Saving too big to fail French banks would cost AAA rating
By Marc Chandler
There are two spotlights in Europe today. France and Switzerland and their problems are intertwined. Despite denials by various French officials, the market suspects there is sufficient smoke to indicate a fire. Reuters reports that an Asian bank has cut credit lines to top French banks and other counter-parties are considering the same.
The French banks are perceived to be too big to fail–not that there is real talk at this juncture along those lines. However, the share and bond prices are eating away at their Tier One capital and the market situation is getting worse, not better. If push comes to shove, France can recapitalize its banks. However, to do so would likely be at a cost of its triple A rating, even though all three leading agencies have a stable outlook on France’s sovereign rating.
Separately, we have been concerned that if, in order to meet their own fiscal objectives, Italy and Spain were to beg out of the Greek 2.0 program, the burden would have to be picked up by Germany and France and the latter is ill-positioned to do so. In some ways, short French bonds is a way to position for greater Italian and Spanish woes. And in this context, we note that despite the ECB-induced rally in Italian and Spanish bonds, the CDS prices are going in the opposite direction. Although there may be liquidity considerations, given that the sovereign bond market is being manipulated, the CDS market may offer a "cleaner" read of sentiment.
Another reason why the market suspects that where there is smoke there is fire is the borrowings from the ECB. Recall that the ECB’s reserve maintenance period is a month-long. Yesterday was the first day of the new period. Usually the beginning of a period see slack demand as banks have the whole month to build their reserve position. However, yesterday borrowing from the ECB’s marginal lending facility rose to 4.06 bln euros, compared with 147 mln euros the last day of the previous reserve period on August 9.
Recall too that the ECB charges 2.25% (annualized) for its overnight loans. This is more than 75 bp more than its main refinancing facility. The heavy borrowing would seem to suggest that something is amiss and it is not simply hoarding cash, given these rates.
Lastly, note while since late May the euro’s correlation with the US S&P 500 has been fairly steady, since late May the euro’s correlation with the financial sub-index of the Dow Jones Stoxx 600 has nearly doubled to stand now near 0.62.
France has a choice. Save its banks or save itself. It cannot do both. If they save the banks they will have committed financial suicide. Just like Ireland they will be on an inevitable slide to insolvency. Frances banking system is far too concentrated in three big banks.
If the eurodespots decide to ban short-selling why don’t they criminalize bidding lower offers? That would at least keep the market value, ECB keeps buying bonds and keep repo’ing like there is no tomorrow and then they should freeze accounts to prevent bank runs.
And behold, CT1 ratios would show good, solid and sound. Confidence returned, right? =)
Yes but short selling only works when the asset is over valued. It shows market errors. I am against short selling bans. When the market is falling there are no prospects to profit in a falling market. The quicker markets hit their bottom the quicker they can recover. By stopping the natural movement of markets does not make them any more realistic. I can support freezing the market when prices fall 5% as that will allow slower moving investors to sell when they are caught unawares, this would end flash crashes as well. Though if they are supposed to be free markets then why ban short selling?
The fact that short selling may or may not be banned does not change the inherent value of a French bank. It will still be insolvent if that is what is balance sheet says. This becomes an embarrassment for politicians that their banks are insolvent especially when they chastised other nations for the same issue.
Short selling ban won’t fix the problem, but that goes fine with the line the eurodespots have agreed upon: to increase fear and suspicion.
https://www.reuters.com/article/2011/08/11/us-funds-eurozone-idUSTRE77A3C420110811
“long-only funds retreating…”
To be honest I would not have touched any financial institution since 2008. They are all hiding problems. The Reuters report commented on the lack of transparency of European banks balance sheets. Though that really can be applied to US banks as well.
Short selling is a completely legitimate investment strategy. As long as France does not bail out its banks it can retain its credit rating or only suffer a minor downgrade.