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The first victim of the European bank crisis: investment in the US

by Jerome a Paris Thu Sep 15th, 2011 at 07:10:04 AM EST

As I noted in a comment a few days ago, some of the most likely victims of the current banking crisis in Europe are going to be in the US. Yesterday, I talked to a colleague in a big European bank who confirmed this in stark terms: they (and other European banks) have no problem finding long term funding in euros, and are still finding short term funding in dollars, but they are no longer having enough long term funding in dollars.

Which means that European banks have basically stopped lending to US / dollar clients (something which includes the whole shipping and aviation industries worldwide...). And while that may sound innocuous, the underlying reality is that US banks do not do long term lending - close to 100% of long term lending (as opposed to bond financing) in the USA is done by European banks (and a few Japanese and Canadian ones). To give you an example, over 2010, of the 50 largest banks active in project finance (ie long term financing of infrastructure projects like bridges, power plants, hospitals, mines, etc...) in the USA, only a handful were American, with insignificant volumes contributed.

So soon enough, Boeing is no longer going to be able to sell its planes, GE won't be able to sell its gas turbines or wind turbines, construction groups will see big contracts delayed, and, maybe more interestingly, independent oil&gas producers will have more trouble finding money to drill new wells...

US banks find disintermediated finance (underwriting bonds and selling them to investors) more attractive - the real reason of course is that bankers make bigger bonuses selling bonds than negotiating loans, and banks take less risk on their balance sheet if they don't hold the paper (but then nobody knows who really carries the risk, as we've seen). Big US corporations can also find cheap funding on the bond markets. But infrastructure requires long term funding, and can be too complex to explain to investors, so bank lending still dominates that activity. And that means European banks, borrowing dollars from US money market funds and lending long term - the banks' traditional role of maturity conversion (ie using short term deposits to do long term investment). Trust is essential for such activity, and it's disappearing fast. So strangely enough, the US panic about European banks will likely have real world implications for the economy in the US before they do in Europe.


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by Jerome a Paris (etg@eurotrib.com) on Thu Sep 15th, 2011 at 07:47:44 AM EST
We don't build bridges and hospitals in this country.

Be nice to America. Or we'll bring democracy to your country.
by Drew J Jones (pedobear@pennstatefootball.com) on Thu Sep 15th, 2011 at 10:05:30 AM EST
[ Parent ]
So soon enough, Boeing is no longer going to be able to sell its planes, GE won't be able to sell its gas turbines or wind turbines, construction groups will see big contracts delayed, and, maybe more interestingly, independent oil&gas producers will have more trouble finding money to drill new wells...
There is one way out, which is that the European and Japanese banks lend American firms Euros or Yen.

So, Boeing and General Electric can price their capital goods in Euros for the US market and the American investment banks can sell both buyer and seller an FX swap.

Economics is politics by other means

by Migeru (migeru at eurotrib dot com) on Thu Sep 15th, 2011 at 08:13:08 AM EST
Are European banks doing this through US subsidiaries or through cross-border lending?

Economics is politics by other means
by Migeru (migeru at eurotrib dot com) on Thu Sep 15th, 2011 at 08:20:20 AM EST
You say
European banks ... are still finding short term funding in dollars, but they are no longer having enough long term funding in dollars.

...

And that means European banks, borrowing dollars from US money market funds and lending long term - the banks' traditional role of maturity conversion (ie using short term deposits to do long term investment). Trust is essential for such activity, and it's disappearing fast.

Do the European banks really fund themselves long-term in dollars, and aren't you contradicting yourself when you say the European banks have no trouble finding short term funding in dollars, only to later say that short-term money market funds are disappearing?

This may make your argument harder to understand.

Economics is politics by other means

by Migeru (migeru at eurotrib dot com) on Thu Sep 15th, 2011 at 09:03:44 AM EST
I've always been a bit confused by this myself, as all loans, even long term loans, are always structured around 3-month or 6-month LIBOR (or EURIBOR in the case of euros) - ie the bank borrows the money for 6 months, lends it to the client, and rolls over the portion not repaid by the client 6 months later on the interbank market.

So liquidity is always going to be in 3-month or 6-month money, but I guess that long term funding is about getting commitments by other people to not ask for repayment after 6 months (or automatically rollover the funding) but leaving it in place ofr longer, ideally matching the maturity of the back-to-back loans to the clients.

So money markets may have lent money for 5 years using 6-month instruments, but now are lending only for 6-months, using the same 6-month instrument but with no guarantee of rollover.

But maybe I'm completely wrong on this.

Wind power

by Jerome a Paris (etg@eurotrib.com) on Thu Sep 15th, 2011 at 09:49:49 AM EST
[ Parent ]
There are two possibilities that make sense for long-term funding.

One is variable-rate loans indexed to 3-month or 6-month USD Libor.

The other is using FX swaps with a periodicity of either 3 or 6 months.

I have long been convinced that interest rate and FX structured swaps have been used massively as covert loans. That is, as sources of funding rather as hedging instruments. Since they are derivatives (off-balance sheet) they don't count as debt even if in effect they are a hidden loan.

