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December 31, 2011

We Hold This Truth To Be Self-Evident: You Can't Solve A Debt Problem With More Debt

We Hold This Truth To Be Self-Evident: You Can't Solve A Debt Problem With More Debt

Flat Earth
"Whoever cannot seek the unforeseen sees nothing for the known way is an impasse."
― Heraclitus, Fragments

Which path will we take? If we could only grow our way out of our sovereign debt problems. But growing debt creates even more problems if not dealt with, making it even more difficult to deal with; yet getting the debt and deficit under control brings its own form of pain.

As I keep pointing out, there are no easy choices left. Some countries must choose between difficult and very bad, and others are faced with either disaster or calamity. Greece simply gets to choose what it wants to be the cause of a depression. Long and slow or fast and deep? Choose wisely.

It's that time of year when we start thinking about what the next may hold for us. I am reading and thinking a great deal about my annual forecast issue next week, taking some time off from my usual Friday missive; so this week we look at what I think is one of the best pieces of analysis I have read in the past few months. It is from a private letter for the Boston Consulting Group, and Dan Stelter graciously allowed me to let my friends read it.

Follow this thinking carefully and then think through their outline of what a country would have to do to leave the euro, which starts at the subhead entitled "What if… ?". Then ask yourself what do you need to do. The short answer from me is that you need to consider more what you already own rather than what you should buy.

At the end of the letter is a link to an in-depth review of what scenarios businesses should be considering, but it will also work for individual investors. Now, let me turn it over to Dan and David.

Collateral Damage

What Next? Where Next?

What to Expect and How to Prepare


David Rhodes and Daniel Stelter

January 2012

This paper covers some familiar ground in order to remind readers of the interplay among the most important economic developments, considers the scenarios for which companies should prepare, and suggests some steps that prudent companies may wish to consider. For those readers who are well acquainted with the economic scenarios described, we suggest that you start reading at "What Should Companies Do to Prepare?" beginning on page 13, below.

The economic travails of much of the West are reaching a decisive stage as the year ends. In 2008, we predicted sluggish recovery and a long period of low growth for the West in a two-speed world. This picture does not now properly reflect the downside risks. The policy of "kicking the can down the road" is failing, as the intensifying crisis in the euro zone and the failure of the G20 summit in late October clearly demonstrate. As to December's European summit, we describe its impact later in this paper.

Such extreme uncertainty is challenging for companies trying to prepare their budgets for next year—or, more fundamentally, trying to plot their strategic course. It helps to have a clear understanding of what may happen and why it may happen. So before we address the question of which scenarios to expect and how to prepare, let us remind ourselves about the root of the problem: the West is drowning in debt.

A World with Too Much Debt

Total debt-to-GDP levels in the 18 core countries of the Organisation for Economic Co-operation and Development (OECD) rose from 160 percent in 1980 to 321 percent in 2010. Disaggregated and adjusted for inflation, these numbers mean that the debt of nonfinancial corporations increased by 300 percent, the debt of governments increased by 425 percent, and the debt of private households increased by 600 percent. But the costs of the West's aging populations are hidden in the official reporting. If we included the mounting costs of providing for the elderly, the debt level of most governments would be significantly higher. (See Exhibit 1.)

Add to this sobering picture the fact that the financial system is running at unprecedented leverage levels, and we can draw only one conclusion: the 30-year credit boom has run its course. The debt problem simply has to be addressed. There are four approaches to dealing with too much debt: saving and paying back, growing faster, debt restructuring and write-offs, and creating inflation.

Saving and Paying Back. Could the West simply start saving and paying back its debt? If too many debtors pursued this path at the same time, the ensuing reduction in consumption would lead to lower growth, higher unemployment, and correspondingly less income, making it more difficult for other debtors to save and pay back. This phenomenon, described by Irving Fisher in 1933 in The Debt-Deflation Theory of Great Depressions, can result in a deep and long recession, combined with falling prices (deflation). This is amplified when governments simultaneously pursue austerity policies—such as we see today in many European countries and will see in the U.S. beginning in 2012. A reduction in government spending by 1 percent of GDP leads to a reduction in consumption (within two years) of 0.75 percent and a reduction in economic growth of 0.62 percent. Saving (or, more correctly, deleveraging) will reduce growth, potentially trigger recession, and drive higher debt-to-GDP ratios—not lower debt levels. Indeed, during the early years of the Great Depression, President Hoover—convinced that a balanced federal budget was crucial to restoring business confidence—cut government spending and raised taxes. In the face of a crashing economy, this only served to reduce consumer demand.

