Credit - Squaring the Circle

"Evolution has long been the target of illogical arguments that use presumption." - Marilyn vos Savant 

While listening to Olli Rehn's recent comment relating to Greece, and seeing France's latest rating cut to AA, with aggravating industrial production pointing to a weaker GDP going forward, we reminded ourselves of the famous problem proposed by ancient geometers for this week's chosen title namely "Squaring the Circle".

“I’m sure that we will be able to find a satisfactory solution as regards to how to ensure the fiscal gaps will be filled and the fiscal targets will be met.” - Olli Rehn

The different steps taken to resolve the inadequacies of the euro have been strikingly similar with the problem proposed by ancient geometers, namely "Squaring the Circle" being the challenge of constructing a square with the same area as a given circle by using only a finite number of steps with compass and straightedge.

Although in 1882, the task was proven to be impossible, as a consequence of the Lindemann-Weierstrass theorem proving that pi is transcendental, rather than an algebraic irrational number, it did not prevent an amateur eccentric crank by the name of Dr. Edwin J. Goodwin to try to brace mathematical immortality by trying to have the legislature in Indiana in 1897 to redefine the value of pi through House Bill 246! We kid you not. It would have enabled the brave Dr Goodwin to solve the aforementioned problem of "squaring the circle".

In similar fashion to the brave Dr Goodwin, our European politicians such as Olli Rehn are trying to finalize the construction of the Euro through a "finite number of steps", and on that note we think about the upcoming AQR (Asset Quality Review) and the willingness of European politicians to secure the creation of a European Banking Union, through legislature.

By that point you are probably asking yourselves where we are going with all this but, our fondness for behavioral psychology reacquainted us with one of our past quote following our "Generous Gambler" aka Mario Draghi latest rate cut stunt:

"The greatest trick European politicians ever pulled was to convince the world that default risk didn't exist" - Macronomics.

In this week's conversation we will focus our attention once more on Europe and the impossibility of "Squaring the Circle" even through European Banking Union.

Our European "deceiver in chief" has pointed out the improving credit conditions in the money multiplier - graph source Bloomberg:

"ECB President Mario Draghi noted in comments following a rate cut that euro zone fragmentation had been improving from mid-2012, though progress halted three to four months ago. This echoes a north-south divide in wholesale bank funding costs that has again widened. Further, the money multiplier demonstrates how the flow of credit had begun to improve from mid-2012. September's 7.7x figure is the first month in a year that the multiplier has contracted." - source Bloomberg.

The issue of course is that, given the pending AQR, the Euro zone contraction in excess liquidity could no doubt counter the wishes of our European "generous gamblers" we think - graph source Bloomberg:

"Excess liquidity in the euro zone bank system is considered tight when below 200 billion euros ($267 billion) and a sustained period below this level has driven interbank rate increases in prior cycles. Even as the ECB has cut its main refinancing rate, which may lead to a steeper yield curve and income boost for some banks, an increase in wholesale funding costs could offset this. Euro zone excess liquidity may also fall as banks withdraw ECB deposits to reduce leverage."  - source Bloomberg.

Arguably what has been most beneficial as of late for European exporters has indeed been the proverbial "sucker punch" delivered by the surprise rate cut by the ECB on Thursday to 0.25% on the Euro currency versus the US dollar - graph source Bloomberg:

But, we have long argued that the previous LTROs amounted to "Money for Nothing". The latest round of "generosity" courtesy of the rate cut by the ECB will only favor more of the same, namely more carry trades for peripheral banks which have been gorging themselves with government bonds from their respective countries with the help of the two previous LTROs as displayed by the below Bloomberg table:

"A fringe benefit from today's ECB rate cut, beyond signaling an aggressive stance and longer-term low-rate environment, may be a steepening of the yield curve. Regionally, at 10.2% of bank-system assets, Italian banks have the greatest sovereign-bond exposures with 422 billion euros ($564 billion). They are followed by Spanish lenders at 312 billion euros (9.5% of assets) as at the end of September. Any steepening may benefit interest income." - source Bloomberg.

So we think that the willingness through "legislature" in severing the link between European sovereigns and their respective financial institutions amounts to "Squaring the Circle" in true Dr Goodwin fashion hence the path for this week's chosen title.

Throughout our numerous conversations, we have argued about the deflationary forces at play and the raging battle attempted by central bankers to ward off the threat of deflation. It is a losing battle we think when one looks at the crumbling inflation in Europe as displayed by Bloomberg Chart of the Day from the 6th of November:

"The CHART OF THE DAY shows the five-year consumer-price swap rate declined to 1.34 percent on Nov. 1. That’s within one basis point, or 0.01 percentage point, of the level reached in June last year, which was the lowest since December 2008 and was followed by a 25-basis point reduction in the ECB’s main refinancing rate the following month. Reports today showed euro-area services output rose in October and German factory orders increased in September. “Despite the recovery, there’s still a lot of slack in the euro-zone economy,” said David Mackie, chief European economist at JPMorgan Chase & Co. in London. “If the ECB doesn’t respond to falling prices, people will worry about its commitment to meeting its medium-term objectives. The risk is that inflation expectations will fall further and create problems for them.”" - source Bloomberg.

For those who have been following us, you know that like any good cognitive behavioral therapist, we tend to watch the process rather than focus solely on the content. As we indicated in our conversation "The Dunning-Kruger effect": 

Not only do our central bankers suffer from the Dunning-Kruger effect but they are no doubt victim of the well documented "optimism bias" which we discussed in our "Bayesian Thoughts" conversation:

"Humans, however, exhibit a pervasive and surprising bias: when it comes to predicting what will happen to us tomorrow, next week, or fifty years from now, we overestimate the likelihood of positive events, and underestimate the likelihood of negative events. For example, we underrate our chances of getting divorced, being in a car accident, or suffering from cancer. We also expect to live longer than objective measures would warrant, overestimate our success in the job market, and believe that our children will be especially talented. This phenomenon is known as the optimism bias, and it is one of the most consistent, prevalent, and robust biases documented in psychology and behavioral economics."

Tali Sharot - The optimism bias - Current Biology, Volume 21, issues 23, R941-R945, 6th of December 2011.

When it comes to "optimism bias", the surprised rate cut by the ECB was indeed a proper demonstration given only 3 out of 70 economists had predicted a rate cut of 0.25% on Thursday but we ramble again...

