Disagreement Arises Over Leader’s Memo Of Understanding And ESM Crushes Euro, Stocks And Commodities

Financial Market Report for Tuesday July 10, 2012

Stocks and commodities traded lower today on a falling Euro

The Euro, FXE, traded lower as the National Bank of Greece, and Greece, GREK, led Automobiles, CARZ, Risk Assets, ONN, Energy Exploration, XOP, Small Cap Energy, PSCE, REITS, RWR, Residential REITS, REZ, US Infrastructure, PKB, Semiconductors, XSD, Home Builders, ITB, S&P High Beta Stocks, SPHB, Gold Miners, GDX, Silver Miners, SIL, Junior Gold Miners, GDXJ, Coal Miners, KOL, Uranium Miners, URA, Copper Miners, COPX, Aluminum Producers, ALUM, Nasdaq 100, QTEC, and Metal Manufacturers, XME lower, as Oil, USO, Silver, SLV, Gold, GLD, and Base Metals, DBB, led Commodities, DBC, lower.

Zero Hedge relates Negative yields tighten deflation’s grip.

Political chaos engulfs Europe as disagreement on Leaders’ Memo Of Understanding and ESM arises.

1) … Euro Intelligence provides the best of Eurozone news and analysis; and in their copyrighted and for fee daily newsletter service, which I recommend that one subscribe they relate On Spanish banks, the EU cannot agree on what they agreed.  Spanish 10-year yields rose to over 7.1%, as investors conclude that there is no such thing as an agreement on direct ESM cash for Spanish banks.

  • Eurogroup decides the outlines of the ESM loan to Spain; first tranche of €30bn to be disbursed this month;
  • Troika will come every three months and assume full power over banking supervision;
  • Spanish government must set up a bad bank;
  • Eurogroup confirms 3% deficit target for 2014, and raises 2012 target to 6.4%;
  • It forces Spain to increase tax, most likely VAT;
  • An official document warns that even the looser targets may be hard to reach, and are subject to big risks;
  • Klaus Regling is confirmed as head of the ESM, Yves Mersch at the ECB, and Juncker at the eurogroup;
  • La Stampa says Italy has only a few weeks left to avoid a catastrophic crisis;
  • Corriere says Mario Monti scored another victory at the eurogroup yesterday, as they reconfirmed the bond purchasing plan;
  • Italian yields, however, still rose on the day;
  • Politicians put pressure on constitutional court ahead of today’s ESM hearing;
  • France borrows short term at negative interest rates for the first time;

What was that agreement on Spanish banks? If you read today’s press, you got a lot of confusion of what was actually agreed at the summit in terms of Spanish bank rescue. Yesterday we reported a Reuters story according to which the ESM will not inject equity in European banks, and that the ultimate guarantee would still have to come from the member state.

There were loads of denials of that story – from Jean Claude Jucker and Olli Rehn, who said yesterday there will be no state guarantee. But there will be no equity injections either. Peter Spiegel and Joshua Chaffin had an excellent analysis in this morning’s FT in which they quoted a senior EU official as saying: “If the ESM lends to Spanish banks, it has to be structured so the first loss, which would be common equity, would be borne by the Spanish government.” That statement, if true, ultimately confirms yesterday’s story – that the pernicious link between banks and sovereign will not be broken. Olli Rehn’s spokesman, however, maintained: “There will be no need for a sovereign guarantee for banks being directly recapitalised by the ESM.” (I guess the meaning depends on what they mean by “sovereign guarantee”. If it is a first-tranche loss, then it is technically not a guarantee, but it is economically a guarantee, for this is what a first-tranche loss is all about.)

Wolfgang Schauble and others also played down expectations that there could be a quick deal on supervision. “That will take time, it’s complex, that’s not easy to create, but we will work on that.” He did not address the issues of how the loans would be turned into a direct equity injection.

To recap, it is completely uncertain whether, when and how the EU meets the conditionality that is needed to trigger direct ESM bank aid to Spain. And it is completely uncertain, and contested, what form that bank aid will take. If the Spanish government takes first loss, then we are talking about some hybrid type investment.

These doubts have contributed to yesterday’s increase in Spanish 10-year yields, which have risen further to over 7.1%, with the spreads at over 5.8%. The euro was at $1.2285 this morning.

Time is running out for Rome. Italy must be saved before August, La Stampa reports citing government sources. Huge borrowing costs, recession, lowest business climate since 1998 (according to Italian statistics office ISTAT): the crisis is not over in Italy. Several government officials warned that Italy may have just few weeks to save itself, avoiding a Greek style death spiral. The spending review decree is only one step of the reforms plan arranged by Italy with the European Commission. The risks of a political deadlock in 2013 are huge. That’s why, according to La Stampa sources, the Italian PM is mulling to stay in his role for another year. Monti’s mandate expires in spring 2013.

