Monday, June 07, 2010

europe is heading for a depression...,

Counterpunch | Despite a nearly-$1 trillion rescue operation, financial conditions in the eurozone continue to deteriorate. All the gauges of market stress are edging upwards and credit default swaps (CDS) spreads have widened to levels not seen since the weekend of the emergency euro-summit. Libor (the London Interbank Offered Rate) is on the rise and liquidity is draining from the commercial paper and money markets. According to the Federal Reserve, the total amount of (foreign banks’) commercial paper has shrunk 15 percent or $32 billion since late April. Central bank officials insist that there's no chance of another Lehman-type meltdown, but their actions don't match their words. Apart from the massive $920 billion EU Stabilization Fund, the European Central Bank has beefed-up its liquidity facilities and is aggressively purchasing state bonds from struggling countries in the south. Without the ECB's assistance, the slow-motion slide into recession could turn into a full-blown market crash. Brussels has every reason to be worried.

EU banks are over-leveraged, under-capitalized, and too exposed to emerging market debt. In the next 12 months, they'll have to roll over more than $400 billion in loans in a market where funding is scarce and liquidity is drying up. The ECB should present a plan for restructuring Greek debt now instead of trying to keep the bubble afloat and hoping for a miracle.

The run on the shadow system is forcing more banks to seek funding from the ECB. The central bank has loaned out more than $850 billion and that figure is expected to rise. The ECB's balance sheet is proof that the wholesale funding system is broken and needs basic structural change. The EU is moving forward with a raft of regulatory reforms on everything from hedge funds to naked shorts, from corporate governance to a financial transaction tax, from tighter oversight on CDS to revamping the ratings agencies. So far, however, the shadow banking system has escaped their attention, which is unfortunate. The system is inherently unstable and will lead to more serious crises in the future. Financial institutions that act as banks (investment banks, hedge funds, insurers) must be regulated as banks, that's the bottom line. The dangers of maximizing leverage and unsupervised credit expansion, should be clear to everyone by now.