After all, one only need to look at the German 2 year yield to realize that credit wise Europe is indeed turning Japanese. It's D,  D for deflation. German 2 year notes versus Japan 2 year notes indicative of the deflationary forces at play we have been discussing over and over again - source Bloomberg:

Credit dynamic is based on Growth. No growth or weak growth can lead to defaults and asset deflation which is what we are seeing in Europe and what a 0.7% inflation rate is telling you hence the ECB rate cut this week. It is still the "D" world (Deflation - Deleveraging).

As pointed out previously by our friend Martin Sibileau (who used to blog on "A View From The Trenches"), here is a reminder from his work which we quoted in our conversation "The law of unintended consequences" in Macronomics on the 25th of January 2012:

"With a more expensive Euro, Germany is less able to export to sustain the rest of the Union and growth prospects wane. At the same time, the private sector of the EU looks for cheaper funding in the US dollar zone, which will eventually force the Fed to not be able to exit its loose monetary stance."  - Martin Sibileau

Europe's horrible circularity case - Martin Sibileau

By tying itself to Europe via swap lines, the FED has increased its credit risk and exposure to Europe:
"If the ECB does not embark in Quantitative Easing, the Fed will bear the burden, because the worse the private sector of the EU performs, the more dependent it will become of US dollar funding and the more coupled the United States will be to the EU." - Martin Sibileau

As a side note and in relation to the EU private sector seeking USD funding as displayed in Martin's chart above, in 2012 over a third of the US Investment Grade supply (net issuance in $430 billions) was from non-US issuers up from 25% in 2011. This year we have seen about a third of the new issuance from non-domestic issuers (estimated net issuance for 2013 $400 billions).

As we have argued in "Mutiny on the Euro Bounty" in April 2012:

"More downgrades mean more margin calls, more margin calls means more liquidation and more Euros being bought and dollars being sold, with a growing shortage of AAA assets, Europe is moving towards mutiny on the Euro Bounty ship..."

Unless of course Mario Draghi goes for the nuclear option, Quantitative Easing, that is.

And as indicated by Martin Sibileau from his note from the 17th of October "The EU must not recapitalize banks":

"The circular reasoning therefore resides in that the recapitalization of banks by their sovereigns increases the sovereign deficits, lowering the value of their liabilities, generating further losses to the same banks, which would again need more capital."

What would be a solution for the EU? We have repeatedly said it: Either full fiscal union or monetization of the sovereign debts. Anything in between is an intellectual exercise of dubious utility."

When it comes to the growth divergence between the United States and Europe ("Growth divergence between US and Europe? It's the credit conditions stupid...", it is all about Stocks versus Flows. We posited the following in various conversations:

"We mentioned the problem of stocks and flows and the difference between the ECB and the Fed in our conversation "The European issue of circularity", given that while the Fed has been financing "stocks" (mortgages), while the ECB is financing "flows" (deficits). We do not know when European deficits will end, until a clear reduction of the deficits is seen, therefore the ECB liabilities will have to depreciate."

As the ECB approaches the zero bound boundary in its "easing" process, the only tools left will of course will have to be "unconventional" as pointed out in our conversation "Fears for Tears" in August:

"Should Mario Draghi feel the urge to trigger is "nuclear" device, it will have to be "Brighter than a Thousand Suns", to quote, J. Robert Oppenheimer...

Oh well..."

The interesting issue as of late when it comes to the AQR and banks recapitalization in Europe is that Germany firmly opposes the use of the ESM for that specific purpose. Excluding the ESM from financing the winding down of troubled banks will raise the problem of a financial backstop for the SRM (Single Resolution Mechanism), possibly delaying its proper operation for years, which from our point of view is interesting as we think that Germany in the end will be the country putting the nail in the coffin for the Euro experience as we indicated in our conversation "Eastern promises" on the 9th of June:

"We think the breakup of the European Union could be triggered by Germany, in similar fashion to the demise of the 15 State-Ruble zone in 1994 which was triggered by Russia, its most powerful member which could lead to a smaller European zone. It has been our thoughts which we previously expressed."

Squaring the Circle cannot be solved and the vicious cycle of banks and sovereigns cannot be solved either by a European Banking Union on its own.

Angela Merkel in this "Game of Century", while only appearing to be making material sacrifices, has managed to keep most of Germany's liabilities unchanged. So delaying the proper operational prospects for the SRM is in fact the application of what we said in our Chess analogy used in our "Game of Century" conversation in July 2012:

"In respect to the recent European summit, if European countries such as Italy, Spain and France gang up on Germany and ask for material changes in the rules and treaties of the "chess game" being played, we believe that "the only possible Nash equilibrium for Germany will be to defect""

Interestingly, Ambrose Evans-Pritchard from the Telegraph, in his article from the 4th of November entitled "Italy's Mr Euro urges Latin Front, warns Germany won't sell another Mercedes in Europe" reported on possibility of "Mutiny on the Euro Bounty":

"The plot is thickening fast in Italy. Romano Prodi – Mr Euro himself – is calling for a Latin Front to rise up against Germany and force through a reflation policy before the whole experiment of monetary union spins out of control.

"France, Italy, and Spain should together pound their fists on the table, but they are not doing so because they delude themselves that they can go it alone," he told Quotidiano Nazionale

Should Germany persist in imposing its contractionary ruin on Europe – "should the euro break apart, with one exchange rate in the North and one in the South", as he puts it – Germany itself will reap as it has sown. "Their exchange rate will double and they will not sell a single Mercedes in Europe. German industrialists know this but all they manage to secure are slight changes, not enough to end the crisis."" - source The Telegraph.

As a matter of fact funding for the ESM is capped at 700 billion euros and Germany is responsible for contributing about EUR190 billion by next April to the program but there is a snag. While the German Constitutional court has no legal authority on the ECB, it does have authority over the German parliament when it comes to committing German money to European programs (ESM and OMT included) given a debt of the ESM is a contingent liability of all the non-bailed out Eurozone countries.

As far the "optimism bias is concerned, a majority of analysts believe the German Constitutional court will allow the OMT to stand on the basis that EU treaty allows for purchases in the secondary bond market. We beg to differ. 

Once a debt is a contingent liability, for instance "super senior" there is no turning back, but the ESM being capped and the OMT yet to be firmly backed by Germany, the nuclear option is still an option rather than a reality.

We quoted Dr Jochen Felsenheimer in our conversation "The Unbearable Lightness of Credit" in August 2012, let us do it again for the purpose of the demonstration:

"The advantage of explicit guarantees is that the market can value them and that the guarantee can be taken up - even in a crisis! For this reason, we can quote the "last man standing" at this point, the president of the German Federal Constitutional Court, Andreas Vosskuhle:"The constitution also applies during the crisis". That is a hard guarantee, both for politicians and for investors!"