For the private sector and government to reduce debt simultaneously would require running a trade surplus. So long as surplus countries (China, Japan, and Germany) pursue export-led growth, it will be impossible for debtor countries to deleverage. Martin Wolf put it trenchantly in the Financial Times: "The Earth cannot, after all, hope to run current account surpluses with the people of Mars." The lack of international cooperation to rebalance trade flows is a key reason for continued economic difficulties.

Saving and paying back cannot work for 41 percent of the world economy at the same time. The emerging markets would have to import significantly more, which is unlikely to happen.

Growing Faster. The best option for improving woeful debt-to-GDP ratios is to grow GDP fast. Historically, this has rarely been achieved, although it can be done—for example, in the U.K. after the Napoleonic Wars and in Indonesia after the 1997/1998 Asia crisis (although Indonesian debt levels were nowhere near contemporary highs in the West). Attacking today's debt mountain would require reforming labor markets or investing more in capital stock. Neither is happening.

Politicians are unwilling to interfere in labor markets given today's elevated levels of unemployment. Moreover, empirical evidence shows that the initial impact of such reforms is negative, as job insecurity breeds lower consumption.

Companies can afford to invest significantly more, as they are highly profitable. The share of U.S. corporate profits in relation to U.S. GDP is at an all-time high of 13 percent (as are cash holdings), yet corporate real net investment (that is, investment less depreciation) in capital stock in the third quarter of 2011 was back to 1975 levels. But companies are reluctant to invest while demand is sluggish, while existing capacities are sufficient, and while the outlook for the world economy remains highly uncertain.

The aging of Western societies will be a further drag on economic growth. By 2020, the workforce in Western Europe will shrink 2.4 percent, with that of Germany shrinking 4.2 percent.

The inability to grow out of the problem is bad news for debtors. Look at Italy, for example: Italian government debt is 120 percent of GDP. The current interest rate for new issues of ten-year bonds is 7 percent—up from 4.7 percent in April 2011. If Italy had to pay 6 percent interest on its outstanding debt, such a high rate would materially increase the primary surplus (that is, the current account surplus before interest expense) that Italy would need to run in order to stabilize its debt level. If we assume that Italy's economy grows at a nominal rate of 2 percent per year, the government would need to run a primary surplus of 4.8 percent of GDP (calculated as 6 percent interest incurred on its debt minus 2 percent nominal growth multiplied by 120 percent debt to GDP) just to stabilize debt-to-GDP levels; the latest forecasts show only a 0.5 percent surplus for 2011. Any effort to increase the primary surplus through austerity and tax increases runs the risk of creating a downward spiral. When investors start doubting the ability of the debtor to serve its obligations, interest rates rise even further, leading to a vicious circle of austerity, lower growth, and rising interest rates.

Debt in itself makes it more difficult to grow out of debt. Studies by Carmen Reinhardt and Kenneth Rogoff and the Bank for International Settlements show that once government debt reaches 90 percent of GDP, the real rate of economic growth is reduced. This also applies to the debt of nonfinancial corporations and private households. Exhibit 2 shows the current debt level of key economies by sector. In all countries, the debt level of at least one sector is beyond the critical mark. Somewhat perversely, only in Greece are the two private sectors below the threshold. And only in Germany and Italy (in addition to Greece) do private households have a debt level below 70 percent of GDP.

[Note: For those not familiar, the flags represent the US, Japan, Germany, France, Britain, Portugal, Italy, Ireland, Greece, and Spain, in order. – JM.]

Debt Restructuring and Write-offs

We explored this option in our last paper (Back to Mesopotamia: The Looming Threat of Debt Restructuring, BCG Focus, September 2011). Assuming a combined sustainable debt level of 180 percent of GDP for private households, nonfinancial corporations, and governments, we estimated the debt overhang to be €6 trillion for the euro zone and $11 trillion for the U.S. We argued that (some) governments might be tempted to fund this through a one-time wealth tax of 20 to 30 percent on all financial assets.

