Going French on sovereign debt solutions

When the going gets tough, the tough usually gets going. In the case of the sovereign debt crisis, we have the Greek discussions with private creditors coming to a halt and a March deadline coming up (will the IMF grant a new tranche of loans ?). In the US, we are getting prepared for a repetition of the debt ceiling debate of late August.

The greenshoot of hope over the past couple of weeks is however is the ECB, that is what Mr Market seems to be telling us lately. We have previously reported on this gigantic ECB liquidity injection into European banks (almost 490 bio eur with 525 banks participating). And end of February, a similar operation will occur taking this ECB intervention to almost 1 trillion eur. Quantitative easing ? Not in the strict sense of the word because it involves ECB lending to banks while the FED prints outright and buys the bonds from the financial institutions (also in primary deals). But it's nevertheless a clever form of hidden quantitative easing by super Mario. And for now they have defused the bomb and this was necessary because the transmission mechanism in Europe is still very much is reliant on the financial sector (in the US, the bond market occupies still a more important spot). And the ECB knows that refinancing in 2012/2013 for banks might become a problem so it's better to pre-empt, just in case.

From the numbers, we can conclude the following : of the 480 bio eur, 280 bio came from switch extension operations, meaning, 1 week to 3 month liquidity operations being rolled over into 36 months. The net demand by definition amounted some 200 bio eur. Now looking at the increase in the ECB deposit facilities - categorized as new money returned to sender - we see an increase of 250 bio from 21/12 towards 493 bio bio eur last week. So basically, the money went to sleep ?

Apparently, we have something called the "announcement effect" and this implies more of the same, potentially being 500 bio eur at the disposal of European banks some weeks from now : and they can either hold the money safeguarding their own obligations in refinancing ; or as Basel 3 prescribes, some of the money might actually go to "safe" households and enterprises. Or if there's some money left over in the piggy-bank, banks can make money out of playing the sovereign curve. And exactly here - as the rumor goes - we have some suggestions coming from Napoleon Sarkozy. Apparently Sarkozy does not suggest playing the curve across borders but would like to see national banks playing "the national curve". Sarkozy and his French lieutenant at the Banque de France seems to be urging for the following : each private bank across the euro-zone purchases sovereign bonds from its own country. Why ? Because France and French banks have learned a lesson from the present credit crisis : never again allow a small country (Greece, Portugal) to take your public finances (or banks) hostage. Does the market take this seriously ? Part of this story seems to be telling us yes (orange W-Eur gov CDS, white Bank CDS):

So banks are closing the risk gap (CDS down from 350 to 250) and the ECB and the market might be hoping that pretty soon risk on sovereign bonds might be subsiding as well. Come to think of it, this trick is really quite simple, contrarian to all text book prescription but that is the last thing on Frankfurt's mind right now (or London and Washington for that matter). And if it doesn't turn out to be enough, be prepared for some additional LTRO operations coming from the ECB in favor of banks, may be even extending the maturity range from 3 years to 5 years or even more : As long as political Europe doesn't come to grips with the problem, banks will be given a wide open road to fulfill the task.

When Jan Tinbergen presented his first rudimentary macro-econometric models before the League of Lations in 1939, he was received by a lot of scepticism : "How can a simple mathematical model with a restricted number of equations be a reflection of complicated structure called the entire market or a nation's economy ?". Tinbergen, like his colleague Laurence Klein, replied : "I know it seems brutal, but it works". Let's see how this brutal move will gonna work out.