We will not discuss the issue of implicit guarantees and explicit guarantees from a credit valuation point of view as we have already approached this subject in our conversation quoted above. The only point you should take into account is that the advantage of explicit guarantees is that markets tend to "function" better under them. Obviously our great poker player "Mario Draghi" at the helm of the ECB has played with his OMT a great hand but based only on "implicit guarantee". That's a big difference.

An illustration on how distorted market can become when taking advantage of "explicit guarantees" has been the European car industry. We have extensively covered the subject as an illustration of the deflationary forces at play back in April 2012 in our conversation "The European Clunker - European car sales, a clear indicator of deflation" for those of you who would like to go deeper into the analysis. More recently, the effect of the latest Spanish Cash-for-Clunkers to support 70,000 new cars is illustrative of "explicit guarantees" we think as pointed out in the Bloomberg table below:

"Spain plans to support 70,000 new-car purchases under the fourth cash-for-clunkers scheme it has introduced in a year. Buyers will get 2,000 euros ($2,700), evenly funded by the government and dealer, when trading in a car between seven and 10 years old, and buying a new, more fuel-efficient vehicle costing up to 25,000 euros. Spanish auto sales through September were 51% below the average for the same period in 2000-07." - source Bloomberg.

Markets being extremely feeble creatures in the face of uncertainty will obviously react "rationally" when it comes to being provided with "explicit guarantees".

Obviously the lack of German Constitutional support could indeed prevent the whole "whatever it takes" European moment from moving from the "implicit guarantees" towards more "explicit guarantees" we would argue.

As pointed out by Bloomberg editors in their column from the 6th of November 2013 entitled "Europe's unfinished business threatens another recession",the European Banking Union is a must have. For us Europe is just trying to "Square the Circle:

"The most important stalled reform is in banking. Another round of bank “stress tests” has just been announced -- and this time, the ECB says, it’s serious. But there’s still no agreement on what happens to the banks that fail the tests. It’s universally agreed that the euro area needs not just a single bank supervisor -- which it now has in the form of the ECB --but also a single bank-resolution mechanism. That won’t fly, because Germany and like-minded countries won’t hear of bailing out failing banks or their financially stressed national governments.

This reluctance is understandable. But without a single bank-resolution mechanism, the euro project remains fatally flawed. The toxic link between distressed banks and distressed governments will remain. So long as that’s true, recovery will be held back and the euro area’s supposedly integrated capital market will be at risk of further splintering into separate zones. If the euro is to survive and its member countries prosper, a real banking union is indispensable." - source Bloomberg

The crux lies in the movement needed from "implicit" to "explicit" guarantees which would entail a significant increase in German's contingent liabilities. The delaying tactics so far played by Germany seems to validate our stance towards the potential defection of Germany at some point validating in effect the Nash equilibrium concept. We do not see it happening. The German Constitution is more than an "explicit guarantee" it is the "hardest explicit guarantee" between Germany and its citizens. It is hard coded. We have a hard time envisaging that this sacred principle could be broken for the sake of Europe.

On a final note, and in relation to "markets" going forward, in our conversation "The Cantillon Effects", we indicated of one of our "outside the box indicator" namely Sotheby's stock price versus world PMIs since 2007 - graph source Bloomberg:

We have argued that the performance of Sotheby’s, the world’s biggest publicly traded auction house was indeed a good leading indicator and has led many global market crises by three-to-six months.

It was interesting to see Sotheby’s stock price being down as much as 4% on the 6th of November, most intraday since Aug. 7, to lowest since Oct. 15, on 71% avg 3-mo. vol. as other auction house Christies flopped for a second consecutive night on the 6th of November in New-York with top-priced lots by Picasso, Modigliani and Leger failing to find buyers as reported by Bloomberg by Katia Kazakina and Philipp Boroff:

"Last night’s sale “also suffered from overestimation on several of the top lots,” said art adviser Mary Hoeveler. “Buyers don’t need to be told when something is a ‘masterpiece.’”

Alberto Giacometti’s portrait of his brother Diego, estimated at $30 million to $50 million, didn’t attract a bid in the room or on phone banks.

The painting was guaranteed by an undisclosed third party before the sale and the guarantor took it home for $32.6 million, a record for a Giacometti painting. Prices include commissions. Estimates do not.

The 1954 piece was sold by Jeffrey Loria, an art dealer and owner of the Miami Marlins baseball team, according to a state regulatory filing." - source Bloomberg.

So there you go the "explicit guarantee" did indeed lead to a sale in the end for Giacometti's portrait of his brother Diego, but we would not call this a "functioning market", somewhere, somehow someone took a hit.

As pointed out by our friend Cameron Weber in our conversation  "The Cantillon Effects", using art as a reference market in describing Cantillon effects and asset bubbles if of great interest as per his presentation entitled "Cantillon effects in the market for art":

"The use of fine art might be an effective means to measure Cantillon Effects as art is removed from the capital structure of the economy, so we might be able to measure “pure” Cantillon Effects.

This is as well confirmed by our good friends at Rcube Global Macro Asset Management in their recent monthly review:

"The Art market has always been an interesting indicator. The only major public auction house is Sotheby's since its floatation in the mid-1980s. It has proved a timely indicator of potential global stock markets reversal.

Whenever its price reached 50 or so with sky high valuations, a reversal was not far away. We can also take notice of the extremely weak jewelry and contemporary art auctions recently."

"To acquire knowledge, one must study; but to acquire wisdom, one must observe." - Marilyn vos Savant, American writer

Stay tuned!

Credit - The Yield Skeksis

"The ignorant mind, with its infinite afflictions, passions, and evils, is rooted in the three poisons. Greed, anger, and delusion." - Bodhidharma 

While watching the on-going "Yield Famine", with credit investors dipping their toes more and more clearly outside their comfort zone and snapping up CLOs (Collateralized Loan Obligations), providing the necessary fuel for the biggest surge in corporate buyouts since the outset of the financial crisis, we thought our weekly analogy should, no doubt, refer to some of the main antagonists, the Skeksis, from Jim Henson's legendary 1982 fantasy film the Dark Crystal.

In the Dark Crystal, the Skeksis are the corrupt rulers of the planet Thra, having inherited it from their benevolent Urskek predecessors. While they are the embodiment of their knowledgeable predecessors, due to the accelerated decomposition of their bodies, the Skeksis constantly search for ways to prolong their lives at all costs. In similar fashion to the Dark Crystal Skeksis, our Yield Skeksis constantly search for ways to enhance their yield returns.

