Disaster Myopia, Normal Accidents, and the Euro Policy Elite

2012 has taken on a decidedly optimistic tone after an  inauspicious start.  Some people seem to think that things in the Eurozone are largely settled and done with and that we can begin moving on with our lives.   I am not one of those people.


As we stand today there are two possible outcomes for the EU. In the first scenario, a critical mass of member states enacts a sweeping range of thoughtful and clever reforms that allow them to transform themselves into sustainable economic systems, capable of  creating livelihoods for the majority of the population without placing untenable costs on society.  This will require convincing or forcing a large number of entrenched insiders - politicians, pensioners, workers in closed trades, criminals, subsidized farmers, and so on- to relinquish some or all of the benefits they have come to enjoy over many years to outsiders.  By outsiders, I mean largely mean people under 30.  And they must do so while not incurring adjustment costs so high as to break the fragile banking system and, by extension, the EU.  This doesn't mean simply firing people and exposing uncompetitive enterprises, public or private, to economic realities, it means having a significant number of people consent to their lives being drastically changed so that others might have the opportunity to live productive, dignified lives.


It is that, or the EU continues to slowly deteriorate until it won't, at which point policy makers will find the decisions being made for them.  It didn't always have to be this way.  But this is what the EU's assembled political apparatus has left us with.  In zen bhuddism, this is called 'small mind'.  In markets, we call this disaster myopia, or perhaps simply collective incompetence.

Repo & Euro Financials' Intermediation of Shadow Banking

Despite a less-worse Italian auction this morning, the Euro took a rather ominous swan dive this morning on the wholly unsurprising announcement that the ECB’s balance sheet has swelled to an all-time high of €2.73 trn.    With the market otherwise fairly dull (aside from the odd story about JPMoMo sticking it to some infants and widows with a BBG headline comparing the House of Dimon to the Wehrmacht) I figure I’d take the time to succinctly re-cap my views on Europe, which I briefly touched on in my post last week.

I’m not negative on LTRO per se.  I just think that the necessity of LTRO speaks volumes about the dire funding situation of Euro banks and to the inability of the EU as a federal body to summon the political will to act comprehensively and decisively.  As we lose count of the number of EU interventions lets not forget that this is a slow-rolling, snowballing crisis that has been mounting for more than a year, during the course of which the EU has lost its credibility as a crisis manager.  In LTRO we have yet another stop-gap, backdoor solution that barely responds to the immediate problems while leaving little possibility of further rapid expansion should the situation fail to improve on its own.  A significant improvement in the policy environment notwithstanding, I don’t feel that this is a particularly likely outcome. 

LTRO may look impressive at first glance.  However, with €291.6bn maturing from the ECB’s 7 day main repo operation (MRO) and €169bn of MRO financing rolled on 12/21 against a further €140.6bn of older LTRO maturing (with only €29.7bn rolled), the actual new credit extended is significantly less.  Net this refinancing against a slight increase in fixed-term deposits (€3.5bn) and €45.7 bn moved from October’s 12 mo. LTRO, the new 3-year LTRO adds only €206.5bn in new repo financing extended to financials.  It’s worth noting that this covers only about 60% of the approximately €350bn of sub/unsecured/and otherwise currently un-rollable debt maturing in the coming year.  

LTRO, Maasichism, and the Future of Europe in 2012

December has brought another acronym to the rescue kit of European policy makers in the form of the ECB’s Long Term Refinancing Operations (LTRO), the arrival of which has been heralded by at least some market observers with a sense of cautious optimism and hope.  So, with a full allotment of €489.2bn to 523 bidders, clocking in at the upper range of analyst expectations, where do we stand today as we look forward to 2012?    

In sum, it is my view that those looking for LTRO to accomplish what the summit of December 10^th did not are likely to be disappointed.  Before reviewing the specifics of LTRO and the extent to which it changes the situation of the European financial infrastructure, let’s briefly discuss the other avenues through which relief may or may not be possible:

While the headline €750bn figure highlighted by the Euristocrats in their presentation of the summit agreement is at first glance impressive the substance of the program is highly problematic.  What was needed was enough money to credibly demonstrate that Europe could buy itself the time necessary to make some very difficult decisions.  Having wasted earlier opportunities, the commitment required has likely grown after countless 'final solutions'.  A a number above €1trn (and probably closer to €2trn by some estimates) would perhaps have signaled that Europe has the intention and the ability to defend its financial system for at least the coming year.  In the end, a sizeable chunk of the committed capital would likely prove to be unnecessary but the important task of halting the reflexive self-fulfilling collapse of confidence would have been accomplished.  Instead, we have for the time being an amount unable to cover even a fraction of the sovereign issuance that is on the table for 2012.  Even had the financial commitment had been credibly adequate, the ultimate success of such a response remains contingent on timely, genuine structural reform of the European system.