The credit markets are worsening again
It is getting worse again, on all fronts. We reported on Friday morning that the money market indicators that had improved in the immediate aftermath of the rescue packaged, started to worsen again Wednesday and Thursday. The trend continued and accelerated on Friday. Calculated Risk has all the details from the US: TED spread up from 2.58% to 2.7%, 3-month Treasury yield down from 0.94 to 0.8%. Overnight Libor was up too, and the two year swap spread is also up. In Europe, the snail’s pace improvement in the 3-m Euribor continued. On Friday it was 4.918%.
But the really bad news comes from the credit markets, where the cost of insurance against default is now unbelievably high. The European itraxx hit 900bp, which is a dramatic 100bp deterioration from the day before. This means, that it costs €900,000 a year to insure a portfolio of €10m in junk bonds. Risk aversion has historically never been as high.
Loan guarantees crowd out private credit market
The FT perhaps provides an answer why risk aversion should rise when government guarantee all bank debt. In October, for example, there has been no issuance of bonds backed by credit card loans in the US or in Europe, a class of asset-backed securities that continued to perform well during the crisis. The article quotes a banker as saying that it is now more attractive to raise funds through guaranteed paper, rather than through the asset-backed markets. So what we are seeing here is a classic crowding out effect.
Some evidence on the US and UK recapitalisation packages
There is more on the same theme on Vox this morning, where Viral Acharya and Raghu Sundaram, two finance professors from New York, evaluate the UK andf US rescue packages’ loan guarantees. The UK scheme has the flavour of a small tax, and is partly market-reliant; the US plan the flavour of a $50 billion subsidy, and is almost fully government-reliant. The UK scheme is likely to lead to a separating equilibrium, in which banks whose credit risk is lower than the market’s perceptions opt out. The US scheme will force a pooling outcome wherein all eligible banks – regardless of their health – participate because it is not possible to re-enter later. Which scheme works better depends upon the depth of the coming recession. The UK scheme assumes that following the recent capital infusions, even the unhealthy players are now solvent and are unlikely to fail. If the financial crisis worsens, this may prove incorrect.
Germany between complacency and panic
The German government discovered that its populist imposition of a €500K ceiling on salaries for bailed-out banks has produced a massive disincentive for private banks to step forward. Instead, it is perfectly rational for the board of a privately owned bank to decide that the proper way to deal with its balance sheet problems is to reduce credit to companies. Frankfurter Allgemeine reports that finance minister Peer Steinbruck – who spontaneously introduced the cap in a fit of populism – now accuses the banks of behaving irresponsibly. The German government got alarmed when Deutsche Bank last week categorically denied that it needed any government help. There is a growing sense among economists that the voluntary nature of the package was wrong. Ifo chief Hans-Werner Sinn is quoted as saying that banks should either get the money from the private sector, or else face obligatory government intervention.
In a comment, the paper suggested that Steinbruck should impose conditions on WestLB, another Landesbank that has applied for aid. In the past, the Federal government was not in a position to force merger, as those Landesbanken, are directly and indirectly owned by states and municipalities. But he can use the aid as a lever to force change.
Lots of IMF bailouts this weekend – Hundary, Ukraine and DSK
The IMF bailed out a few countries this weekend, in addition to its MD who was found not guilty of abusing his office in the aftermath of a much reported affair. After Iceland, the IMF has now advance emergency loans to Hungary and to the Ukraine. The IMF is also talking to Pakistan. As far as Strauss-Kahn is concerned, the matter now appears to be closed.
Now comes the employment rescue package
After a bank and a business rescue package Sarkozy is to announce tomorrow an employment rescue package. Trade unions, arguing that their employees are the great losers from the financial crisis, are expecting a strong gesture from the government otherwise they will bring their anger to the streets, reports Les Echos. But the government has a bigger concern that is of rising unemployment. The measures that surfaced so far focus on the support for the transition between jobs.
The horrible economics of Sarkozy
Christophe Jacubyszyn in Le Monde has a look at Sarkozy’s economic policy and argues that while his speech last week about the ‘return of the state’ was “truly socialist”, his actions are not. In his bank rescue package the state refrained from any influence in the bank management for recapitalisation and from regulating further management salaries or golden parachutes. The course of economic policy however will certainly change. Together with the new measures on employment to be announced this week, Sarkozy promised a total of €650bn as relaunch package for the economy. Even if many of the initiatives are associated with private investments, it is clear that the state will need additional finance, even if only to serve interest on the additional debt. The strategic wealth fund, praised by Sarkozy to invest only in business with future, will be prone to political pressure to bail out failing industry. Sarkozy, liberal or interventionist, does he know where his initiatives lead him to?
Munchau on Sarkozy
Wolfgang Munchau says in his FT column that Sarkozy’s wish to remain president of the eurozone for another year, while the Czechs and the Swedes hold the EU presidency, may be another sign of grandstanding, but also an opportunity. There are six reasons he can think of why this attempt to force a system of political governance for the euro area might actually work. First, the need for a stimulus will become apparent soon, second, the money market still needs to fixed, and this can only happened at euro area level, third, the bank recapitalisation scheme are not working as well as they should, forth, the eurogroup has been disaster, fifth, Germany is losing support among other euro area members, and sixth, the uncertainty of Lisbon necessitates some workable crisis resolution system. Merkel will now try to break Sarkozy. But she won’t be able to stop him.
Schwarzer on Sarkozy
Daniela Schwarzer, writing in Eurozone Watch, makes the point that the financial crisis has handed Sarkozy a unique opportunity to press ahead with his euro area governance agenda, but he should not overdo it, and not overload it. She cites the passage in his EP speech last week, when he raised the idea of a sovereign wealth fund to invest in strategic industry, which was immediately sized on by the German press and German politicians as an opportunity to denounce French interventionism.
AFOE on Sarkozy
Writing on the same theme, Alex Harrowell of A Fistful of Euros looks at the transformation of Sarkozy from a year ago. He argues that the Sarkozy presidency has reverted “to its default settings”. The crisis has given him a new lease of life, just as happened to Gordon Brown. Nobody is talking about the 35-hour week any longer. “Instead, Sarko has found his inner Gaullist.” The blog also makes the point that Sarko’s proposed sovereign wealth fund was mainly support to invest into SMEs.
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