Tuesday, September 30, 2008

Payments crisis developing in the Eurozone!

European countries are not sovereign, currency issuing nations and therefore are highly limited, fiscally, in being able to address a problem such as large scale bank runs. The ECB is precluded by the Maastricht Treaty from bailing out institutions. European banks and financial institutions have exposure in dollars, which only the U.S. Fed can supply. A real crisis may be developing, which could result in a crash of the euro and a total shutdown of the banking systems in many European countries.

Read Bloomberg article below.

Euro Falls Most Against Dollar Amid European Banking Failures

By Daniel Kruger and Ye Xie

Sept. 30 (Bloomberg) -- The euro fell the most against the dollar since the introduction of the shared currency in 1999 after France and Belgium led a state-backed rescue of Dexia SA, as the widening financial crisis forces governments to prop up financial institutions across Europe.

The 15-nation currency also weakened against the British pound after Belgian Prime Minister Yves Leterme said Dexia, the world's biggest lender to local governments, will receive about $9.2 billion to shore up its capital. The dollar rose against the yen on speculation the U.S. Senate will salvage a $700 billion bank-bailout plan as early as tomorrow after Congress rejected it yesterday.

``The consensus is the U.S. banking system is a little bit further along in its exposure of its toxic assets,'' said Firas Askari, head currency trader at BMO Nesbitt Burns in Toronto. ``It's a case of which is relatively worse. The dollar's going to benefit against the euro because Europe has more to expose.''

Mike Norman says:

"Euro nations have borrowed in foreign currency (U.S. dollars) and only one institution can provide them with that currency: that would be the U.S Federal Reserve. This is the crux of the issue and the heart of the problem. Possiblilty that this leads to a classic payments crisis and collapse, like Argentina in 2001, or the U.S. banking system when we were on the gold standard
in the early 1930s."

The euro fell 2.5 percent to $1.4079 at 11:55 a.m. in New York, from $1.4434 yesterday. The euro also slid to 149.10 yen from 150.38. It earlier reached 148.55, the weakest since Sept. 16. The yen weakened to 1056.93 per dollar from 104.18, after earlier reaching 103.54, also the most since Sept. 16.

The capital infusion for Dexia comes two days after Belgium, the Netherlands and Luxembourg rescued Fortis, the largest Belgian financial-services company, Britain took control of Bradford & Bingley Plc, the country's biggest lender to landlords, and Germany bailed out Hypo Real Estate Holding AG.

Implied volatility on one-month euro-dollar options rose to 16.9575 percent, or the highest in almost eight years. On Sept. 18, it reached 15.55 percent, the same level that triggered the Group of Seven nations to buy euros in 2000 to halt the 27 percent slide from its 1999 debut.

`Fundamentals Are Irrelevant'

Banks are being squeezed amid a surge in borrowing costs as lenders hoard cash on concern more financial institutions will fail. The euro interbank offered rate, or Euribor, that banks charge each other for one-month loans climbed to a record 5.05 percent today, the European Banking Federation said.

The London interbank offered rate, or Libor, that banks charge each other for such loans in dollars climbed 431 basis points to an all-time high of 6.88 percent today, the British Bankers' Association said.

``There's a dollar shortage globally,'' said Alan Ruskin, head of international currency strategy in North America at RBS Greenwich Capital Markets Inc. in Greenwich, Connecticut. ``Demand for liquidity trumps the fundamentals. Fundamentally, the U.S. is awful, and Europe is awful. Fundamentals are irrelevant today.''

Cross Currency Swaps

Foreign banks are paying the highest premiums in at least a decade to borrow in dollars in the swaps market even after the Federal Reserve more than doubled the amount of funds available to other central banks yesterday by expanding swap lines.

The Fed's actions included increasing existing currency swaps with foreign central banks by $330 billion to $620 billion to make more dollars available worldwide. The European Central Bank, the Bank of England and the Bank of Japan are among the participating authorities.

The price on one-year cross-currency basis swaps between yen and dollars reached minus 70 basis points, the biggest effective premium for dollar funding since Bloomberg began tracking the data in 1997. The highest reached in 1998, during the Asian banking crisis was minus 38.5 basis points in October 1998, according to Bloomberg data.

`Mad Scramble'

``There is a mad scramble for U.S. dollar funding demand from a global U.S. dollar-based financial system,'' said Claudio Piron, Singapore-based head of Asian currency research at JPMorgan Chase & Co, the second-biggest U.S. bank by market value. ``Central banks have been extending swap lines as lenders of the last resort. The banks access this liquidity, but they hoard it for themselves as they believe it too risky to lend to anyone else.''

The U.S. Senate will try to revive a $700 billion financial-rescue package after yesterday's defeat in the House of Representatives. The bill would have allowed the government to buy troubled assets from banks. Institutions posted $590 billion of losses and writedowns since the start of last year following the collapse of the U.S. subprime-mortgage market.

Rising Yen

Higher-yielding currencies recouped losses against the Japanese yen as Europe's benchmark Dow Jones Stoxx 600 Index gained 1 percent. The Australian dollar rose 1.2 percent to 84.84 yen after falling 4.9 percent yesterday. The New Zealand dollar gained 2.2 percent to 71.55 yen after dropping 3.7 percent yesterday.

``I would be very cautious in betting on further near-term dollar-yen losses,'' said Michael Klawitter, a currency strategist at Dresdner Kleinwort in Frankfurt. ``Any positive news on the political front would have quite an impact.''

The yen typically declines when demand for high-yielding currencies rises, as traders put on so-called carry trades. In such transactions, investors get funds in countries with low borrowing costs and buy assets where returns are higher. Japan's 0.5 percent target lending rate compares with 7 percent in Australia and 7.5 percent in New Zealand.

The yen rose the most of all 16 most-actively traded currencies yesterday after the Standard & Poor's 500 Index plunged the most since the 1987 crash.

The Japanese currency is up 12 percent against the euro this quarter. The dollar has fallen 0.3 percent against the yen, paring a 7 percent gain in the previous three months. The euro is down 11 percent against the dollar.

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