The primary method of the original Skeksis was to expose themselves to sunlight channeled directly through the Dark Crystal, though the amount of energy replenished to them was greatly dependent on the conjunction of Thra's three suns. In similar fashion, our Yield Skeksis are highly dependent on interest levels set up globally by the Central banks to replenish their level of "energy". 

Another method used by the original Skeksis to prolong their lives at all cost was to drain the lifeforce from other life-forms by exposing them to the reflect beams of the Dark Crystal, with the life-force collected in a liquid form (or coupons for our Yield Skeksis) and drunk only by the Emperor, who regains his youthful appearance. The effect on the drained victims was to turn them into near-mindless husks which the Skeksis use as slaves.

Looking at the incredible surge of Greece ASE equity index since 2012 (up more than 110%), in similar fashion to the end of the Dark Crystal, following the unification of the crystal triggering in effect the merger between the Mystics and the Skeksis, the land is shown rejuvenated and equities rallied:

No doubt, our post from the 4th of March 2012 entitled "Equities, there is life (and value) after default!", indicates the powerful effect of bond restructuring / partial default can have on equities. It looks "crystal clear" to us, but we ramble again...

Of course our reference to the corrupt Skeksis from the Dark Crystal and some European politicians would be purely fortuitous as the saying goes. Although the Skeksis are capable of forming alliances, they are by nature extremely paranoid toward each other. After all the Skeksis were only 10 compared to the 27 members of the European Union:

-The Emperor skekSo (having originally been an energetic ruler who enjoyed lavish festivity and sporting events which he invariably won. As he aged however, he became increasingly paranoid and spiteful).

-The Chamberlain skekSil (skekSil is the most devious, most notably as his intentions are never fully revealed and seemingly contradictory).

-The Scientist skekTek (the other Skeksis fear him out of ignorance of his work. His fascination with anatomy was very great he went as far as amputating his right arm and leg, replacing them with mechanical constructs).

-The Ritual Master (aka High Priest) skekZok (spearheads the various rituals the Skeksis practice such as the "Ceremony of the Sun", and sees their laws as absolute).

-The The Garthim Master (aka General) skekUng (his constant blundering in the capture of the surviving gelflings fails to evoke the desired respect of his subjects).

-The Gourmand skekAyuk

-The Slave Master skekNa

-The Treasurer skekShod (He frequently bribes the other skeksis into temporarily loaning him their personal possessions).

-The Scroll Keeper (aka Historian) skekOk, (also the most dishonest as he constantly rewrites the Skeksis' history to suit his allegiances and propaganda needs).

-The Ornamentalist skekEkt (skekEkt is nonetheless described in The World of the Dark Crystal as an extremely vain and callous character who would gladly cause the death of countless animals for the sake of fabricating one cloak).

but we wander in our thoughts once more.

Similar to the Skeksis from the Dark Crystal, by preventing the ultimate restructuring  in Europe (which will eventually happen), creative destruction cannot happen in true Schumpeter fashion.

Following a quick overview, we would like to focus once again on the broken credit transmission mechanism in Europe in general and in peripheral countries in particular.

The indicator we have been monitoring, has been the 120 days correlation between the German Bund and its American equivalent, namely the US 10 year Treasury notes. In "Risk Off" periods we have noticed that the 120 days correlation had been close to 1 in 2010, 2011 and 2012, whereas in "Risk On" periods, the correlation was falling to significantly lower level. Currently the correlation is falling towards 70%, indicative of the on-going "Risk-On" in risk assets. - source Bloomberg:

The divergence between the performance in US equities (S and P500) and the Eurostoxx 50 has been clearly receding recently following the Italian elections scare, the red line in the graph being Italian 10 year yields - source Bloomberg:

In similar fashion, this divergence between US equities and Europe equities can be seen in the evolution of VIX versus its European counterpart V2X - source Bloomberg:

The short volatility spike in both the VIX and V2X has clearly receded, with V2X receding from 24 towards 17.

We have been monitoring as well the relationship between the Eurostoxx volatility and the Itraxx Crossover 5 year index (European High Yield gauge) - source Bloomberg:

The significant tightening witnessed this week in credit indices, has led the European High Yield risk gauge to recede towards the lowest points of 2010 and 2011, closing around 405 bps. The benchmark of 50 companies mostly speculative-grade ratings has fallen 47.5 bps this week, the biggest fall since January 4th and the lowest level since July 2011, supported by the US jobless rate and nonfarm payrolls number on Friday coming at 236 K.

But when it comes to the 7.7% unemployment level touched in the US. As far as we are concerned, unless we start seeing both a rise in velocity M2 and the US labor participation rate, we will remain skeptical about the much vaunted US recovery underway - source Bloomberg:

So, you might have 7.7% unemployment level but the US labor participation rate is still trending down and is now at 63.5%, a 32 year low and velocity remains muted. As we argued in our conversation "Zemblanity":

"Does the end (lowering unemployment levels) justify the means (increasing M) or do the means justify the end (deflationary bust)?"

So can someone please demonstrate to us how "this time it is going to be different" in terms of outcome for the US labor market given the "paradox of thrift" with bank reserves sitting idle at the Fed like we indicated in our previous conversation, with a broken transmission to the US economy, and questions surrounding fiscal stimulus which could potentially alleviate the situation (tax breaks for small companies anyone...)?"

Moving back to our Yield Skeksis analogy and relating to "Pareto Efficiency" in a Pareto efficient economic allocation, no one can be made better off without making at least one individual worse off, it is that simple, and the losers today being unfortunately the younger generation in "developed" countries, leading to high unemployment in Europe and lower growth.

We have highlighted the deflationary forces at play in Europe in our shipping conversations, the lack of credit and the broken credit transmission channel have led to poor growth prospects in conjunction with a significant rise in bankruptcies in Europe leading to a continuous rise in unemployment levels. The recovery in exports and shipping which could bring some improving growth prospects for Europe is clearly hindered by unemployment levels - source Bloomberg:

"Unemployment within the euro zone is expected to increase to 11.95% in 2013 from 11.7% in 2012, and to improve slightly to 10.8% by 2015. Lower unemployment is crucial for expanding global demand for goods, keeping capacity loose and rates depressed. The recovery in the shipping industry will not be fully realized without improving unemployment trends."  - source Bloomberg.

But if you think that in this game of survival of the fittest, the prolonged impact has only impacted the greed of  "Yield Skeksis" in a true Pareto efficient way, the QE induced rise in Bunker fuel prices has as well killed off the "velocity" of ships forcing them in essence to adjust their supply chain to survive:

"Slow steaming, or moving slower to conserve fuel, has affected 90% of shippers' supply chains and 85% of them had to make changes to their operations, according to a survey by Centrx and St. Joseph's University. Given the longer transit times, shippers are increasing inventory levels and moving to multiple carriers to gain access to additional departure times." - source Bloomberg.

