Thursday, November 10, 2011
There is a 65 percent chance of a banking crisis between November 23-26 following a Greek default and a run on the Italian banking system, according to analysts at Exclusive Analysis, a research firm that focuses on global risks.
A domino effect on banks is 65% likely following a Greek default and a run on the Italian banking system according to analysts
Having tested a number of assumptions in a scenario modeling exercise, the Exclusive Analysis team warned it is becoming less and less likely that EU leaders will simply “muddle through” and have made some bold calls with clear timelines on when the euro zone will be thrown into a major financial crisis.
The most likely outcome according to their analysis is a sudden crisis in which the US, UK and BRICs nations refuse to provide funding via the IMF for the euro zone. In a world where predictions are made with no time lines, the paper makes some bold predictions which can be held to account over the next three weeks.
In the worst case scenario, Exclusive Analysis expects the governments of Greece and Portugal to collapse due to a lack of consensus on how to handle the debt crisis leading to social unrest. German opposition to handing more funds to the EFSF rises, leading Germany’s parliament to actually reduce the money available to the bailout fund.
“In face of that, China and the other BRICs give clear signals that they will not support the bailout fund. The EFSF turns to the ECB , which refuses to print out the amount of money the former needs to bailout the PIIGS. In face of the EU's failure to boost the EFSF, the European banks refuse to accept the 50 percent haircut on the Greek debt.
Between November 18-22, French debt, under Exclusive Analysis' most likely scenario, is downgraded leading to the interbank lending market freezing up with new governments in Greece and Italy “faced down by protestors in their attempts to implement more austerity”.
Civil unrest follows in Spain following the election of a new government which pushes through even tighter austerity measures, and Portugal announces it cannot meet financial targets putting its bailout cash from the IMF and ECB at risk.
“Increased fear that these economies will default creates bank runs in Greece and Portugal and a downgrade of French sovereign debt from AAA to AA. EFSF is subsequently downgraded to AA+” said the report.
“The spreads applied to the debt of all PIIGS increase with yields on Italian bonds reaching 7.3 percent. In a second contagion effect, depositors in Spain and Italy fear a banking crisis in their own countries, which end up creating a series of bank runs and a collapse of the interbank credit market as banks know that most of their counterparts are at risk. Greece defaults.”
Europe's purported "firewall" to safeguard Italy does not, in fact, exist. The EU's vague plans to leverage its EFSF rescue fund to €1 trillion have come to nothing. Investors could see at once that plans to use the fund as a "first loss" bond insurer concentrates risk, dooming France's AAA rating and accelerating contagion to the core.
The European Central Bank (ECB) has been buying Italian bonds, but too slowly to stop the debt spiral. The ECB's new chief, Mario Draghi, kicked off his term with a blunt warning that it would be "pointless" for the bank to try to cap the yields of struggling debtors for long. It was an invitation for frightened investors to dump their bonds.
With almost nothing in place to halt contagion, the market verdict has been swift and brutal. Capital Economics said "the Rubicon may have been crossed" after yields on 10-year Italian bonds smashed through 7pc on Wednesday. Clearing house LCH.Clearnet has raised margin requirements once and will almost certainly do so again. Italy is effectively shut out of global capital markets.
Rome will not be able to roll over some €300bn in debt next year and will spiral into "disorderly default" unless EU authorities immediately face up to the enormity of the crisis.
"It is a panic. Rome is burning. Governments need to stop the fire spreading," said Jennifer McKeown, the group's Europe economist.
Wider contagion was alarmingly clear as yield spreads on French debt rose to a post-EMU record of 146 basis points over Bunds. French lenders have $416bn (£261bn) of exposure to Italian debt of various kinds. The two Latin nations are joined at the hip.
"It is obvious what needs to be done," said Tim Congdon at International Monetary Research. "The ECB must engineer a 'boomlet' by purchasing €1 trillion of bonds – boosting the M3 money supply by 10pc – to end all the agony. This means that Germany must put up with 4pc to 5pc inflation for while, but is that such a disaster? If they want to save the euro, they have to give some hope to the peripheral countries."