The target level of 180 percent can be debated (and was debated by many readers of Back to Mesopotamia), but a level of 220 percent would still imply a debt restructuring of $4 trillion in the U.S. and €2.6 trillion in the euro zone, leading to a one-time wealth tax of 12 percent and 14 percent, respectively. Given the unpopularity of such a tax, we are likely to see less incendiary taxes imposed. This means that politicians must resort to the last option: inflation.

Inflation. Another option to reduce Western debt loads would be financial repression—a situation in which the nominal interest rate is below the nominal growth rate of the economy for a sustained period of time. After World War II, the U.S. and the U.K. successfully used inflation to reduce overall debt levels. In spite of today's low-interest-rate environment, we have the opposite situation: interest rates are higher than economic growth rates. As risk aversion in financial markets increases and a new recession in 2012 looms large, the problem could get even worse.

So the only way to achieve higher nominal growth will be to generate higher inflation. Aggressive monetary easing has barely moved the inflation needle in the U.S. and most of Europe, although the impact on U.K. inflation has been greater. Inflation is not being generated, because the expectation of inflation remains low and because there is still overcapacity and overindebtedness in the private and public sectors. Continued monetary easing could (and will) lead to a substantial monetary overhang that could, if the public loses trust in money, lead to an inflationary bubble. Some argue that inflation is unlikely because of the oversupply of labor and continued competition from new market entrants like China. Certainly we may see continued pressure on wages because of globalization, although the longer low growth persists in the West, the more likely it is that Western governments will resort to increased protectionism, leading to upward pressure on prices. Moreover, some observers believe that the inflation indicators do not give a true reading of the underlying rates of inflation.

It is also a matter of trust. Take, for example, the history of hyperinflation in Germany in the early 1920s. The German Reichsbank funded the government with newly printed money for several years without causing inflation. But once the public lost trust in money, people started to spend it fast. This led to higher demand and an inflationary spiral.Today the velocity of money in the U.S. is at an all-time low of 5.7. If the number of times a dollar circulates per year to make purchases returned to the long-term average of 17.7, price levels in the U.S. would rise by 294 percent over that period—unless the Federal Reserve simultaneously reduced its balance sheet by $1.8 trillion. Some inflation is probably attractive to those seeking to reduce debt levels. The problem is stopping the inflation genie once it has left the bottle.

There are no easy solutions to the debt problem. At best, we expect a sustained period of low growth in the West. Even this would require the following:

A coordinated effort to rebalance global trade flows, which would require the emerging markets, Germany, and Japan to import more, thereby allowing the debtor countries to earn the funds necessary to deleverage

Stabilizing the overstretched financial sector through recapitalization and slow de-risking and deleveraging—in contrast to today's new rules, which encourage banks to shrink their balance sheets rather than finance commercial activity (it is worth noting that the effect of monetary easing during a period when ultra-low interest rates are below the rate of inflation is essentially to provide additional support to the banking system through the provision of low-cost liquidity)

Reducing excessive debt levels, ideally through an orderly restructuring or higher inflation

Current policies fall short against all these criteria. The coordinated intervention of several global central banks on November 30 could be construed as a positive sign of global cooperation, given that the whole world fears the implications of a (disorderly) breakup of the euro zone. In reality, it was once again merely a case of pulling the only lever left—that of printing money—and so did not address the one fundamental problem facing the world economy. Even China's participation reflected its worries about its biggest export market (Europe) and the risk of another (possibly deep) recession more than a true willingness to support the West by rebalancing trade flows.

Any new recession, given growing and unsustainable debt levels, would increase the risk of short-term defaults and significantly increase the medium-term risk of higher inflation. Companies should therefore prepare for these scenarios. But they also need to consider how the situation in Europe could amplify the problem.

December 29, 2011

Euro Slide Could Be Preview of a Troubled New Year - CNBC

European sovereigns have to finance EUR 150 billion in the first quarter, of which Italy needs EUR 50 billion. Add to that an additional EUR 800 billion needed to recapitalize the banks and you see why the euro is weak...

CNBC: Euro Slide Could Be Preview of a Troubled New Year

The euro's dramatic slide to the year's lows in light trading is a likely prelude to more weakening in the New Year and highlights the long haul ahead for the euro zone's debt crisis.