Courtesy of ZIRP, our Yield Skeksis have seen:
-Falling Yields (in the Dark Crystal movie, originally, Gelflings were most ideal in essence extraction until they were exterminated and Podlings were used in their place, their lifeforce having a temporary effect on the drinker)
-Falling labor participation rate
-Falling velocity

In relation to the European government bond picture, this week Spanish 10 year yields closed around 4.85% and Italian 10 year yields around 4.57% whereas German government yields closed around 1.50% levels - source Bloomberg:

But even the excess liquidity which have been provided to financial institutions via LTRO 1 and LTRO cannot prevent the return at some point of sovereign risk - source Bloomberg:

"Excess euro-zone bank liquidity, defined as ECB current and deposit accounts less reserve requirements and marginal lending, drove falling yields and improved bank liquidity from late 2011. Current concerns on Italian political instability and delivery on austerity targets demonstrate that while retained LTRO funds continue to ensure adequate liquidity, bond yields and bank funding costs may rise again. Excess liquidity in the euro-area banking system fell below 400 billion euros for the first time since December 2011, when the first ECB long-term refinancing operation (LTRO) was announced and disbursed. Collectively, 224.7 billion euros of LTRO I and II have been repaid since the end of January. If excess liquidity falls further, scrutiny will likely fall on Euribor, EONIA and other liquidity-cost indicators. - source Bloomberg

Moving on to the subject of the broken credit transmission mechanism in Europe in general and in peripheral countries in particular, we have long argued that LTRO liquidity injections amounted to "Money for Nothing". 

Only 61 billion of Euros came back to the ECB relating to the second tranche of the LTRO, indicative on the  cautious stance of financial institutions in peripheral countries, which had been the biggest beneficiary. This is not really a surprise given that Italian banks for instance are seeing a steady rise in bad loans as the political gridlock is staving growth in the process. This is clearly indicated by Sonia Sirletti and Fabio Benedetti-Valentini in their Bloomberg article from the 7th of March entitled - Italian Banks' Bad Loans Seen Rising as Gridlock Hampers Growth:

"Italian corporate and household non-performing loans rose to a record in December, reaching 125 billion euros, according to data from the Italian Banking Association. Banks’ gross non-performing loans as a proportion of total lending increased to 6.3 percent from 5.4 percent a year earlier. France’s BNP Paribas SA, which owns a retail bank and consumer credit unit in Italy, and Credit Agricole SA reported higher bad-loan provisions from their Italian branch networks in the fourth quarter. 

Italy’s central bank has increased inspections and is urging banks to take more provisions. “In periods of market tension, the intensity of supervision cannot be relaxed,” Governor Ignazio Visco said in a speech on Feb. 9. “The Bank of Italy review of the top 25 banks likely means an increase in non-performing loans coverage” in the fourth quarter, Francesca Tondi, an analyst at Morgan Stanley, wrote in a report March 6. “We think 2013 accounts will also be affected by still-growing NPLs and the need for more coverage. 

Sovereign Debt:

UniCredit shares as much as doubled in Milan trading, and Intesa surged as much as 73 percent, after European Central Bank President Mario Draghi’s July pledge to do “whatever it takes” to defend the euro. Those gains began to erode over the past month as Italian government borrowing costs increased in the run-up to the elections. “Any renewed rise in funding costs would be the equivalent of a tightening in monetary conditions, with the potential to slow the economy,” Credit Suisse Group AG analysts including Yiagos Alexopoulos and Christel Aranda-Hassel said in a note last week. Italian banks tied their fortunes more closely to the financial strength of the state in 2012, increasing holdings of the country’s sovereign debt by 58 percent to 331 billion euros. Italy has 2 trillion euros of debt, more as a share of its economy than any developed nation other than Greece and Japan.” - source Bloomberg

This provision pressure on Italian banks can already be seen in the growing spread difference between German, and Italian Corporate loans with costs widening - source Bloomberg:

"The cost of accessing a corporate loan in Italy is nearly 1.5% higher than the equivalent in Germany. In mid-2011, Italian new loans were priced more cheaply than Germany's and since 3Q12, new corporate lending in Italy has cost more than in Spain. Coupled with lower repayment of LTROs by Italian banks than witnessed in Spain and political turmoil, the outlook for credit costs and supply in Italy is deteriorating." - source Bloomberg.

But it is not only Italy which is stricken by this broken credit mechanism transmission to the real economy. Spain has well is facing similar issues of significant rising corporate loan costs - source Bloomberg:

"The cost of a new corporate loan in Spain of more than 1 million euros for a duration of one to five years reached a four-year high in January, underlining how supply and cost of credit to Spain's corporates remains a source of concern. While IMF analysis suggests significant progress has been made on reform, and anecdotal evidence suggests that the domestic deposit war may soon come to an end, supply of credit remains poor." - source Bloomberg

According to Bloomberg, Rates on consumer credit loans up to one year in duration fell 0.8% in Spain and 0.4% in Italy during December but not enough to offset the pressure coming from rising nonperforming loans.

As we posited in January 2013 in our conversation "Cool Hand", the Bank of Spain has been revisiting the introduction of caps to time deposit rates in order to reduce the deposit war which started in 2012. While there is no doubt, early signs, of some sort of ceasefire, as indicated by Bloomberg. The lower than anticipated refund of the LTRO in conjunctions with rising nonperforming loans, might not be enough to increase credit access to the real economy - source Bloomberg:

"Interest rates on new spanish household deposits, with less than one year maturity, fell more than 50 bps to 2.43% in January, the biggest absolute drop for four years. Following five straight months of growth in deposits with an agreed maturity, this hints at improving liquidity and banking conditions following many months of bank restructuring and reform." - source Bloomberg.

The fall to 2.43% is the biggest monthly decline since Bank of Spain records began in 2003.

Truth is when it comes to the deleveraging process for European financial institutions, much more is needed when one looks at the level of Loans to Deposits as indicated by Morgan Stanley in their note from the 1st of March on European Banks:

Credit wised, the Loan-to-bond refinancing, or disintermediation, is another growth driver in European High Yield markets as European banks tighten lending conditions. According to Bloomberg, analysis shows 50% of funding in Europe from loans vs 40% in U.S. so while banks are in retrenching mode, companies are switching to the bond market rather that asking banks for loans with the stringent covenants normally attached to bank loans:

After all our the greed of our "Yield Skeksis" knows no bound and if ones looks at CLO demand for AAA  rated portions, one could see that the average spread on institutional loans was 377.6 basis points last month, down from 515 at the end of June 2012, as reported by Bloomberg and according to S&P Capital IQ Leveraged Commentary and Data.

