Thursday, November 17, 2011

The Euro Comes to the US

Markets took a tumble yesterday after Fitch's Ratings released a report saying that Europe's debt crisis may be a significant threat to American banks.

I can't believe this was really fresh news to anyone.

To me, what it really illustrates is the fact that U.S. investors have been assuming for months that euro crisis will all somehow just work itself out. While that might still be the case, global bond markets are telling you a completely different story.

Yields in "safe haven" countries like Germany (1.86% on 10 year bunds) and Sweden (1.66%) continue to move lower. Even the U.S. - which was only downgraded last summer - still can find investors willing to lend it 10 year money at 2.01%.

Meanwhile, the countries that really need the cash are getting killed. Even after massive intervention by the European Central Bank (ECB), Italy still needs to pay almost 7% to borrow money. Spanish 10 year notes now yield 6.60%, up from 5% a month ago.

And now France (mon dieu!) is coming under attack. French bonds are trading at levels nearly 200 basis points higher than Germany. If France is in trouble, then the euro really is in dire straights.

With all of this as a backdrop, it is little wonder that European banks are desperately trying to secure funding. Here's how the blog Business Insider describes the situation:

Specifically, traditional sources of bank funding in Europe, such as institutional investors and other banks, are getting cautious as fears grow about the need for sovereign debt restructurings. As liquidity dries up, the only reliable source of funding is often the ECB.

But the ECB only accepts certain types of assets as collateral for loans, and some banks are running out of those assets.

So they're turning to investment banks and other "counter-parties" that have them. And they're entering into "swap" agreements in which they exchange their assets for the counter-parties' assets and then stock-pile the latter assets for use as collateral.

And that's a fine plan... until the music stops and one big "counter-party" fails.

So is it really a surprise that the US banks are also at risk?