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Lenders Flee Debt of European Nations and Banks

Financial institutions are dumping their vast holdings of European government debt and spurning new bond issues by countries like Spain and Italy. And many have decided not to renew short-term loans to European banks, which are needed to finance day-to-day operations.

If this trend continues, it risks creating a vicious cycle of rising borrowing costs, deeper spending cuts and slowing growth, which is hard to get out of, especially as some European banks are having trouble meeting their financing needs.

“It’s a pretty terrible spiral,” said Peter R. Fisher, head of fixed income at the asset manager BlackRock and a former senior Treasury official in the George W. Bush administration.

The pullback — which is increasing almost daily — is driven by worries that some European countries may not be able to fully repay their bond borrowings, which in turn would damage banks that own large amounts of those bonds. It also increases the already rising pressure on the European Central Bank to take more aggressive action.

On Friday, the bank’s new president, Mario Draghi, put the onus on European leaders to deploy the long-awaited euro zone bailout fund to resolve the crisis, implicitly rejecting calls for the European Central Bank to step up and become the region’s “lender of last resort.”

The flight from European sovereign debt and banks has spanned the globe. European institutions like the Royal Bank of Scotland and pension funds in the Netherlands have been heavy sellers in recent days. And earlier this month, Kokusai Asset Management in Japan unloaded nearly $1 billion in Italian debt.

At the same time, American institutions are pulling back on loans to even the sturdiest banks in Europe. When a $300 million certificate of deposit held by Vanguard’s $114 billion Prime Money Market Fund from Rabobank in the Netherlands came due on Nov. 9, Vanguard decided to let the loan expire and move the money out of Europe. Rabobank enjoys a AAA-credit rating and is considered one of the strongest banks in the world.

“There’s a real sensitivity to being in Europe,” said David Glocke, head of money market funds at Vanguard. “When the noise gets loud it’s better to watch from the sidelines rather than stay in the game. Even highly rated banks, such as Rabobank, I’m letting mature.”

The latest evidence that governments, too, are facing a buyers’ strike came Thursday, when a disappointing response to Spain’s latest 10-year bond offering allowed rates to climb to nearly 7 percent, a new record. A French bond auction also received a lukewarm response.

Traders said that fewer international buyers were stepping up at the auctions. The European Central Bank cannot buy directly from governments but is purchasing euro zone debt in the open market. Bond rates settled somewhat Friday, with Italian yields hovering at 6.6 percent and Spanish rates around 6.3 percent; each had been below 5 percent earlier this year.

For Spain, the recent rise in rates means having to spend an extra 1.8 billion euros ($2.4 billion) annually to borrow, rapidly narrowing the options of European leaders. For Italy, every 1 percent rise in rates translates to about 6 billion euros (about $8 billion) in extra costs annually, according to Barclays Capital.

If officials simply cut spending to pay the added interest costs, they face further economic contraction at home. If they ignore the bond market, however, they could find themselves unable to borrow and pay their bills.

Either situation risks choking off growth in Europe and threatens the stability of the Continent’s banks, which would further undermine demand and business confidence in the United States and around the world.

Experts say the cycle of anxiety, forced selling and surging borrowing costs is reminiscent of the months before the collapse of Lehman Brothers in 2008, when worries about subprime mortgages in the United States metastasized into a global market crisis.

Graham Bowley and Liz Alderman contributed reporting.

This article has been revised to reflect the following correction:

Correction: November 19, 2011

A previous version of this article misstated Peter R. Fisher’s title and experience. He is the head of fixed income at the asset manager BlackRock, not a vice chairman, and he was a senior Treasury official in the administration of President George W. Bush, not President Bill Clinton.

Article source: http://www.nytimes.com/2011/11/19/business/global/lenders-flee-debt-of-european-nations-and-banks.html?partner=rss&emc=rss

Central Bank Props Up Spain and Italy, for Now

Spanish and Italian bond prices rose and their yields fell on Tuesday after the central bank stepped in for a second day to buy their sovereign debt, part of expanded efforts to prevent the European debt crisis from deepening in two of the largest economies in the euro currency zone.

