Wednesday, November 23, 2011

Credit Crisis Worsens in Europe

“The crisis takes a much longer time coming than you think, and then it happens much faster than you would have thought.” - Rudiger Dornbusch

The situation in Europe continues to worsen.

New leaders have been installed in Italy and Greece, to no avail. Spain held an election last weekend that should have provided some comfort to the capital markets, but instead Spain is now paying a higher rate of interest on its short term debt than Greece.

The role of the European Central Bank (ECB) remains critical. Reluctantly, the ECB has been pulled into the crisis even as there is little agreement on how far it can go without violating its original charter.

In the meantime, the ECB has provided essentially the only bid for Italian and Spanish bonds in the secondary market. In addition, European banks have turned to ECB for critical funding as credit conditions in Europe continue to tighten.

And now Germany - the bastion of the euro zone - is having its own credit quality questions.

Today's German bond auction was one of the worst in recent memory. Trying to sell €6 billion 10 year bunds, investors only bid for €3.6 billion, meaning that the Bundesbank is now the not-so-proud owner of €2.4 billion bunds that it will attempt to sell in the coming weeks.

The U.S. government has been the beneficiary of the euro zone crisis. The U.S. Treasury sold $35 billion in 5 year Treasury notes yesterday at a yield of 0.937%, which is the lowest yield on record. Indirect bidders - mostly foreign central banks - bought 44% of the deal, while investors only bought 9% of the new issue. Safety of principal, not yield, is driving Treasury bond prices these days.

OK, I know this is the day before Thanksgiving, and I should be giving thanks to the Europeans for helping us keep our government's interest costs lower.

But time is working against European leaders, and we can only hope that a workable solution to all of this is figured out in short order.