Corriere celebrates another European victory for Monti. Mario Monti leaves Eurogroup early but as winner, Il Corriere della Sera claims. “The agreement goes in the direction desired by Italy,” government sources told Luigi Offeddu, Brussels correspondent for Il Corriere. Monti has attended the Eurogroup as Italian Finance Minister, helped by deputy Finance Minister Vittorio Grilli. On the last European Council in Brussels, Monti was fighting for “his political survival,” Il Corriere wrote. Later he obtained, also thanks to Spanish cooperation, an agreement on his proposal about a larger role of the ECB or the EU bailout funds EFSF/ESM  for sovereign bonds purchase for those Eurozone members that are punished by higher interest rates but are showing good fiscal behaviour. Monti reiterates Italy did not intend to apply for a bailout or an access to EU bailout funds EFSF/ESM. Meanwhile, the yield of Italian 10 year government bond rose to 6.13% from 6.02%.

Politicians put pressure on constitutional court ahead of today’s ESM hearing.  As a sign of rising nervousness several politicians put pressure on the constitutional court ahead of today’s hearing on the ESM and the fiscal pact, Frankfurter Allgemeine Zeitung reports. “Some observers rightly criticize that the Karlsruhe judges do not have a complete understanding of European affairs which leads them sometimes to erroneous appeciations”, Alexander Graf Lambsdorff, a liberal deputy from the EU parliament said. Helmut Brandt, chief lawyer of the parliamentary group of the CDU and CSU in Bundestag warned against a ruling that would declare the German participation in the ESM and the fiscal pact unconstitutional. “It would be economically and politically fatal if such a ruling would be the outcome”, he said. Martin Schulz, the social democrat who is currently president of the EU parliament said the rulings where “sometimes marked by a lack of factual knowledge”. The Karlsruhe court will today start oral hearings.

France borrows short term at negative interest rates for the first time.  For the first time France yesterday borrowed short term at negative interest rates, Les Echos reports. At their weekly issue of treasury bonds the French treasury Agence France Trésor emitted bonds with a maturity of three months at -0.005% and with six months at -0.006%. According to the paper the negative interest rate shows that investors appreciate the liquidity of the French debt market which despite France’s loss of its AAA top rating they currently consider as the only safe alternative in the eurozone to the German debt market.

The German constitutional court will take more time

  • At yesterday’s hearing, the president of Germany’s constitutional court hinted that he may not run this case under the emergency procedure – and this implies that Germany won’t be able to ratify the ESM for some time yet;
  • Andreas Voßkuhle says court may need to undertake an in-depth analysis;
  • Wolfgang Schauble warns that a negative rule would have considerable implications for the financial markets;
  • plaintiffs argue that the ESM and the fiscal pact deprive the Bundestag of its effective budgetary control;
  • Jens Weidmann used the opportunity to criticise the ESM in front of the constitutional court;
  • he said the ESM challenges the autonomy of central banks;
  • we have the full list of the ESM programme agreed by Spain: a highly invasive action plan to reform the Spanish financial sector;
  • it includes provisions for the bail-in of shareholders, preferred shareholders and subordinated bondholders, i.e. including a lot of small savers;
  • also includes provision for a strengthening of the role of the Bank of Spain, and for a bad bank;
  • El Pais says that EU has taken Spain under guardianship;
  • Vitor Constancio says the ECB will not help fund bank restructuring funds and deposit insurance schemes because this was against the spirit of the treaty;
  • the Bundestag interrupts its summer break to decide on the Spanish rescue;

Weidmann criticizes ESM during the court hearing.   Jens Weidmann criticized central elements of the ESM during his hearing at the constitutional court yesterday, Frankfurter Allgemeine Zeitung reports. The Bundesbank president stressed that the ESM was in a position to change central elements of its working autonomously. Also it was not quite clear how much say the euro member states had if it proved necessary to prop up the ESM with additional means. Also Weidmann said that the ESM weakened the incentives for potential receivers of rescue aid to be responsible by themselves for solid public finances and for adapting their economies. He added that the fiscal pact did not add a sustainable framework for EMU. The Bundesbank president stressed that a rejection of the German ESM law could provoke major market turbulences but he added that unconditional transfers also contained dangers. A rapid ratification of the ESM was no guarantee against further turbulences, Weidmann cautioned.