Full Story:

December 28, 2011

Carlyle in record $15bn return to investors

Not bad for a forgettable year for investments

Carlyle in record $15bn return to investors
Financial Times, 5:34pm Tuesday December 27th, 2011
By Henny Sender in New York
Investment group aggressively takes advantage of market window and raises value of assets under management to $104bn

Read the full article at:

December 26, 2011

Why So Many Market Pros Made Bad Calls This Year Article: Why So Many Market Pros Made Bad Calls This Year

When the history books are written, 2011 may go down as the year when political risk trumped economics, earnings and interest rates as the main force driving capital markets.

Full Story:

December 23, 2011

India: U.S. To Invest $1 Trillion In Infrastructure

What about spending that money in the US....

India: U.S. To Invest $1 Trillion In Infrastructure
Stratfor logo

India: U.S. To Invest $1 Trillion In Infrastructure

December 23, 2011

The United States will invest $1 trillion in infrastructure development in India, Indian Ambassador to the United States Nirupama Rao said, The Times of India reported Dec. 23. Rao said U.S. Secretary of Commerce John E. Bryson will lead a trade delegation to India by March 2012 to discuss the investment. Rao added that India and Washington's political engagement has strengthened significantly as well as their strategic understanding.

© Copyright 2011 Stratfor. All rights reserved.

December 13, 2011

Steve Cohen calls insider trading rules vague | Reuters

Exclusive: Steve Cohen calls insider trading rules "vague"
By Matthew Goldstein

NEW YORK | Tue Dec 13, 2011 2:06pm EST

(Reuters) - Hedge fund billionaire Steven A. Cohen in sworn testimony earlier this year called the rules on insider trading "very vague" and said sometimes it's a "judgment call" as to whether a tidbit about a public company is inside information.

The founder of SAC Capital Advisors LLC, one of the hedge fund industry's best-known firms, offered up his views on insider trading during two days of deposition testimony in February and April this year as part of a long-running civil lawsuit filed by Canadian insurer Fairfax Financial.

It's rare for Cohen to speak publicly and even rarer for him to share his views on something as controversial as insider trading. Cohen's insights are revealing not just because of his status as an industry titan, but because his $14 billion firm continues to draw attention in an ongoing investigation by U.S. authorities into insider trading.

In the deposition, an extended excerpt of which was obtained by Reuters, the 55-year-old trader says he often leans on his fund's lawyer to determine whether something constitutes inside information and admits to being not well-versed in SAC Capital's own internal compliance manual.

"The answer is when you're trading securities, it's a judgment call," said Cohen, during the deposition that spans more than 600 pages. "Whatever the compliance manual says, it probably doesn't take into account every - every potential situation."

The deposition was taken in connection with a lawsuit filed in 2006 by Fairfax, alleging SAC Capital, Kynikos and other traders took part in a so-called short conspiracy.

The lawsuit alleges the hedge funds bet against Fairfax shares and then spread negative stories about the company in hopes of driving down the stock price. Recently, SAC Capital won a motion to be dismissed from the insurer's lawsuit but Fairfax's claims of improper trading against other hedge funds and traders continues.

Reuters petitioned the court to obtain the transcript. SAC Capital and its lawyers had sought to keep the excerpts of Cohen's deposition sealed, arguing that the contents were trade secrets and information that would be useful to competitors.

A Cohen spokesman was not immediately available for comment.

In the deposition, Cohen acknowledges that in the aftermath of Galleon Group founder Raj Rajaratnam's arrest on insider trading charges in October 2009, his public relations firm suggested he begin reaching out to some reporters to burnish his image and "dispel" rumors of improper trading.

In particular, Cohen talked about a December 2009 story in The New York Times on SAC Capital and a subsequent June 2010 profile of Cohen and his wife Alexandra in Vanity Fair.

"There are rumors and what we wanted to do was dispel any notion of that," he said.

When asked by a Fairfax lawyer what rumors he was referring to, Cohen responded: "The rumors you just stated, that people weren't sure how we conducted our business."

In the questioning, Cohen comes off as controlled and well-prepared to engage in a sometimes testy back-and-forth with Fairfax's lawyer, Michael Bowe, over the dividing line between what constitutes permissible and improper trading.

Cohen says the rules on what constitutes inside information are "very vague" and sometimes it can depend on whether the information will move a stock, hurt another trader or can be obtained through another source.

