; Two-Year Yield soars 60 Basis PointsMish’s
At some point, however (and this could be it), Spain is going to hike the VAT one time too many. At that juncture, the willingness of Spanish voters to stay on the euro will fly right out the window.

Prepare for Spanish Implosion: Businesses Threaten to Leave Spain Over Tax Hikes; Finance Minister Proposes 56% Tax on Short-Term Financial TransactionsMish’s
In short, Spain is resisting the measures that would be productive, and implementing those measures that will do the most harm.

Desperate for more ECB funding and running out of collateral, Spain is creating a new type of covered bondsSober Look
With these new bonds in place the central bank lending will increase further. Over time the nation's whole economy will in effect be funded by the central bank and any private credit that can be packaged into covered bonds will be pledged as collateral.

Four More Spanish Regions Seek Bailout; German Nürburgring Faces BankruptcyZH
Castilla-La-Mancha, Murcia, the Canary Islands and possibly Andalusia are also having difficulty funding themselves and some of these regions are studying plans to tap the recently created emergency-loan fund that Valencia said it would use

Monthly Economist ReportMinistry of Economy and Competitiveness (pdf)

OTHER PIIGS
Fears over Sicily's future as euro flow stops and bankruptcy loomsThe Guardian
A bleak combination of routine corruption, misused funds and mafia influence is taking the beautiful, troubled island to the brink of the abyss

Expect Strikes and Protests to Spread to Italy; Another Look at Why Italy Will Exit the Eurozone Before SpainMish’s
Every day that passes, the more strength the Five-Star Movement will gain. The irony is that it would be in the best interest of the eurocrats to hold elections now rather than later, before the anti-euro movement becomes politically unstoppable.

Collateral eligibility of bonds issued or guaranteed by the Greek governmentECB

ECB Says Greek Bonds No Longer Eligible As Collateral, Leaves Greece With Under €65bn Of ELA Borrowing CapacityZH

IMF Seeks to Halt Aid to Greece, Bankruptcy Pending; Dominoes Will Fall Mish’s
According to Der Spiegel, the IMF Wants to Stop Aid to Greece as soon as the ESM is up and running in September. At that time Greece would become bankrupt.

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