Back in 2007 the tightest level was 243.3 basis points. On top of that and according to Bloomberg, borrowers obtained more than $88 billion in loans last month from non-bank lenders, exceeding the pre-crisis peak of $55 billion in April 2007 and more than tripling the $26.7 billion received in January, according to JPMorgan Chase & Co. More than 80 percent of the loans made this year were used to reduce borrowing costs or extend maturities.
On top of that ZIRP engineered by the Fed has managed to raise the level of corporate takeovers to 86.6 billion dollars in the US in February, the busiest month since July 2008 according to data compiled by Bloomberg.

Given the appetite of our Yield Skeksis it remains to be seen how low spread can go in order for them to replenish their level of "energy", but that's another credit bubble story, we think.

"It is greed to do all the talking but not to want to listen at all." - Democritus

Stay tuned!

Credit - The Donk bet

"There are three roads to ruin; women, gambling and technicians. The most pleasant is with women, the quickest is with gambling, but the surest is with technicians." - Georges Pompidou, former French president (1969-1974)

While watching the much anticipated LTROs refund on Friday, as well as the economic data during the week  with the rebound of the European PMI which we had anticipated (France being an outlier, but, our readers  know it doesn't come to us as a surprise), Spain's Economy Minister Luis de Guindos took center stage for us on Friday by declaring on Bloomberg TV: "Spain doesn't need any sort of bailout", adding that the target for the budget shortfall this year is "achievable" and concluding his remarks by "The perception of the Spanish economy has improved and will continue to do so over the next weeks and months". 

Given last week's title analogy referred to poker games in general and the art of bluffing in particular, we thought we had to use yet another poker game reference in our title namely the "Donk bet".

 The "Donk bet" being:

1. A bet made by a donk, i.e. one that is generally considered weak or to demonstrate inexperience or lack of understanding of strategy.
2. A bet made in early position by a player who didn't take initiative in the previous betting round. It was named because this move is often considered indicative of a weak player (since it is more often reasonable to expect a continuation bet). - source Wikipedia

It seems to us that Spain's Economy Minister has not fully demonstrated his understanding of the "Fabian Strategy" of Mario Draghi. Our "Generous Gambler" has been trying to "call the clock" (using another poker game reference) on Spain  namely trying to discourage them to take a long time to act.

We would therefore "agree to disagree" with Mr de Guindos given Spain pose the biggest threat to the survival of the Euro. In fact the Spanish Misery index has beaten Greece as the crisis bites and unemployment has reached 26.60% as indicated by Bloomberg:

The European Commission prediction for Spain’s budget shortfall last year is already wider than the EU’s goal of 6.3 % of gross domestic product. The target for 2013 is 4.5 %...

We quoted in our conversation "Agree to Disagree" Henry Queuille. Henri Queuille was the epitome for "professional politician": he served three times as Prime Minister and was 21 times minister in a French government under the IIIrd and IVth French Republic. He was the symbol of the inefficiency and the failure of the French IVth Republic:

"Politics is not the art of solving problems, but to silence those who ask." - Henri Queuille

It appears to us that Mr de Guindos is indeed a true disciple of Henri Queuille when we listened to his latest Bloomberg interview. As a matter of Spanish "quote" comparison, BBVA's Chief Operating Officer Angel Cano said in April 2010 that asset quality was probably going to be "stable from now on". Looking how "stable nonperforming loans have in been in Spain, one can wonder whether or not a Henri Queuille award should be set up in Europe for the best delusional political quote, but, we ramble again...

So in true poker fashion, one can posit "there's indeed plenty of action in this game". In this week's conversation we will therefore look at what lies ahead for the Spanish banking sector in general and Spain's real economy in particular in conjunction with the LTRO impact of the early refund. But first a quick credit overview.

US PMI versus Europe PMI - source Bloomberg

"Short term, we do expect a minor reduction in the divergence as reflected in credit prices such as the US leveraged loan cash price index versus its European peer." - Macronomics, The Fabian Strategy, 5th of January 2013

We explained the divergence in our conversation "Growth divergence between the USA and Europe" and we indicated early January that this divergence should persist in 2013. 

The uncanning similarity of the US leveraged loan cash price index versus its European peer with the above PMI graph - source Bloomberg:

"Loan prices have risen to 97.72 cents on the dollar, the highest since July 2007, from 59 cents in December 2008, as concern eases that the world’s largest economy will slide back into recession. Leveraged loans and high-yield, high-risk bonds are rated below Baa3 at Moody’s Investors Service and lower than BBB- at S&P." - source Bloomberg.

The current European bond picture with the continuing fall in Spanish and Italian yields with rising Core European yields - source Bloomberg:

In relation to our "Flight to quality" picture, Germany's 10 year Government bond yields have been recently rising above 1.60% and the 5 year CDS spread for Germany has been rising in tandem in the process - source Bloomberg:

2 year German bond yields versus 2 year Japanese yields, yet another "sucker punch" courtesy of the LTRO's refund anticipations. From 0% yield to 0.23% in January 2013 - source Bloomberg:

Credit and volatility wise, the Itraxx Crossover index (representing the credit risk gauge for 50 European high yield entities) have as well falling in tandem but with volatility (a subject we recently touched on) breaking through important levels similar to the regime of 2004-2007 - source Bloomberg.

Credit wise, what really caught our attention was not only the "new regime" in volatility (or should we say Central Banks' dictatorship via "financial repression"), but, the US High Yield space, where Tenet Healthcare has issued a 7 year bond with a single "B" rating with a coupon of 4.25%, which is an "all time low" level for a primary yield level on a single "B" credit on a 7 year bond.  

As we have discussed in our first credit conversation of the year "The Fabian Strategy", we don't believe the hype in credit and as we argued in our conversation "Hooke's law" previously the "credit mouse-trap" has been set by Central Banks. Well done...

