Trader’s Review of the Week; 26 June 2011

[private] Sunday 26th – European banks reliance on US$ funding from money market funds

A number of European banks rely on short term US$ financing, provided by US money market funds. The Investment Company Institute reports that US investors have withdrawn some US$51bn from such US money market funds recently, and less than the US$400bn was withdrawn from these funds in the month post Lehman’s.

The FED has, in the past, provided swap facilities to a number of European Central Banks, who can then on lend to their banks, but US$ financing for a number of European banks is going to get trickier. Fitch estimates that short term paper issued by the top 15 largest banks represent some 40% of the US$2.7tr of funds held in these money market funds.

Of these 15 banks, 10 are Europeans who, between them account for 30% of total money market fund assets (source: FT). The ECB will have to provide yet more financing (bad loans will increase) when funding from US money market funds dries up.  Remember the ECB’s capital is just above E10bn with a FED type balance sheet in terms of assets, which are ever rising.

Some analysts estimate that ECB losses (on purchases of peripheral country bonds and on collateral held against loans) could approach E100bn, though I must admit it is difficult to get a true picture. In the event of the ECB incurring losses (as it surely will) the ECB will have two choices, either print money (an anathema for the Germans) or allocate losses to their Euro Zone Central banks. Therefore Germany will have to pay up for 27% of losses, that’s going to go down well with its public i.e. the voters.

Given the rising problems in Europe, the signalled rise in interest rates by the ECB of 25 bps seems insane. Whilst the ECB always wishes to project its macho image, I just wonder whether they will be quite so stupid to raise rates in this environment at this time.

Increases in interest rates have a disproportionate negative impact on the peripheral Euro Zone countries, given high consumer debt levels, such as mortgages, which are subject to floating interest rates. As days go by, more private sectors held peripheral assets get transferred to the public sector.

This is making Euro Zone taxpayers having to bear a larger portion of the eventual costs. And it just keeps increasing in size as time goes by. In due course there will be pay back, particularly when elections are called. Can someone tell the ECB/Euro Zone politicians the simple fact? This is a solvency and not a liquidity issue.

Downside risks to the Euro prevail, in my humble view and in any event, the Euro remains grossly overvalued. It’s really supported by positive interest rate differentials, but there is risk of it disappearing.

Trader X is a pseudonym. The author is a former senior corporate financier at a prominent London investment bank who now manages his own money from his homes in London and the West of Ireland. [/private]