Economics is politics by other means

by Migeru (migeru at eurotrib dot com) on Thu Sep 15th, 2011 at 09:54:22 AM EST
[ Parent ]
Money, investment capital, comes from two different groups of investors:

  1.  The Money Market, short term - up to a year (max) - using commercial paper, banker's acceptances, time deposits, etc. instruments

  2.  The Bond Market, long term - up to 20 years - using notes and bonds.

Without going into a long explanation, a firm can get more money in one fell swoop in the Money Market than in the Bond Market; we're talking a project being able to get (roughly) $100 million in the Money Market versus $10 million in the Bond Market.  The reason is the longer the investment period, the greater the perceived (and actual) risk of the lender not getting their money and interest payments.

What this does is shift the risk of a project to not being able roll-over its loans.  If you've borrowed $100 million for six months you have to go back to the Money Market for $100 million every six months.  Nobody cared about the risk since they assumed the money would always be there.

Well ...

This whole thing started, as I said when it started, by banks not lending, short term, to each other.  What Jerome is saying is EU banks have now taken the next step and are starting to halt lending short term to everybody else.    

This step means, as I predicted when this whole thing started, the global financial crisis will really get going when firms are unable to roll-over their debt.  Even if you only need a piddling $100 million if you can't get it ... you're bankrupt, gone, finished, kaput.  You close your doors, go into receivership, and (critically) fire your employees!

Which ramps-up the old micro-economic Positive Feedback Loop in the Negative Direction to eleven.

She believed in nothing; only her skepticism kept her from being an atheist. -- Jean-Paul Sartre

by ATinNM on Thu Sep 15th, 2011 at 12:43:37 PM EST
[ Parent ]
So soon enough, Boeing is no longer going to be able to sell its planes, GE won't be able to sell its gas turbines or wind turbines, construction groups will see big contracts delayed, and, maybe more interestingly, independent oil&gas producers will have more trouble finding money to drill new wells...

What sort of timescale is "soon enough" measured over ? Weeks, months ?


keep to the Fen Causeway

by Helen (lareinagal at yahoo dot co dot uk) on Thu Sep 15th, 2011 at 09:22:45 AM EST
This is all about liquidity in the 3-month Eurodollar market.

Economics is politics by other means
by Migeru (migeru at eurotrib dot com) on Thu Sep 15th, 2011 at 09:35:05 AM EST
[ Parent ]
Why are european banks having problems finding dollar funding ? I don't see a mechanism here

keep to the Fen Causeway
by Helen (lareinagal at yahoo dot co dot uk) on Thu Sep 15th, 2011 at 09:24:00 AM EST
US money market funds used to hold dollar deposits with European banks. As a result of this summer's banking scares in France, they are withdrawing in droves.

Eurointelligence: Euro crisis creeps into France (13.09.2011)

US money funds reduce holdings in French banks

US money-market funds have cut their lending to French banks at a pace that may force the banks to raise capital by selling assets, Bloomberg reports quoting from a report from Deutsche Bank. Prime money funds reduced their holdings in certificates of deposits issued by French banks by about 40% in three months through August.  Holdings of CDs from banks across Europe fell about 31%.



Economics is politics by other means
by Migeru (migeru at eurotrib dot com) on Thu Sep 15th, 2011 at 09:33:46 AM EST
[ Parent ]
Pesky unintended consequences

keep to the Fen Causeway
by Helen (lareinagal at yahoo dot co dot uk) on Thu Sep 15th, 2011 at 09:50:44 AM EST
[ Parent ]
As if on cue: ECB Coordinates With Federal Reserve in Lending Dollars to Euro-Area Banks
The Frankfurt-based ECB said that, in coordination with the Federal Reserve, the Bank of England, the Bank of Japan and the Swiss National Bank, it will conduct three U.S. dollar liquidity-providing operations with a maturity of approximately three months. The loans are in addition to the bank's regular seven-day dollar offerings and will be conducted as fixed-rate tenders with full allotment, the ECB said in a statement.

...

Two banks this week borrowed dollars from the ECB in its regular seven-day operation, a sign they are finding it difficult to gain access to the U.S. currency in markets. The premium European banks pay to borrow in dollars through the swaps market is close to the highest level in almost three years.

The ECB yesterday allotted $575 million in its regular seven-day liquidity providing operations, without naming the banks who borrowed the cash. French



Economics is politics by other means
by Migeru (migeru at eurotrib dot com) on Thu Sep 15th, 2011 at 09:39:21 AM EST
Get your news early on ET...

Wind power
by Jerome a Paris (etg@eurotrib.com) on Thu Sep 15th, 2011 at 09:44:10 AM EST
[ Parent ]
Clearly
What, you're telling me the ECB allowed the Eurozone banking sector to accumulate massive US$ liabilities without building up a reserve base of comparable size with which to act as a lender of last resort in US$?


Economics is politics by other means
by Migeru (migeru at eurotrib dot com) on Thu Sep 15th, 2011 at 09:49:39 AM EST
[ Parent ]
that thread, but that conversation yesterday, put some things into perspective for me.