We also recently reflexionate around the return of mega leveraged buyout transactions such as DELL inc  in our recent conversation "The return of LBOs - For whom the Dell tolls".  Record low borrowing costs in the market for junk bonds (high yield) where LBOs are financed is creating the ideal set up for a leverage buyout   buying spree: "There will be about $135 billion in LBO volume this year, compared with an average of $100 billion during the past two years, and below the $600 billion annual peak of 2006 and 2007, he said. Credit-default swaps typically surge on LBO speculation because the debt added to a company’s balance sheet to fund the takeover erodes its credit quality and leads to ratings downgrades. 
“As the recent experience with Dell illustrates, the risk of LBOs has a particularly large impact” on Markit’s investment-grade benchmark, pushing it a net 2 basis points wider, Bank of America’s Mikkelsen and Yuriy Shchuchinov wrote in a Jan. 23 note. Their model shows 14 percent of the index’s underlying credits are feasible LBO candidates. 
 Credit-default swaps on Quest Diagnostics have climbed 38.5 basis points to a mid-price of 123 basis points since Bloomberg News first reported Dell’s buyout discussions with private- equity firms, according to data provider CMA, which is owned by McGraw-Hill Cos. and compiles prices quoted by dealers in the privately negotiated market. 
Buying Protection:   
That was “precipitated by investors’ buying protection on names that have traditionally been considered LBO candidates,” following the Dell news, according to a note dated Jan. 23 from Barclays Plc analysts led by Shubhomoy Mukherjee. Credit-default swaps tied to Nabors surged 42 basis points to 191, the highest since July, and contracts on Avnet Inc.’s debt climbed as high as 254 basis points on Jan. 14 before falling to 178 basis points yesterday, CMA data show. Those on Falls Church, Virginia-based Computer Sciences Corp. added 40.5 basis points since Jan. 11 to 193 yesterday. Buyout firms announced a record $1.6 trillion of acquisitions from 2005 to 2007. The end of that era was “quite painful for many overleveraged deals and many PE firms and their investors have continued their long wait to reach that point where they can exit and take their gains,” CreditSights Inc. analysts Glenn Reynolds and Ping Zhao wrote in a note."  - source Bloomberg - Dell Lifts Default Risk on Next Buyout Targets: Credit Markets.

Could that be another indication of a "Donk bet" taking place in the credit space? We wonder...

As we have argued last week's Dell LBO conversation:
"One thing for sure with which we clearly agree on with CreditSights, is that the yield curve management policies of the Fed is clearly pushing investors into higher risk assets to reach for return in this "Yield Famine" induced environment of "Financial Repression" (probably out of their comfort zone too...)."

Moving on to the Spanish "Donk bet", no disrespect to Mr de Guindos and Mr Cano but we will have to agree with Citi's recent note on Spanish Banks - Iberoamerican Big Picture from the 21st of January:
"A change in the latest asset quality deterioration trend is needed for the sustainability of the banking system. If at a system level we maintain the loan contraction and the NPL growth during the next 5 quarters, the NPL ratio for the corporate segment would increase to 29.1% in 4Q13E from 16.6% in 3Q12. As expected the key drivers of the NPL growth will be the construction and the real estate sectors" - source Citi

"Just as an example, if we maintain the yoy loan contraction and the NPL growth during the next 5 quarters, the NPL ratio for the corporate segment would go from 16.6% in 3Q12 to 29.1% in 4Q13E. Just keeping the contraction deleverage pace stable pace with the stock of NPLs, the NPL ratio would increase to 18%." - source CITI

So much for "stability Mr Cano. So much for "improvement Mr de Guindos.

In last week's conversation "Cool Hand" we discussed the Bank of Spain's recent willingness in stemming the  war for deposits taking place in Spain:
"By trying to put an end to the deposit wars, the Bank of Spain ambitions to reduce the pressure on banks' earnings and profitability which would reduce the capital shortfall for some Spanish banks and the level of capital injunctions needed. It is once again a "Fabian strategy", buying time that is."

Citi's recent note on that matter is as follows:
"On 8 January 2012, the Spanish press reported that the Bank of Spain had “recommended” the largest banks in Spain to limit the yield of saving products. Other banks followed shortly. The measure apparently would also affect guaranteed funds and commercial paper products. The penalty for high yield deposits would consist of higher capital requirements, which would not affect foreign banks operating in the country (ie Banco Espirito Santo, ING). 

The press sources differ in the way the penalty is going to work, given the lack of official statements from Bank of Spain, the interpretation of the law can vary significantly. We expect a law to regulate this “recommendation” shortly. The Bank of Spain has taken this measure in order to reduce the cost of funding for the banks, which are expected to transfer part of this reduction to lower lending rates. We have to take into account that, according to the 3Q12 results, banks are already reducing the yield of loans after the repricing cycle during 2012. 

How do we understand the new recommendation? It will apply to the new savings production from banks — 85% of the new production of the banks won’t be able to exceed the yield limits set in the table below (Figure 4). The banks exceeding this limit will need to comply with higher core capital requirements, according to the press up to 125bps more from the current 9.0% requirement. The latest reports point out that the deposits above €10 million won’t be affected by the new requirement, supporting big corporate and public deposit accounts." - source CITI

The larger than expected EUR 137.2 billion initial repayment from the first three year LTRO (consensus was for 84 billion), we will have to wait until mid-march to get the geographical breakdown from National Central Banks in order to assess the complete picture for European countries.

But some Spanish banks such as Banco Sabadell indicated on the 11th of January, that the bank was planning to repay EUR 4.8 billion of LTRO funding (20% of the total requested) according to Citi's note.

As far as profitability for Spanish banks is concerned, as indicated by Citi's note:
"Given that the last LTRO was already announced in February 2012, it should be fully included in analysts’ estimates, reducing revenues expectations for 2015. Below we can find the revenue consensus estimates of our coverage universe. It is not only that revenues seem high, in our view, it is also that consensus seems to be missing the LTRO effect in 2015 revenue estimates, as they are expected to grow by 7% on average (ex Santander and BBVA)." - source Citi

An interesting analysis from Citi, while there are not missing out on the LTRO impact on earnings, we think they are lacking some essential points in relation to Spanish banks.