Bild applauds the court’s in-depth-analysis of the ESM but worries about Germany overburdening itself
Mass circulation daily Bild applauded the court’s judges for their decision not to let themselves be rushed into taking a quick decision on the constitutionality of the ESM. “It is totally right that the constitutional judges take more time – after all, the question is whether Germany is overburdening itself financially. That would be a lot worse than short term turbulences on the financial markets”, the paper tells its 10m daily readers. Also Bild applauds the nomination of Klaus Regling as the ESM’s chairman. “In any case it is very good that a German occupies this important position. But it is unclear whether he will prevail in the long run against the predominance of Southern Europe”. But the article finishes with worries for the future. The Spanish bank rescue increases the liabilities for Germany, the paper notes. “Should Italy also request aid the burden would almost become unbearable”, Bild concludes.

That Spanish rescue in full.  El Pais has a carpet-bombing style news coverage of the Spanish EU programme that feels a bit like as though the country was invaded. The paper’s main headline says “EU places Spain under guardianship”. The inside headlines talks about “shock therapy”. We presented a few of the measures highlights in yesterday’s briefing. El Pais has the full list of the concrete 32 measures agreed. There can be no doubt that, once implemented, the Spanish banking sector is going to be very different – except of course that all risks remain inside the country. Note especially point number five – which will affect a lot of small savers. This is probably the most important conditions, and may have implications for other countries, including Ireland. Here is the full list, abridged of course.

1. Provide data necessary to monitor the entire banking sector, including weekly data of deposits and liquidity positions.

2. Prepare with the European Commission plans to restructure a first group of banks;
July, mid-August.

3. Finalize proposals for disclosure requirements;
late July.

4. Have consultants provide information required for stress tests , including results of the review of asset quality, by mid August 2012.

5. Introduce legislation to apportion losses to several classes of shareholders and subordinated bondholders. Late August 2012.

6. Update the bank resolution framework , ie, strengthen the powers of settlement with the FROB and the deposit insurance fund. Late August 2012.

7. Prepare plans for a bad bank. End of August.

8. Complete stress tests for all banks. Second half of September.

9. Finish proposed regulation to improve transparency of banks. End of September.

10. Banks with capital shortages to apportion losses to shareholders, preferred shareholders and holders of subordinated debt. Between October and December.

11. Banks develop recapitalization plans. Early October.

12. Plan to restructure or liquidate banks in a second group;
October 2012.

13. Improve Bank of Spain’s guidelines or binding rulings, but short of full regulatory powers. Late October 2012.

14. Internal review of processes and decision making. Late October 2012.

15. Legislation for a bad bank. Fall 2012.

16. Improvements in credit reports. End of October.

17. Develop proposals for the strengthening of non-bank financial intermediaries. Mid-November.

18. Propose measures to strengthen the governing bodies of savings banks. End of November.

19. Provide a road map for an eventual stock exchange listing of banks that have received state aid. End of November.

20. Prepare legislation to clarify the role of savings banks in their capacity as shareholders of credit institutions to reduce their holdings to levels that do not involve control.

21. Banks should provide standardized estimates of quarterly balance sheets. As of December 1

22. Present a policy paper on what to do after the expiry of the royal decrees 2/2012 and 18/2012, applying to the restructuring of the banking sector. Mid December 2012.

23. Issue Cocos for a third group of banks. End-December 2012.

24. Transferring the powers of enforcement and bank licensing from the finance ministry to the Bank of Spain. Late December.

25. Require lenders to review strategies to address impair assets. Late December.

26. Require that all Spanish credit institutions have at least 9% tier-one quality at least until late 2014. January 1, 2013.

27. To review the rules governing the FROB and deal with conflicts of interests. January 1, 2013.

28. Review the problems of credit accumulation in certain parts of the economy. Mid January 2013

29. Propose specific legislation to limit the sale by the banks of subordinated debt securities to retail customers. Late February 2013

30. Amend legislation to improve the credit registry. End of March 2013

31. Raising capital requirements for banks planning to increase equity. Late June 2013

32. Banks in the third Group with Cocos must submit restructuring plans . Late June 2013
Constancio says No ECB help for bank resolution funds and deposit insurance. EFX News reports that Vitor Constancio has ruled out any ECB help to refinance banks. He said a provision in legislative proposal now being discussed by EU governments that would allow national bank resolution funds to borrow from central banks could not be applied in the euro area. “It goes against the spirit of the treaty, with respect to the independence of central banks from the financing tasks of the government,” he said. The ECB’s vice president also said he believed there needed to be “financial backstops at the national level in place in order to avoid any doubts by the citizens on the capacity of deposit guarantee schemes to fulfill their commitments.”

