Europe Credit Crisis Stage Two, Internal Bank and Sovereign Debt Crisis Combined

Interest-Rates / Global Debt Crisis
Jul 20, 2010 - 04:32 AM

By: Bob_Chapman

The crisis affecting Europe is nothing new. It goes back three years and the beginning of the credit crisis, 60% of the subprime CDOs, collateralized debt obligations, had been sold to European institutions. These were the mortgage bonds, which contained a variety of toxic waste, which the rating agencies, S&P, Moody’s and Fitch, in collusion with banks and brokerage houses, had sold as AAA bonds, when in fact their ratings should have been considerably lower. The holders of these bonds in many instances became insolvent and had to be bailed out by capital injections from central banks, most of the funds were lent by the Federal Reserve.

These debt problems, as in the US, have never been resolved. Those companies and institutions have over the past three years been allowed to keep two sets of books.

Six months ago the Greek crisis arose adding another financial and economic problem not only for Greece, but also for four other euro zone members and their debt holders, namely banks and other sovereign debt holders.

You might say the current additional crisis was frosting on the cake, because unbeknownst to most, Europe has never emerged from its original crisis. We have now an internal bank and sovereign debt crisis combined. What is of passing interest is that the raters and sellers of the toxic waste, that started all this, have never been prosecuted nor pursued civilly.

European banks a year ago used a temporary ECB loan facility funded by more than $500 billion, which was in part funded by the Federal Reserve and has been due for the past two weeks. Needless to say, the introduction of the Greek crisis and the recognition of the problems in Portugal, Ireland, Italy and Spain have put European banking into a very compromised position. If the ECB liquidity is removed very simply the bottom could fall out. This is still a severe crisis with no solution in sight. What we have is crisis upon crisis caused in part by the US subprime crisis, but also the result of European credit expansion that began ten years ago and structural problems caused by one interest rate fits all within the euro zone. The cost of money fell during the past ten years due to perceived safety and guarantee that all euro zone debt would be equal to the quality of German debt. It did not work out that way and as it turned out Germany in varying degrees ended up carrying all the other members, especially when it came to balance of payments deficits.

In last weeks missive we cited the end of the one-year loan program for refinancing on July 1st. That now has been replaced by another facility. The new loans of $166 billion for three months and a $140 billion six-day facility and numerous other offerings now replace the original facility. The original one-year facility was for $557 billion. If you total the 3-month increments for a year at least $664 billion is available, plus the other goodies. The bottom line is more and more money is being lent into a failing system.

ECB President Jean-Claude Trichet in last week’s press conference would not give any details on the current “stress test,â€