-First missing point - the issue of puttable bonds which we discussed in our conversation "When causation implies correlation":
"Banco Santander SA, Spain’s biggest lender, is placing its trust in bondholders by issuing 4.4 billion euros ($5.7 billion) of fixed-income securities that investors are able to redeem before maturity.
Bonds with put options make up 36 percent of Santander’s debt funding this year, compared with 9 percent in 2011, according to data compiled by Bloomberg. While the bonds have lower interest rates, they leave the bank vulnerable to a potential 7 percent increase in the 33.4 billion euros it must repay next year. Investors have already demanded early repayment on 1 billion euros of the notes." - source Bloomberg
Puttable bonds are indeed a typical instrument used by financial institutions under stress. For us, a big red flag." - source Macronomics, When causation implies correlation, 27th of October 2012

-Second missing point - the issue of the dwindling capacity in absorbing potential losses at the parent bank due to partial IPOs discussed in the same October conversation:
Another red flag we think for Santander, comes from its dwindling capacity in absorbing potential losses at the parent bank by its increasing policy of partial IPOs such as the one done in Mexico as indicated by CreditSights in their report Spanish Banks - The Value of Empires from the 22nd of October:
"In Santander's case especially, the capacity of equity in its foreign subsidiaries to absorb potential losses at the parent bank is being reduced by its policy of partial IPOs(the goal being to list all the most significant subsidiaries within five years – see Santander: Partial IPO in Mexico). The erosion of loss absorbing capacity that this implies at parent or group level is reflected in the Basel 3 reform that will ultimately prevent banks from including in consolidated CET1 capital any surplus equity contributed by minorities in excess of the subsidiaries' minimum regulatory requirements." - source CreditSights" 

-Third missing point being one of Macronomics's favourite namely the importance of "Goodwill" (see our conversation from November 2011 - "Goodwill Hunting Redux"):
"Large Goodwill Impairments increase the debt to equity ratio.
It is therefore paramount to track goodwill impairments in relation to future banks earnings."

Goodwill:
"Goodwill is an accounting convention that represents the amount paid for an acquisition over and above its book value. Under the accounting rules European banks use, the International Financial Reporting Standards, companies have to write down goodwill on their balance sheets if the underlying assets have permanently deteriorated in value."

In December 2010 ("Goodwill Hunting - The rise in Goodwill impairments on Banks Balance Sheet"), this is what we discussed as a reminder:

"When a bank acquires another one, goodwill as intangible asset goes on its balance sheet. When a medium bank acquires a smaller one, goodwill is created onto the balance sheet. But, when the medium bank is acquired by a larger one, there is a compounding effect given that the larger bank will also create some more goodwill of its own and therefore inflates its balance sheet.

As the process goes on and on, for banks on the acquisition war path, you find more and more goodwill making up the capital."

We also indicated at the time:

"Looking at non-cash intangible assets (i.e., goodwill) can be a good indicator and used as a proxy to determine the health of banks.

The significance of the write-downs on Goodwill is often presaged as rough waters ahead. These losses often take a real bite out of corporate earnings. It is therefore very important to track the level of these write-downs to gauge the risk in earnings reported for banks."

When one looks at European banks, Spanish bank Santander, Credit Agricole and Italian bank Intesa are carrying the most "Goodwill" as indicated in the table below from Bloomberg:

"A mere 5% of the 800 billion euros of outstanding goodwill was impaired in 2011, with about 19.2 billion (2.4%) relating to financial services, according to an analysis of 235 public European companies by the European Securities and Markets Authority. The top 24 European banks' combined goodwill fell to 173 billion euros at FY07, from a 2007 peak of 233 billion euros, with further impairments likely." - source Bloomberg.

In relation to the "real economy" in Spain and the on-going "Donk bet", Spanish recession has deepened in the last quarter of 2012 with GDP contracting 0.6% from the previous 6 months when it slipped 0.3%. So while Spanish Economy Minister Mr de Guindos is seeing an improvement in the perception of the Spanish economy, there is a difference between perception and reality. Even the European Commission on the 22nd of January indicated Spain would miss its 2012 deficit target. with a GDP contraction forecast of 1.4%, taking the deficit to 6% for 2013, not the "ambitious" 4.5% Mr de Guindos seems so sure of.

What matters is loan growth for economic growth to resume in Spain. We do not see it happening in 2013 for the "real economy" - graph below source Citi:

As indicated in the article from Charles Penty in Bloomberg from the 21st of January 2013 entitled - "Spain Banks selling debt still won't cut loan costs:
"The prospect of diminishing competition for retail deposits may boost lending margins. Reports that the Bank of Spain wants lenders to cap the yields they offer on deposits are positive for banks because it would provide relief for their funding costs and bolster margins, Sergio Gamez, an analyst at Bank of America Merrill Lynch, wrote in a Jan. 10 note to clients. Bank behavior may make it hard for Spain to rejuvenate an economy mired in a five-year slump and headed for a further contraction this year, said Tobias Blattner, an economist at Daiwa Capital Markets in London. Spain’s economy will shrink 1.5 percent this year after contracting 1.4 percent in 2012, according to the median forecast of 38 analysts surveyed by Bloomberg. “The interest rates that banks are charging to lend to companies aren’t going down and that’s a big worry,” Blattner said. “There are no signs yet of a pass-through by banks of their lower funding costs to the real economy.”" - source Bloomberg

We hate sounding like a broken record but, no credit, no loan growth, no loan growth, no economic growth and no reduction of aforementioned budget deficits:
"So austerity measures in conjunction with loan book contractions will lead unfortunately to a credit crunch in peripheral countries, seriously putting in jeopardy their economic growth plan and deficit reduction plans."- "Subordinated debt - Love me tender?" - Macronomics, October 2011

From the same Bloomberg article: 
“If they’re using wholesale debt that costs 3 to 4 percent to replace ECB funding that costs 0.75 percent, that means substantial pressure on margins,” Creelan-Sandford said. Banks are trying to wring more revenue from loan books as they seek to absorb the rising cost of a clean-up of 180 billion euros of real estate assets ordered by the government last year, he said. Banks in other nations have dropped their lending rates, ECB data show. German rates declined to 2.9 percent from 3.9 percent a year earlier, while French companies pay 2.2 percent, down from 3.2 percent. In Portugal, the cost of a loan for as much as 1 million euros fell to 6.7 percent from 7.6 percent, while Irish banks charge 4.6 percent, compared with 5.3 percent. Spanish companies are petitioning Prime Minister Mariano Rajoy, who says one of his priorities in government is to create conditions for credit to recover in Spain. The Spanish Confederation of Small and Medium-Sized Companies said in a Jan. 17 statement that it didn’t see “normal” financing conditions returning until 2016 at the earliest and that the lack of funding put firms in a “situation of extreme weakness.” - source Bloomberg

It is deflation in Europe and Spain is still mired in a deflationary spiral. 

On a final note the VIX volatility index passed the 5 year level as Bank CDS fall further as indicated in the Bloomberg chart from the 21st of January:

"The VIX Index, a widely-used measure of market risk often called the investor fear gauge, fell to its lowest level in more than five years as macroeconomic concerns, including those regarding the U.S. fiscal cliff, recede. Certain bank revenue streams remain correlated to volatility, with lower volatility increasing demand for risky assets, pressuring prices higher, and vice versa." - source Bloomberg

"There is no gambling like politics." -   Benjamin Disraeli, British statesman

Stay tuned!