Hans Redeker from Morgan Stanley said the ECB must cap yields at 6.5pc by soaking up an "unlimited supply" of Italian bonds if necessary. "At the end of the day, we all know what the ultimate solution is going to be. They are going to have to monetise," he said.
This does not seem likely yet. On Tuesday, Germany's two ECB members warned that the bank must not stray into debt monetisation or start quantitative easing, though there are at last signs that parts of the German establishment are starting to think creatively. The heads of the country's five top institutes – the "Five Wise Men" – have together called for a debt pact to break the "vicious circle of an intertwined sovereign debt crisis and a banking crisis". The radical plan proposes a €2.3 trillion fund to enable joint bond issuance on a chunk of debt. This is a bitter pill for Germany but is the only way to avoid an "uncontrolled collapse of monetary union" or recourse to the "sin" of unlimited debt purchases by the ECB.
The Wise Men said their idea is a "very different animal" from eurobonds – anathema to the Bundestag – because the shrinking fund would be wound down gradually. It would not be a form of fiscal union. Chancellor Angela Merkel shot down the idea, warning it would require an EU treaty change and amendments to the German constitution. She stuck to her mantra that the solution is for Italy to carry out reforms and meet its austerity target.
The European Commission stepped up its surveillance demands, calling for a list of state assets to be sold and "additional measures" to balance the budget by 2013 if the economy goes into a deeper downturn.
Italy is now being forced to tighten fiscal policy into a deepening recession – against the advice of the International Monetary Fund – repeating the formula that has failed in Greece and closely resembles the final debacle of the 1930s Gold Standard.
The country is almost certainly in recession already, the result of combined monetary and fiscal tightening across the eurozone earlier this year. Real M1 deposits turned negative for the whole region over the summer, with dire rates of contraction in Italy and Club Med.
Milan consultants Ref Ricerche believe Italy's economy will shrink all through 2012 and 2013 in what amounts to a full-blown depression. This will itself cause debt dynamics to metastasize.
The strange feature of the crisis is that Italy is not fundamentally insolvent. Public debt has been stable for several years at about 120pc of GDP. The country has a primary budget surplus. Household debt is low at 42pc of GDP. Net household wealth is €2.3 trillion, higher in per capita terms than in Germany. Combined public and private debt is under 260pc, lower than in Holland, France, Britain, the US and Japan. The core problem is not Italy's debts but the 40pc loss of labour competitiveness against Germany over the past 15 years. This has left the country trapped inside EMU with misaligned currency, choking growth.
It is hard to see how the resignation of Silvio Berlusconi makes any difference. He has run one of Italy's most stable post-war governments. Elections are likely to throw up a splintered political mix, with gains for the Left but no one bloc able to put together a strong coalition. The nation remains bitterly divided on redundancy law and "firm-level" wage bargaining. The trade unions remain militant.
Stephen Lewis from Monument Securities said the search for some sort of "Grand Plan" or mega-fund to save the euro is an evasion of the North-South intra-EMU currency misalignment corroding the whole project. "Whatever they do, the underyling economic divergence will still exist. It may be that there is no solution and that it would be better to finance an orderly break-up of the euro," he said.
There are already hints of this comimg from Brussels, with reports of "intense consultations" between German and French officials on reshaping or "pruning" the currency bloc, reducing it to a manageable core.
"You'll still call it the euro, but there will be fewer countries," said a German official. Veteran EU watchers say the leaks appear to be a heavy-handed attempt from certain quarters in Berlin to force austerity compliance in southern Europe.
Oil prices could surge to $175-200 per barrel if Israel attacks Iran’s nuclear facilities, leading to the closure of an important oil route, according to market observers. Tensions between the two arch foes have escalated after the International Atomic Energy Agency reported it had ‘credible’ evidence of Tehran’s nuclear weapons plan.
