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Fed Expected to Give Trillions to European Banks

The Euribor/OIS spread or`fear gauge’ is flashing red warning signals. Dollar funding costs in Europe have spiked to Lehman-crisis levels, leaving lenders struggling frantically to cover their $2 trillion (£1.3 trillion) funding gap.

America’s money markets are no longer willing to lend to over-leveraged Euroland banks, or only on drastically short maturities below seven days. Exposure to French banks has been slashed by 69pc since May.
Italy faces a “sudden stop” in funding, forced to pay 6.5pc on Friday for six-month money, despite the technocrat take-over in Rome.

German Bund yields have risen to 59 basis points above Swedish bonds since Wednesday’s failed auction. German debt has been relegated suddenly against Swiss, Nordic, Japanese, and US debt. As the Telegraph reported two weeks ago, Asian central banks and sovereign wealth funds are spurning all EMU bonds because they have lost confidence in a monetary system with no lender of last resort, coherent form of government, or respect for the rule of law.

Even if EU leaders could agree on fiscal union and joint debt issuance – which they can’t – such long-range changes cannot solve the immediate crisis at hand. The push for treaty changes has become a vast distraction.

Unless Germany agrees to the full mobilization of the European Central Bank very fast, the eurozone will spiral out of control. As The Economist put it, “The risk that the currency disintegrates within weeks is alarmingly high.”

Theoretically, EMU can limp on though the Winter until the Italian debt auctions of €33bn in the last week of January, and €48bn in the last week of February. The reality is that sovereign contagion to the financial system may well bring matters to a head more swiftly.

If break-up occurs in a disorderly fashion, with Club Med states and Ireland spun into oblivion one by one, the chain reaction will cause an implosion of Europe’s €31 trillion banking nexus (S&P estimate), the world’s biggest and most leveraged. This in turn risks an almighty global crash – first class passengers included.

via Should the Fed save Europe from disaster? – Telegraph.

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