For instance, Cohen said if he got a tip that an analyst is going to downgrade a stock and his fund opts to buy the stock that is proper "because I'm on the other side of the trade."

Cohen said what is "material" in analyzing whether or not it is inside information often depends on the circumstances.

"You know, I mean, I can argue that someone else could think that a - being short in front of a sell recommendation is a non-event because it's not going to move the stock, and somebody else would think, you know, that's trading on material nonpublic information regardless if it moves the stock or not," said Cohen. "These are judgment calls."

The release of a redacted version of Cohen's deposition came about after Reuters went to court to seek access to it and other documents produced in the lawsuit filed by Fairfax in a New Jersey state court.

A copy of Cohen's full deposition was subpoenaed last year by the Securities and Exchange Commission, which was conducting its own investigation into Fairfax's allegation.

Last week Reuters reported that the SEC closed its investigation in the Fairfax case with regards to SAC Capital and James Chanos' Kynikos Associates. (

(Reported by Matthew Goldstein; editing by Claudia Parsons and Martin Howell)

Exclusive: Steve Cohen calls insider trading rules vague | Reuters

December 8, 2011

Forget Europe… Germany’s Got Its Own Problems to Deal With | ZeroHedge

Source: IMF data

Forget Europe… Germany’s Got Its Own Problems to Deal With

Phoenix Capital Research's picture

Every day that Germany continues to flirt with the idea of propping up Europe, is another day that the country gets closer to its own fiscal crisis.

The mainstream media believes that Germany is somehow the bastion of fiscal strength. However, even a cursory look at the facts disproves this.

For starters, German banks post some of the highest leverage rations in Europe: higher that Italy, higher than Ireland, even higher than Greece. In fact, German banks are actually sporting leverage EQUAL to that of Lehman Brothers when it went bust.

To make matters worse, Germany has yet to recapitalize its banks. Indeed, by the German Institute for Economic Research’s OWN admission, German banks need 147 billion Euros’ worth of new capital.

Mind you, this is just NEW capital demands. In addition to this, German banks need to roll over 40% of their total outstanding debt within the next 12 months.

This is at a time when the many European nations are relying on the ECB to insure they don’t have a failed bond auction (by the way Germany had a failed bond auction just a few weeks ago).

Suffice to say, the German banking system isn’t as rock solid as the mainstream consensus. The German government knows about this situation which is why it’s already preparing for the potential nationalization of Germany’s largest banks should things get messy.

Germany’s sovereign balance sheet isn’t a whole lot better either. Officially, Germany has a Debt to GDP ratio of 84%. However, according to Axel Weber, the most recent head of Germany’s Central Bank (he left April 2011), Germany is in fact sitting on a REAL Debt to GDP ratio of over 200%. This is Germany… with unfunded liabilities equal to over TWO times its current GDP.

What’s truly frightening about this is that Weber is most likely being conservative here. Jagadeesh Gokhale of the Cato Institute published a paper for EuroStat in 2009 claiming Germany’s unfunded liabilities were in fact closer to 418% (and that was two years ago).

This further goes with my primary view: Germany has its own problems to deal with. So the idea that Germany is somehow going to prop up the EU is not really realistic. After all, if Germany was indeed going to serve as the mega-European backstop, don’t you think it would already have done so?

The truth is this: the German constitution won’t permit the issuance of Euro bonds. And the German population/ social contract between German politicians and voters will not stand for money printing of any kind.

So… don’t bank on Germany coming to save the day. Indeed, even the option of Germany somehow taking over other EU nations budgetary controls is ridiculous as NO EU member would submit to that.

Read the rest of the post here: Forget Europe… Germany’s Got Its Own Problems to Deal With | ZeroHedge

December 7, 2011

Bloomberg News Responds to Bernanke Criticism - Bloomberg

Bloomberg News Responds to Bernanke Criticism

Federal Reserve Chairman Ben S. Bernanke said in a letter to four senior lawmakers today that recent news articles about the central bank’s emergency lending programs contained “egregious errors.”

While Bernanke’s letter and an accompanying four-page staff memo posted on the Fed’s website didn’t mention any news organizations by name, Bloomberg News has published a series of articles this year examining the bailout. The latest, “Secret Fed Loans Gave Banks $13 Billion Undisclosed to Congress,” appeared Nov. 28.