In a survey of oil traders, Washington D.C.-based Rapidan Group said that participants expected an $11 rise in the price of a barrel in the immediate aftermath of an Israeli attack.
“Participants said prices could rise by $61/bbl under the prolonged disruption scenario where IEA [International Energy Agency] stocks are used. The scenario includes price change 30 days after an Israeli strike, and assumes a 21-day disruption of oil traffic through the Strait of Hormuz before returning to normal throughput of 15.5 million b/d. IEA countries offset half the loss with around 8 million b/d,” the Financial Times quoted from the report.“Participants said prices could rise by $175/bbl under Rapidan’s prolonged disruption scenario, where no IEA stocks are used. The scenario looks at price change 30 days after an Israeli strike, and it assumes a 21-day disruption of the Strait of Hormuz before returning to normal throughput of 15.5 million b/d.”
The Strait of Hormuz is the world’s most important oil route, with 40% of the world’s oil passing through the narrow sea route between the Gulf of Oman and the Persian Gulf.
The IAEA findings came weeks after the United States said it unearthed a plot by Iranian agents to kill the Saudi ambassador to the U.S.
“Iran is the most important latent threat in the oil market,” Robert McNally, head of the Rapidan Group, told Platts Energy last week, partly because previous threats against Iran over the years have not materialised, and also as Arab Spring has stolen the limelight from Iran during the past ten months.
McNally noted that oil traders would not have ignored the alleged-Iranian plot to kill the Saudi ambassador had there been a Republican U.S. President, rather than Democrat Barack Obama, despite his hawkish stance on Iran.
Meanwhile, independent consultant Philip Verleger told the Financial Times that the Strait of Hormuz closure is a “$200-a-barrel scenario”.
Verleger correctly predicted in August 1990 the price rally after Iraq invaded Kuwait, the FT noted.
This is not such a far-fetched scenario as crude prices are gearing up to hit $150 as global markets show some signs of improvement and demand ramps up.
The International Energy Agency reported today that oil prices could hit $150 in the near-term if the energy sector remains under-invested.
“If between 2011 and 2015 investment in the MENA region runs one-third lower than the $100 billion per year required, consumers could face a near-term rise in the oil price to $150 per barrel,” the IEA said in its annual World Energy Outlook.
Oil prices have been historically high this year, with North Sea Brent crude oil futures averaging well over $100 per barrel, partly due to the loss of oil production from Libya during its civil war.
Religare, a U.K. based investment bank focused on emerging markets, has also raised the probability of an Israeli attack on Iranian nuclear facilities from 5% in March to 40% in October.
“From a comfortable level of 0% last year, we put the chances of an attack on Iranian nuclear facilities at 5% in March, 15% in June, 20% in September and then finally upgraded it to 40% in October, although we cautioned that it was highly unlike to occur before the IAEA directors meeting in mid-November, after which it would rise to this point,” said strategist Emad Mostaque.
“We maintain our position and see December as the most likely point (Christmas day would especially annoy everyone), diminishing back to 15-20% once we get through to mid-January as Iranian enrichment progresses to dangerous levels and the pace of rhetoric subsides.”
German and French officials have discussed plans for a radical overhaul of the European Union that would involve setting up a more integrated and potentially smaller eurozone, EU sources say.
The claims come as soaring Italian borrowing costs saw global markets tumble overnight and policy makers outside the eurozone warned the crisis could spread.
And political deadlock continues in Greece and Italy, where talks have stalled to replace both countries' outgoing prime ministers.
EU sources say discussions among politicians in Paris, Berlin and Brussels raised the possibility of one or more countries leaving the zone, while the core pushes to deeper economic integration.
"France and Germany have had intense consultations on this issue over the last months, at all levels," a senior EU official in Brussels said, speaking on condition of anonymity because of the sensitivity of the discussions.
"We need to move very cautiously, but the truth is that we need to establish exactly the list of those who don't want to be part of the club and those who simply cannot be part."
