Wed Aug 10th, 2011 at 05:52:10 PM EST
For some weeks now I had been mulling a diary about the inevitable market attack on France, but today's events force me to write now or forever hold my peace. Things are happening so fast, today's planned diary may be tomorrow's outdated analysis.
The news today was a spectacular market crash. From Bloomberg: Societe Generale Leads Fall in French Banks as Credit-Default Swaps Climb
Societe Generale shares slumped as much as 23 percent and were down 16 percent at 21.89 euros at 4:27 p.m. in Paris. Credit-default swaps on the bank rose 29 basis points to a record 299 basis points.
Bank shares lost 5.3 percent, for the biggest decline among the 19 industry groups in the Stoxx Europe 600 Index and the steepest drop since May 2009. French and Italian banks led the retreat. BNP Paribas (BNP) SA shed 11 percent to 35.06 euros and Credit Agricole SA (ACA) sank 15 percent to 5.82 euros.
"If credit default swaps on France are under attack, that's not a good sign," said Yves Marcais, a sales trader at Global Equities in Paris. "That means that France is under attack and that's worrisome. French banks hold a lot of French bonds."
It's unclear what exactly caused the crash. What's ironic is that the attack on the French banks appeared to get under way a couple of hours after
Sarkozy rode into Paris in his shining armor to reassure the markets:
Telegraph: Sarkozy abandons holiday as downgrade fears rock France
French President Nicolas Sarkozy cut short his vacation and promised to pare down huge debts after growing fears it could be the next triple A-rated economy to suffer a downgrade sent bank shares tumbling.
I seem to recall it was before
and not after
but that's not too important now.
Societe Generale shares dropped as mush as 20pc, leading credit ratings agencies Fitch and Moody's to reiterate the eurozone nation's top rating, a day after Standard & Poor's had done the same.
Mr Sarkozy, who along with other European leaders has come under criticism for staying on holiday as the markets were gripped by fear, cut short his vacation on the French Riviera to summon key government ministers for an emergency meeting on the financial crisis.
No new measures were announced, but Mr Sarkozy insisted that "commitments to reducing the deficit are inviolable and will be maintained".
Meanwhile, we are informed (h/t afew
"There is only one sovereign in Europe, and that is Germany," said Stuart Thomson, who helps oversee about $120 billion as a portfolio manager at Ignis Asset Management in Glasgow. "Everything else is a credit and trades like a credit, even France."
Below the fold, the reasons why a market attack was entirely foreseeable, even if I doubt anyone expected it to happen so soon.
I explained the reason why France would be ultimately attacked in a comment on August 1
The EFSF has to source over 50% of its operating capital from "the markets" by issuing bonds backed by guarantees from Euro member states.
The EFSF is the "European Financial Stability Fund", the monster the EU created at the end of the Spring of 2010 in order to pretend to do something about the Greek debt crisis.
As member states get thrown under the bus they switch from guarantors of EFSF bonds to borrowers of EFSF funds.
Currently Spain and Italy are the marginal guarantors of the EFSF, and they are "under attack" by "the markets". Italy has suggested that it may exercise its option under the EFSF rules to withdraw its guarantee if its borrowing costs exceed those of Greece. The recent EU agreement allegedly lowered Greece's EFSF interest rate, while completely ignoring the fact that italy was, indeed, "under market attack".
In addition, France's AAA rating has become the subject of French Presidential Election Campaign Football, so whether France can continue to guarantee the EFSF's AAA rating is an open question, even if France continues to enjoy access to bond markets at reasonable rates.
There is a very good and detailed explanation of how the EFSF is badly designed in Yanis Varoufakis' blog: Why Italy? Why Spain? And why the EFSF's size does not matter
from August 4. Varoufakis lays out the reasons why the EFSF is actually a mechanism for cascading crisis, not an effective ringfence around the already fallen Euro countries.