Wind power
by Jerome a Paris (etg@eurotrib.com) on Thu Sep 15th, 2011 at 09:50:34 AM EST
[ Parent ]
We really should make that our official slogan.

Peak oil is not an energy crisis. It is a liquid fuel crisis.
by Starvid on Thu Sep 15th, 2011 at 09:27:14 PM EST
[ Parent ]
As it applies to both "news" and "commentary", we might want to make that get your insight early on ET or get a clue early on ET...

Economics is politics by other means
by Migeru (migeru at eurotrib dot com) on Thu Sep 15th, 2011 at 09:49:47 PM EST
[ Parent ]
by afew (afew(a in a circle)eurotrib_dot_com) on Fri Sep 16th, 2011 at 02:09:03 AM EST
[ Parent ]
is no longer providing the transatlantic capital flows our economies need. And the guvvermint bankers are stepping in to do the job for them.

Do I see a parallel with the ECB bank liquidity provision mechanim?

i.e. we blithely socialise the risks of lending when the private sector becomes risk-shy.

It is rightly acknowledged that people of faith have no monopoly of virtue - Queen Elizabeth II

by eurogreen on Thu Sep 15th, 2011 at 12:30:53 PM EST
[ Parent ]
Otherwise inflation will rise, unemployment will rise, disposable income will drop, consumer spending will crash.

Oh, wait...

by ThatBritGuy (thatbritguy (at) googlemail.com) on Thu Sep 15th, 2011 at 02:18:16 PM EST
[ Parent ]
See this thread.

Economics is politics by other means
by Migeru (migeru at eurotrib dot com) on Thu Sep 15th, 2011 at 09:44:00 AM EST
The Macro Man is unimpressed: What Euro Dollar funding crisis? (September 15, 2011)

Economics is politics by other means
by Migeru (migeru at eurotrib dot com) on Thu Sep 15th, 2011 at 10:18:20 AM EST
So, the big dogs have sucked the institutions dry (gov'ts, banks, etc.) and are now having a hard time finding a proper vehicle?
by Upstate NY on Thu Sep 15th, 2011 at 10:31:12 AM EST
[ Parent ]
Good example of why NCE macro-economists have their heads up their bums.

Yes we've got liquidity up the old wazoo.

HOWEVER, that money isn't a big pile of goo, it's segmented into markets.  Cutting a long story short, the people playing with money ($1 trillion/day) in the international currency markets don't have the expertise, contacts ... the ability ... to suddenly shift to short term bank lending.  

She believed in nothing; only her skepticism kept her from being an atheist. -- Jean-Paul Sartre

by ATinNM on Thu Sep 15th, 2011 at 12:54:52 PM EST
[ Parent ]
Well, we will always have China.  Too bad they don't buy much.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Thu Sep 15th, 2011 at 10:35:34 AM EST
They do buy lots. Of machinery and raw materials.

Peak oil is not an energy crisis. It is a liquid fuel crisis.
by Starvid on Thu Sep 15th, 2011 at 09:29:34 PM EST
[ Parent ]
I was first thinking of the USA, and, while they do buy capital goods from the USA, the volume of their imports from the USA is a fraction of the volume of their exports. They have simply stockpiled a lot of the difference as $US reserves. They continue to need vent for their exports so they are likely to continue to do so. This is unlike the case with Europe and the US, as discussed above.

But China also does import a lot of capital goods from Germany and could pay for them in $US if they wanted. If European banks are having trouble coming up with US dollars this could be >US$ 1 trillion of solution. Of course China would not want to part with its US$ reserves on the cheap, but if the dollars have appreciated due to supply and demand... We always have China.

"It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Thu Sep 15th, 2011 at 11:03:34 PM EST
[ Parent ]
And should the US$s from China to Germany to the US materialize in the range of $600 billion to $1 trillion it will be interesting to see what is the effect on stock prices, CPI, etc. My sense is that it depends on how the recipients of those $s use them. Unfortunately, the easy responses will be to pump up financial markets and conclude that happy days are here again.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Fri Sep 16th, 2011 at 12:07:11 PM EST
[ Parent ]
China can't pay for capital goods imports from Germany out of accumulated US$ without undercutting their exchange rate policy in whose service they have been accumulating US$.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Fri Sep 16th, 2011 at 07:05:17 PM EST
[ Parent ]
The Chinese are, as I thought they might¹, starting to trade paper for "hard" assets.  Saw, but didn't read, a news report they have started to buy stock of Apple and a couple other high-tech US businesses.  Their recent offer to shore-up the euro can be seen as part of the same process.

The Chinese have an interesting business culture.  They tend to go for the long-term, basing decisions as much on first developing a personal relationship as the "pure" business aspects of the decision.  In "first contact" meetings they will want to discuss your family as a box they have to 'tick.'  This tends to wrong-step people who don't expect it.

¹  Not that it took all that much brain power, it's the obvious next step for them to take.

She believed in nothing; only her skepticism kept her from being an atheist. -- Jean-Paul Sartre

by ATinNM on Fri Sep 16th, 2011 at 12:27:10 PM EST
[ Parent ]


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