French president Nicolas Sarkozy gave some flavour of his thinking on Tuesday, when he said a two-speed Europe - the eurozone moving ahead more rapidly than all 27 countries in the EU - was the only model for the future.
The change has been discussed on an "intellectual" level but had not moved to operational or technical discussions, the EU official said.
But European Commission president Jose Manuel Barroso issued a stern warning of the dangers of splitting the zone.
"There cannot be peace and prosperity in the north or in the west of Europe, if there is no peace and prosperity in the south or in the east," Mr Barroso said.
Politicians outside the euro area have kept up pressure for more decisive action to stop the crisis spreading.
Christine Lagarde, head of the International Monetary Fund, told a financial forum in Beijing that Europe's debt crisis risked plunging the global economy into a Japan-style "lost decade".
"If we do not act boldly and if we do not act together, the economy around the world runs the risk of downward spiral of uncertainty, financial instability and potential collapse of global demand," she said.
The dramatic escalation of the cost of Italian debt bonds to more than 7 per cent forced German chancellor Angela Merkel to issue a call to arms overnight.
Ms Merkel said Europe's plight was now so "unpleasant" that deep structural reforms were needed quickly, warning the rest of the world would not wait.
"That will mean more Europe, not less Europe," she told a conference in Berlin.
"It is time for a breakthrough to a new Europe.
"A community that says, regardless of what happens in the rest of the world, that it can never again change its ground rules, that community simply can't survive."
Italy has replaced Greece at the centre of the crisis and is on the cusp of needing a bailout that Europe cannot afford.
"Financial assistance is not in the cards," one eurozone official said, adding that the bloc was not even considering extending a precautionary credit line to Rome.
The chances of Britain being left unable to service its debt would jump to one in five in the event of an Italian financial collapse, according to a note by Fathom Consulting.
At the moment the price of insuring Britain's debt - through credit default swaps - implies a 9pc chance of default. But Fathom said: "If Italy were to default, the probability of a UK default would rise to 22pc."
The cost of government borrowing would also go up by around 2.5 percentage points.
Italy's cost of borrowing pushed through the 7pc level yesterday raising fears that it will not be able to service its €1.9 trillion (£1.6 trillion) debt pile.
A French default would be even more serious - the risks and the cost of UK government borrowing "would roughly double", according to Fathom.
Britain has managed to remain relatively unscathed by the turmoil of the Greek debt crisis. But the UK has far stronger and more important economic ties with both Italy and France.
Italy is Britain's eighth biggest trading partner. In September, Britain exported £803m of goods to Italy and imported goods worth £1.2bn according to the latest figures from the Office of National Statistics.
France is Britain's fourth biggest export market worth £1.7bn in September. The UK also has the third largest bank exposure to Italy holding an estimated total of €49bn (£42bn) of sovereign debt.
Andrew Brigden of Fathom said: "If Italy defaults, British banks would be hit hard which could lead the a requirement for them to be bail-out by the Government."
Italy is being touted as the country that is too big to save. And with the ECB legally prevented from being a lender of last resort, an Italian debt restructuring is inevitable, according to Nouriel Roubini.
Italian 10-year yields have exploded over 7% and clearing house LCH.Clearnet SA has raised the cost of trading Italian debt.
With the the turmoil in Italy, Ireland is having a harder time convincing markets and investors that it could escape contagion. Meanwhile, Greece is still waiting on a new government.
As the European debt crisis continues, we drew on UBS analyst Andrew Cates' aggregate balance sheet risk index to provide a snapshot of the financial fragility of countries that look most likely to default. The factors that help determine balance sheet risk include high cumulative credit outstanding, high banking sector leverage as measured by loan-deposit ratios, and substantial public sector debt as a percentage of GDP
Read more: http://www.businessinsider.com/italy-countries-most-likely-to-default-2011-11?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+TheMoneyGame+%28The+Money+Game%29&utm_content=Google+Reader#ixzz1dJnrVWC7
U.S. state and municipal funding problems will have a more personal impact on Americans' lives than the credit crisis and will reduce the value of their homes, Wall Street analyst Meredith Whitney forecast on Wednesday.