Bundestag interrupts summer break to decide on Spanish bank rescue. The Bundestag will interrupt its summer break for a special session on July 19 to take a decision on the EU rescue loans for Spanish banks, Börsenzeitung reports. The parliament’s budget committee will already hold a session the day before. Since Wolfgang Schäuble and the euro crisis managers of the finance ministry were all at the constitutional court hearing in Karlsruhe the chief whips of the different parties were yesterday informed via telephone conference on the decisions taken during the eurogroup meeting the previous night.

2) … Martin Sibileau of A View From The Trenches writes More of the same. As we wrote months ago, in order to save their currency, the Euro zone destroyed its banks. And with this last measure, it will have ended its money market. For all practical purposes, the European Central bank made sure that its liabilities, the Euro, will never be able to reach a global reserve status. The damage these irresponsible central bankers are doing is immense because until now, Euro banks were not lending to each other for a genuine reason: Very high counterparty risk within a currency zone that is falling apart. They were taking heavy capital losses on the sovereign debt holdings they had been coerced to invest their funds in but, at least, they were able to earn 25bps on immobilized monies. Now, they won’t even have this “risk-free” income, a situation that actually enhances counterparty risk, as solvency is further crushed.

At the same time, if the banks cannot afford to have funds immobilized, they will discourage the growth of deposits in the Euro zone, precisely when they are most needed. The way markets welcomed this measure shows we are not alone with this view.

Lastly, in our letter of June 25th, we argued that it was now conceivable to see Germany leave the Euro zone first. We think that the latest actions, both by the central bank and the Euro Summit, make this outcome increasingly likely.

3) … Open Europe reports Spain may need to force losses on bank bondholders to gain eurozone bank bailout.  A draft version of the memorandum of understanding for the Spanish bailout was leaked yesterday. It shows that Spain must meet 32 conditions in exchange for the financial assistance. The FT notes that the conditions include forcing certain bank bond and shareholders to take losses to ease bank debt before the banks receive funding and supervision of Spanish banks being transferred from the Bank of Spain to the Commission, IMF and ECB, with this troika also providing quarterly reviews of the progress in reforming the Spanish financial system. The €30bn tranche which is due to be paid by the end of the month will be kept in reserve for emergencies until the final audit of Spanish banks is completed in September. Speaking in parliament this morning, Spanish Prime Minister Mariano Rajoy has announced new austerity measures worth a total €65bn until the end of 2014.
Expansión Expansión 2 El Mundo BBC Spanish MoU FT WSJ CityAM Telegraph Guardian Standard European Voice CityAM 2 WSJ Review & Outlook Les Echos: Almunia

4) … Phoenix Capital Research writes Germany will bail on the Euro rather than bail the Euro out.  It all boils down to Germany. I’ve been forecasting for months that the country will increasingly focus on domestic interests and that it will ultimately opt to leave the Euro rather than prop up the EU.

The former (focusing on domestic issues) is already underway as Bloomberg writes Germany plans joint Federal-State debt in Merkel fiscal deal. Chancellor Angela Merkel agreed to share borrowing costs with Germany’s states to help ease their budget squeeze, completing a deal the opposition said will help secure German ratification of the European Union’s fiscal pact.

Germany’s federal and state governments plan their first joint debt sale in 2013 to help the states meet the pact’s deficit limits, the German government’s press office said in an e-mailed statement in Berlin today.
Pressed by the Social Democrat-led opposition that could block the stricter European fiscal rules in parliament, Merkel agreed to a policy she opposes in confronting the debt crisis in the rest of the 17-nation euro area. She signaled her rejection of joint euro-area debt as recently as June 23, saying “liabilities and controls” must “go together.”

“We reached a solution that makes it clear there will be approval” of the fiscal pact in the upper house of parliament, Kurt Beck, the premier of Rhineland-Palatinate state and member of the opposition SPD, said in an ARD television interview.


As for the latter development (Germany leaving the Euro), I believe that this will occur once the EU Crisis spreads to France.  At that point any discussion of EU bailouts is pointless, as the very countries needing aid (France, Italy, Spain, and Greece) account for 53% of the ESM’s funding.

So far the markets have been willing to ignore the fact that Spain and Italy are meant to contribute 30% of the ESM’s funding. However, if France starts needing aid (and it will) it’s GAME OVER as any discussion of where the money will come from is moot.