The central bank’s move, much more ambitious than its previous forays into the bond market, has set off a debate about how far the bank legally can go under its charter. According to bank insiders and analysts, the answer seems to be: as far as it wants.

But the bigger questions may be how much intervention the central bank’s balance sheet can sustain — and how much help it will get from European governments. The pan-European bailout fund, the European Financial Stability Facility, is politically loaded and months away from having new money brought to a vote by member nations in the euro area.

In late trading Tuesday, the yield on Spain’s benchmark 10-year government bonds was down an additional 0.1 percentage point, at 5.019 percent. It had reached a record high of 6.458 percent on Aug. 2. The yield on 10-year Italian bonds, meanwhile, fell Tuesday to a one-month low of 5.143 percent.

To keep Spanish and Italian bond yields at sustainable levels over the long term will be a huge challenge for the European Central Bank, as investors test the bank’s resolve.

“Once they have started buying it will be difficult to stop buying,” said Jacques Cailloux, chief European economist at the Royal Bank of Scotland.

As it has when buying Greek bonds in the past, analysts say, the central bank will probably portray its interventions as a means to maintain control over interest rates and hold down inflation — not as a rescue of any particular country, which is forbidden by treaty.

And analysts expect the bank to make a show of taking as much money out of circulation as it spends buying bonds, to avoid the appearance the central bank is printing money or flooding the economy with cash through so-called quantitative easing of the sort the United States Federal Reserve has resorted to in recent years.

On Tuesday in Washington, the Federal Reserve stopped well short of such a move, instead indicating it would keep rates low through mid-2013. But it said it might again resort to quantitative easing, if economic conditions did not improve.

The European Central Bank, too, is loath to acknowledge any limitations on its monetary policy arsenal. And, in the worst case, it might even engage in quantitative easing if it saw signs of deflation.

“We do what we judge necessary to be sure that we deliver price stability,” Jean-Claude Trichet, the president of the central bank, said last week, repeating a phrase he has used often.

Confronted by a fundamental threat to the euro or to Europe’s banking system, the central bank might have no choice but to take further action.

“They will do whatever it takes because they will be forced to,” Mr. Cailloux said. “There are no technical impediments to buying unlimited amounts” of bonds, he added.

But that might require effectively printing money. Previously the central bank has intervened only in the much smaller markets for Greek, Portuguese and Irish bonds, spending 74 billion euros ($105 billion).

Some analysts say the bank may need to spend more than 10 times that to maintain control over yields on Spanish and Italian debt. If so, it might have trouble fully offsetting the purchases by paying banks interest to park money at the central bank, as it has done so far.

The bank’s purchases of Spanish and Italian bonds on Monday and Tuesday, reported by traders but not officially confirmed by the central bank, came amid broader market turmoil after Standard Poor’s downgrading of American debt late Friday.

The central bank felt forced to respond because last week the cost of borrowing for both Spain and Italy soared to record highs, with yields on their 10-year bonds topping 6 percent — a level that could raise the countries’ interest payments to ruinous levels and threaten to undermine the entire euro union.

And despite the bank’s efforts, there were growing signs on Tuesday of heightened tensions in the banking system. Money market indicators showed that European banks’ reluctance to lend to one another was approaching levels not seen since the collapse of the investment bank Lehman Brothers in 2008.

Jack Ewing reported from Frankfurt and Raphael Minder from Madrid.

Article source: http://www.nytimes.com/2011/08/10/business/global/insiders-see-no-limits-to-european-central-banks-arsenal-in-debt-crisis-fight.html?partner=rss&emc=rss

Lenders Flee Debt of European Nations and Banks

Central Bank Props Up Spain and Italy, for Now

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