What’s the Story? Eurotrashed

by CC May 30, 2012 8:50 am • Commentary


European markets pared some losses but remained broadly lower as Spain’s banking crisis intensified. The Stoxx Europe 600 index was down 0.6%, but had been down 1.5% earlier in the session.

Spanish banks are seeing an erosion in a primary source of cheap funding: deposits.

Retail and corporate deposits in Spanish banks fell €31.44 billion ($39.31 billion) to €1.624 trillion, their lowest since the euro-zone debt crisis began in earnest, according to data published by the European Central Bank.

Separately, the ECB said it would oppose an attempt by Spain to use the central bank’s lending facilities to fund the €19 billion recapitalization of troubled bank Bankia. Spain then clarified its Bankia bailout plan by saying it would raise the funds through an auction of treasury bonds.

In other developments, Egan-Jones Ratings’ downgrade of Spain’s credit rating further into junk territory after European markets had closed Tuesday helped send yields on 10-year Spanish bonds to their highest level for the year. In addition, data showed that business confidence in euro zone fell more than expected in April.

Asian markets softened as hopes faded that China would launch aggressive stimulus measures. China’s Shanghai Composite lost 0.2% and Japan’s Nikkei Stock Average gave up 0.3%.

Worries about Europe spilled into the crude-oil market, as futures dropped 1.3% to $89.54 a barrel. Meanwhile, gold futures gained 0.5% to $1,555.80 an ounce. The U.S. dollar rose against the euro but declined against the yen.


The European Commission advocated direct aid from a euro zone rescue fund to recapitalize distressed banks in a move that could eventually help Spain, the latest front in Europe’s debt wars, overcome a worsening banking crisis.

Spanish government borrowing costs earlier lurched higher and the Madrid stock market hit a nine-year low on Wednesday as investors rattled by fears about its financial sector fled to the relative haven of German bonds.

In a major economic policy document, the Commission said the vicious circle of weak banks and heavily indebted states lending to each other must be broken. While the Commission is responsible for proposing laws, it is the member states, most notably Germany and France, that decide whether or not to implement those proposals.

Commission President Jose Manuel Barroso told a news conference that tighter euro zone integration could include a banking union, a joint bank deposit guarantee scheme and euro area financial supervision, saying the mood had changed since member states only months ago unanimously rejected a joint deposit guarantee fund.

“In the same vein, to sever the link between banks and the sovereigns, direct recapitalization by the ESM (European Stability Mechanism) might be envisaged,” the report said.


Research In Motion – The BlackBerry maker expects to report an operating loss for the current quarter and that it foresees significant layoffs. RIM has also hired JPMorgan Chaseand RBC Capital to help it evaluate strategic options.

Facebook – Facebook has received a second request for information on its proposed acquisition of photo-sharing service Instagram, meaning that a review of the purchase by antitrust regulators may be lengthy.

Nokia – Mobile Network Group managing director Paul Ansellem predicts Facebook will buy Nokia for $10 billion within 18 months, as it moves towards marketing its own smartphone. The prediction comes in a ComputerWorld article.

LinkedIn – The stock has been upgraded to “buy” at Citi, with a $125 price target. Analyst Mark Mahaney says a recent 20 percent pullback presents a buying opportunity, with the company demonstrating strong execution and customers indicating an increased amount of satisfaction with LinkedIn’s networking services.

The Fresh Market – The upscale grocer reported first-quarter profit of $0.40 per share, four cents above estimates, with sales also topping consensus. Same-store sales rose 8.2 percent compared to the year earlier quarter.

Salesforce.com  – The company is reportedly close to a deal to acquire Buddy Media for more than $800 million, according to AllThingsD. Buddy Media helps brands manage their Facebook presence.

Groupon – The daily deals provider is acquiring Breadcrumb, a maker of point-of-sale software for the hospitality industry. Terms of the deal were not disclosed.

Pep Boys – The sale of the auto-parts chain to private-equity firm Gores Group has been canceled, with Pep Boys receiving about $50 million in termination fees as a result. Gores had agreed to buy Pep Boys in January for $791 million, but later sought to delay the deal after Pep Boys reported just a slightly better than breakeven quarter.

Sallie Mae – The company has added about $400 million to a stock buyback program originally announced by the student lender in January, bring the total to $900 million.

Wynn Resorts  – The hotel and casino operator’s stock has been upgraded to “buy” from “neutral” at Goldman Sachs, with a price target of $136. Goldman says the current stock price reflects most of the risks the company faces, but not the potential upside.

Angie’s List – Bank of America/Merrill Lynch has upgraded the stock to “buy” from “neutral.” Angie’s List is a collector of local reviews about various service professionals.

Finish Line – The footwear retailer has raised its current quarter profit forecast, thanks to better-than-expected sales. It’s now predicting an 8.5 percent increase in same-store sales, and earnings of $0.22 to $0.23 per share, compared to a prior prediction of a mid-single-digits increase in sales and earnings of $0.21 per share. Current analyst estimates for the fiscal first quarter are at $0.22.

Baseline Scenario

Some European politicians are now telling us that an orderly exit for Greece is feasible under current conditions, and Greece will be the only nation that leaves.  They are wrong.  Greece’s exit is simply another step in a chain of events that leads towards a chaotic dissolution of the euro zone.

During the next stage of the crisis, Europe’s electorate will be rudely awakened to the large financial risks which have been foisted upon them in failed attempts to keep the single currency alive.  If Greece quits the euro later this year, its government will default on approximately 300 billion euros of external public debt, including roughly 187 billion euros owed to the IMF and European Financial Stability Facility (EFSF).

More importantly and currently less obvious to German taxpayers, Greece will likely default on 155 billion euros directly owed to the euro system (comprised of the ECB and the 17 national central banks in the euro zone).  This includes 110 billion euros provided automatically to Greece through the Target2 payments system – which handles settlements between central banks for countries using the euro.   As depositors and lenders flee Greek banks, someone needs to finance that capital flight, otherwise Greek banks would fail.  This role is taken on by other euro area central banks, which have quietly leant large funds, with the balances reported in the Target2 account.  The vast bulk of this lending is, in practice, done by the Bundesbank since capital flight mostly goes to Germany, although all members of the euro system share the losses if there are defaults.

The ECB has always vehemently denied that it has taken an excessive amount of risk despite its increasingly relaxed lending policies.  But between Target2 and direct bond purchases alone, the euro system claims on troubled periphery countries are now approximately 1.1 trillion euros (this is our estimate based on available official data).  This amounts to over 200 percent of the (broadly defined) capital of the euro system.  No responsible bank would claim these sums are minor risks to its capital or to taxpayers.