Whitney, who famously predicted the U.S. banking crisis in 2007, also offered insight on possible infrastructure investment in a "golden triangle" of the American heartland that was less affected by the U.S. housing crisis.
Examining data from U.S. states over the last three years, Whitney said she found "these dark pools of information ... that reminded me very much of what the financial industry looked like right before the credit crisis."
"Now that the states are under duress, the easiest thing for them to do is cut aid to municipalities ... cutting services, considering privatizing, cutting hours for parks and libraries. This is where it gets personal ... if you have lower social services, the value of your home is less," she said at the American Water Summit, which attracts those from water-related global and U.S. concerns.
"This situation ... will be so much more personal than the credit crisis," she said.
Whitney made her reputation by correctly predicting in 2007 that Citigroup would need a massive capital infusion. Last year, she said hundreds of billions of dollars of U.S. municipal bonds would default. She has stood by that statement even though this gloomy prospect has not yet come to pass.
Noting that the most debt-ridden areas tended to be along the two U.S. coasts, she described a "golden triangle" of communities spread across the American heartland in a triangle with points starting at Utah in the west, North Dakota in the north and Texas to the south. These areas, she said, didn't experience much of a housing boom and therefore avoided a housing bust and were less leveraged than coastal areas.
She said states have depended more on federal funding in 2011 than in any other year, but also said this was the year when federal stimulus funds expired for many states, creating what she called a "cliff effect" — a sudden drop in resources for states and municipalities.
State spending cannot continue at current levels, which means some states will sell off assets, cut services and privatize some functions, such as prisons and roads. Said Whitney: "You haven't seen anything yet in terms of selling (state and municipal) assets."
However, some states will have no choice but to invest in critical infrastructure, she said, and this is where the potential for investment is greatest.
She said the United States invests 80 percent less in infrastructure than Europe does in public-private partnerships. Declines in infrastructure and services depress the value of U.S. homes, which are many Americans' single biggest asset.
Many of the states in the "golden triangle," she said, are "right-to-work" states, and many of them are also predominantly Republican states politically.
Whitney said the contrast between states with obligations to unions and so-called "right-to-work" states would be a key issue in pinpointing investment opportunities. "These (right-to-work states) are the states that can solve their problems sooner," she said.
The state television channel TRT Haber showed images of several collapsed buildings and rescue workers searching through the rubble after the tremor struck at 9.23pm local time. At least 100 people were believed to be trapped, with one reporter saying up to 70 people may have been staying at one of the hotels.
Panicked residents could be seen running through the streets and ambulances rushed through the town with their sirens wailing.
In a grim replay of scenes from last month's quake in the same region, men climbed onto piles of debris and frantically clawed at twisted steel and crumbled concrete in an attempt to find survivors.
Voices could be heard calling for help from under the debris.
Sky Turk television said one hotel was being used by journalists and aid workers. It was not clear how many people were inside, but 11 had been brought out alive, NTV television reported.
Ozgur Gunes, a journalist with Cihan news agency, was staying at the hotel but had just left the building when the earthquake struck Wednesday night. He said there were journalists working in the lobby at the time.
"There were some small cracks, but we were told that there was no structural damage," he told Sky Turk television.
The Turkish Red Crescent immediately dispatched 15,000 tents and some 300 rescue workers.
About 1,400 aftershocks have rocked the region since the first earthquake hit the province on Oct 23.
At least 2,000 buildings were destroyed and authorities declared another 3,700 buildings unfit for habitation. There was a huge rescue operation after the October quake, as teams searched around the clock for survivors among dozens of flattened buildings and aid groups scrambled to set up tents, field hospitals and kitchens to help the homeless.