By the look of things, this development is not too far away. France’s Socialist party took its lower house during the most recent elections. Already they are proposing reforms that will result in French businesses and capital leaving the country. The Economist writes France’s new Socialist government is embarking on a series of risky experiments in business. Michel Sapin, the labour minister, has promised to make it so expensive for companies to lay off workers that it will no longer be worth their while. Firms that fire people while still paying dividends may be penalised. Another planned ruse is to force companies to sell factories, presumably along with the brands manufactured there, to competitors rather than close them down.
Paris is full of rumours of hasty departures. PPR, a luxury-goods group which owns Gucci and Yves Saint Laurent, is reported to have plans to move its entire executive committee to offices in London as soon as this summer. Technip, a global oil-services firm, is rumoured to be about to move its official headquarters across the Channel. (PPR declined to comment, and Technip said it has no plans to move for now.) To the fury of a French member of parliament, David Cameron, Britain’s prime minister, this week promised to “roll out the red carpet” for French companies on the run from the new tax.

But the most important consequence of stratospheric taxes will be less visible, at least at first. Marc Simoncini is one of France’s best-known entrepreneurs–and one of the few business leaders to denounce the new measures publicly. Why, he recently asked, would anyone want to start a business, invest and succeed in the most taxed country in the world?

Tax is not the only threat to executive pay. Last week Pierre Moscovici, the finance minister, announced that pay for bosses of companies in which the French state holds the majority of shares will be capped at a flat rate of €450,000, or roughly 20 times the wage of the lowest-paid worker. The French experiment will no doubt be watched with interest around the rich world. In some cases it will lead to a 70% pay cut. Over time, the quality of management at these state firms, which had become more professional over the past decade, will surely suffer. Executives such as Guillaume Pepy, the boss of SNCF, the national railways, for instance, could secure a top position anywhere in his industry. Measures to limit pay at fully private firms are expected before long.


As one would expect, the wealthy French are fleeing the country. Spiegel writes Wealthy French take their assets to London. It began in 2010, when wealthy Greeks started coming to London and buying up expensive townhouses in upmarket neighborhoods. Amid fears that Greece might leave the euro zone, they believed their money would be safe in Britain in its splendid isolation from the euro and the Continent’s sovereign debt crisis.
Then rich Spaniards started arriving. They were following by well off Italians, who at the start of the year overtook Russians as the biggest group of foreign buyers snapping up property in London, according to a survey.

Whenever the euro crisis heats up somewhere in Europe, the demand for expensive homes increases in Western Europe’s largest city particularly among well-heeled foreigners beset by asset angst.

London real estate agents are like the canary in the coalmine for the debt crisis. They can sense early on the next country to get sucked into the vortex. So who’s up next? Apparently it’s the French.

Real estate agents have been aware of a new wave of interest for months, but it’s been especially noticeable since Feb. 28. The night before, the then Socialist candidate for French president, François Hollande, who famously said “I don’t like the rich,” announced that, if elected, he would raise the top rate of tax on incomes over €1 million to 75 percent. At home, he got much applause for the announcement. But in London, the news produced a reaction that was noticeable on the computers of the London-based property company Knight Frank.

“Since February, when Hollande announced his wealth tax, there has been a large rise in web searches from French customers,” Liam Bailey, head of residential research at Knight Frank, recently told the Daily Telegraph…

To meet the demand, the property company Douglas & Gordon has just opened an office in South Kensington, where four native French speakers will be available to help out their house-hunting compatriots. Hollande’s tax speech immediately led to a 40 percent increase in inquires from worried French citizens, says David Blanc from the London asset management firm Vestra Wealth.


French banks are already leveraged at 25-to-1. The impact of a capital exodus by the wealthy will rapidly push leverage levels even higher. And given that French banks’ exposure to the PIIGS is equal to 30% of French GDP, it’s no surprise that French banks are posting some truly horrible charts.
I expect the EU Crisis to spread to France before autumn. At that point, it’s game over for any notion of the current EU lasting. Germany will walk.

5)… Spain imposes austerity. Ambrose Evans Pritchard writes Debt crisis: Spain bows to EU ultimatum with drastic cuts.  Spanish premier Mariano Rajoy has raised VAT sharply in a humiliating volte-face and pushed through €65bn (£51bn) of drastic austerity measures to comply with a European Union ultimatum, risking a downward spiral into full depression. Credit Writedowns writes The growing pain in Spain. NYT writes Spain plans new round of tough austerity measures. Chris Marsden of WSWS writes Europe’s austerity zone.  

6) … AP reports Wrecked cruise liner’s captain admits distraction, blames ‘destiny’

7) … The Automatic Earth Libor Was A Criminal Conspiracy From The Start

8) … Financial Sense relates Fractional reserve banking, government and moral hazard.


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