The creation of the EFSF was forced upon Europe by the eruption of the Crisis. Once Germany accepted that the periphery's fall would signal the eurozone's end, the search was on for a funding body that would extend loans to the `fallen' albeit without jeopardising the principle of perfectly separable debts (PSDs). PSD means one thing: Each euro of public eurozone debt, including that incurred to bail out the `fallen', must be assigned to one and only one member-state. In practice, it meant that, to remain faithful to the PSD principle, each EFSF-issued bond contained sliced or tranches of debt and each one of these was the liability of a single eurozone member-state `donor'.
Germany and the rest of the surplus countries were hoping that the loan guarantees that they were offering to the EFSF would never need to turn into actual cash transactions. This would, indeed, be so if the EFSF had a coherent structure: its very institution would have averted speculative games by market traders and German taxpayers would never have had to cough up the euros associated with the loan guarantees to the EFSF. But, with the toxic α(F) inside the EFSF's foundations, markets recognise the shape of the cross diagram above. And nothing pleases them more than an opportunity to bet against an official's incredible threat, promise or prediction. If only for this reason, it was insanity personified to imagine that the α(F) curve might turn out slight enough to help contain the contagion. In short, our leaders ought to have known better.
why are Europe's leaders so committed to the current structure of the EFSF? You may, dear reader, logically conclude that one of two explanations hold: Either my argument here is false or our leaders are irrational. Yet the truth is a little more complicated than that and, therefore, a third explanation may be best: My argument is right and our leaders are rational, albeit in a narrow sense of the word. Put differently, their commitment to the awful EFSF reflects a most peculiar form of rational idiocy. My next post will show what this means and how it is possible that idiocy is reinforced, at a pan-European level, by this narrow form of rationality.
Anyway, in case you missed the reasons why I said "France's AAA rating has become the subject of French Presidential Election Campaign Football", let me point you to this from last June 28
Eurointelligence: Enter the Eurozone Bond
France's AAA rating status emerges as the major presidential election theme
Nicolas Sarkozy warned a Socialist victory at next year's presidential elections would lead to a "debt explosion" in France and jeopardize the country's obligation to get its deficit below the 3 % threshold by 2013, Les Echos report. In a separate interview with Les Echos the former Socialist European minister Pierre Moscovici affirms that in case of his party's victory the Socialists "would have to respect the promises made to the French and the European partners as regards the reestablishment of the public finances towards the EU and its European partners". Moscovici said it was entirely out of question to see "France's rating by downgraded by the rating agencies".
The French Socialist quickly fell in the trap.
David Webb Show: FRENCH SOCIALISTS HARDEN DEFICIT PLEDGE
“We have to balance the public accounts without delay”and cut the deficit to 3 percent of gross domestic product by 2013, Francois Hollande, the leading contender to become the Socialist candidate for president, said in an interview with today’s Le Monde newspaper. “Debt is the enemy of the left and of France.”
Martine Aubry, who’s also seeking her party’s nomination, echoed that view. “It’s a question of sovereignty,” she said today, also promising to meet the 3 percent goal. “Nothing would be worse than becoming president in 2012 and being attacked by financial markets,” she said on Europe 1 radio from Avignon, France.
It's poignant. It's almost as if she's doing it on purpose, but sadly she probably doesn't even realise what that sounds like to a bond trader.
The remarks suggest a shift from April, when the Socialist Party laid out its campaign platform for the 2012 election and avoided a firm commitment on the deficit. Since then, concern about the ability of euro-area nations to repay their debts has increased, with borrowing costs surging last week for Italy, the region’s third-largest economy.
This is all that the Markets need to hear - France's politicians have explicitly and publicly made themselves a target. At that point, the precise details of when France would be attacked, or the excuse or rumour that would trigger the attack, are not all that important. In fact, what's interesting is that France may well be an easier target than, say, Italy or Spain, because all the attack needs to achieve to succeed is a downgrade of France from its AAA rating, not a full-on default or the need to tap the EFSF, which would be the much harder goal of a market attack on Italy or Spain.
Anyway, if France is downrated the AAA rating of the EFSF, which is the result of the sovereign guarantees provided by EU member states, will be in question. At that point, it's quite possible Germany will simply bail itself out in disgust at its European partners, including France.