“Our estimate is for hundreds of lives lost. It could be 500 or 1,000,” Mustafa Erdik, the general manager of the Kandilli Observatory, said at the time.
The airport in Van was also damaged, meaning planes were diverted to nearby cities and relief teams were forced to travel by road.
October’s earthquake had a relatively shallow depth of 12.2 miles, according to the US Geological Survey, which made the damage worse.
Ercis, a town near Van, was hardest hit with at least 55 destroyed buildings, 45 dead and 156 injured.
Many homes collapsed along the town’s main road, raising the possibility of a higher death toll. In smaller villages near the epicentre, the shaking demolished almost all the brick houses.
In the city centre of Van, at least 100 people were confirmed dead, and 970 buildings collapsed. About 200 inmates escaped after the walls of a prison succumbed to the shaking, although 50 were quickly recaptured.
In one rare moment of joy, a two-week-old baby was rescued alive from the rubble of a collapsed building on, 46 hours after the October earthquake struck.
Van province lies several hundred miles east of the East Anatolian fault, one of Turkey’s most seismically active regions.
A Soviet scientist has denied being the brains behind Iran’s nuclear program, despite U.S. media reports that he helped put Tehran on the threshold of making an atomic bomb, a Russian newspaper said on Thursday.
The United Nations’ nuclear watchdog said in a report issued this week that it had strong indications that a foreign expert had helped Iran develop a “high explosives detonation system” but did not identify this person.
The Washington Post newspaper cited intelligence reports that named the foreign expert as Vyacheslav Danilenko and said he had assisted the Iranians for at least five years.
Kommersant, one of Russia’s leading newspapers, said it had tracked down Danilenko, now 76. It said he had worked for decades at one of Russia’s top secret nuclear weapons research centers, known in Soviet times as Chelyabinsk-70.
“I am not a nuclear physicist and am not the founder of the Iranian nuclear program,” Danilenko was quoted as telling the newspaper. He declined any further comment, Kommersant said.
Kommersant said Danilenko was one of the world’s top experts on detonation nanodiamonds, the creation of tiny diamonds from conventional explosions for a variety of uses from lubricants to medicine.
Hard evidence that Iran has sought a nuclear bomb is extremely sensitive as it could prompt an attack on the Islamic Republic by Israel, a step Russia has said would spark a catastrophic war in the Middle East.
The International Atomic Energy Agency said in its report this week that Iran appears to have worked on designing an atomic bomb and may still be conducting secret research, prompting Western leaders to call for more sanctions against Tehran.
Russia criticized the U.N. nuclear watchdog report, saying it contained no new evidence and was being used to undercut efforts to reach a diplomatic solution. Iran denies it is seeking to build a nuclear weapon.
Israeli media have speculated that the Jewish state may strike Iran, though it is unclear whether the United States has the appetite for risking another conflict while President Barack Obama tries to bring back troops from Afghanistan.
Danilenko did not immediately answer a request for comment.
The Washington Post said Danilenko was believed to have tutored the Iranians over several years on building detonators which could be used to trigger a nuclear chain reaction.
He worked at the All-Russian Scientific Research Institute of Technical Physics (VNIITF), a top secret nuclear weapons research centre in the Ural mountains, from the 1950s until retirement.
Kommersant said Danilenko had also worked in Ukrainian nanodiamond company Alit from 1992 to 1996.
The company’s director, Vladimir Padalko, said U.S. and IAEA officials had contacted him several times in previous years for information about Danilenko.
“I told them that nanodiamonds have no relation whatsoever to nuclear weapons. They were interested in Danilenko’s work in Iran,” the paper quoted Padalko as saying.
Padalko confirmed that Danilenko had worked in Iran in the second half of the 1990s, primarily on nanodiamonds but also reading lectures.
Kommersant said a 2010 monograph by Danilenko entitled “Explosion: the physics, the science, the technology” included research on gas dynamics, shock waves, high-velocity strikes and explosions in various mediums.