“Bloomberg stands by its reporting,” said Matthew Winkler, editor-in-chief of Bloomberg News.

Here is a point-by-point response to the Fed staff memo.

From Fed memo: “These articles have made repeated claims that the Federal Reserve conducted ‘secret’ lending that was not disclosed either to the public or the Congress. No lending program was ever kept secret from the Congress or the public. All of the programs were publicly announced when they were initiated, and information about all lending under the programs was publicly released -- both on a weekly basis through the Federal Reserve’s public balance sheet release and through detailed monthly reports to Congress, both of which were also posted on the Federal Reserve’s website.”

Response: Bloomberg’s Nov. 28 story about Fed lending reported that the central bank published regular reports on the scope of borrowings from the discount window and other emergency or temporary programs. The loans were described as “secret” because the amounts, names of borrowers, dates and, often, interest rates weren’t disclosed. The stories reported that the Fed’s rationale for keeping the loans secret was to prevent bank runs.

From Fed memo: “The Federal Reserve took great care to ensure that Congress was well-informed of the magnitude and manner of its lending.”

Response: Bloomberg’s story said Congress wasn’t fully apprised of the details of the Fed’s efforts. “We were aware emergency efforts were going on,” U.S. Representative Barney Frank, who served as chairman of the House Financial Services Committee, said in the Nov. 28 story. “We didn’t know the specifics.” Other members of Congress on both sides of the aisle also said they weren’t aware of the details.

See the rest of the Bloomberg article here: Bloomberg News Responds to Bernanke Criticism - Bloomberg

The text of the Fed Note is below:

Why did the Federal Reserve lend to banks and other financial institutions during the financial crisis?

Intense strains in financial markets during the financial crisis severely disrupted the flow of credit to U.S. households and businesses and led to a deep downturn in economic activity and a sharp increase in unemployment. Consistent with its statutory mandate to foster maximum employment and stable prices, the Federal Reserve established lending programs during the crisis to address the strains in financial markets, support the flow of credit to American families and firms, and foster economic recovery.

All of the Federal Reserve's lending programs were announced prior to implementation and the amounts of support provided were easily tracked in weekly and monthly reports on the Federal Reserve Board's website.

The Federal Reserve followed sound risk-management practices under all of its liquidity and credit programs. Credit provided under these programs was fully collateralized to protect the Fed--and ultimately the taxpayer--from loss. As verified by our independent auditors, the Federal Reserve did not incur any losses in connection with its lending programs. In fact, the Federal Reserve has generated very substantial net income since 2007 that has been remitted to the U.S. Treasury.

Most of the Fed's lending facilities were priced at a penalty over normal market rates so that borrowers had economic incentives to exit as market conditions normalized. Lending peaked at $1.5 trillion in December 2008.* All of the emergency support programs established during the crisis were closed to new lending in 2010. Detailed information on the support provided to individual firms under these programs is available on the Federal Reserve Board's website.

* Liquidity Facilities include: Term Auction credit; primary credit; secondary credit; seasonal credit; Primary Dealer Credit Facility; Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility; Term Asset-Backed Securities Loan Facility; Commercial Paper Funding Facility; and central bank liquidity swaps.

See the Bloomberg article here:
Bloomberg News Responds to Bernanke Criticism - Bloomberg

November 30, 2011

Central Banks in Joint Action to Boost Liquidity to Markets Article: Central Banks in Joint Action to Boost Liquidity to Markets

The world's major central banks unleashed coordinated action Wednesday to ease the increasing strains on the global financial system, a move that sent stock markets up sharply.

Full Story:


November 28, 2011

Intervention No Barrier as Euro Loses to Surplus Currencies Most Since ’03 - Bloomberg

Intervention No Barrier as Euro Loses to Surplus Currencies Most Since '03

For the first time since at least 2003, investors are fleeing the euro for currencies of countries that don't depend on international capital markets to finance their budget deficits.

The franc rose 7.3 percent and the yen 4.6 percent in the past 12 months, the biggest gains as measured by Bloomberg Correlation-Weighted Indexes, even as the Swiss and Japanese central banks intervened to weaken their currencies. The euro was little changed versus the dollar in the period as the European Central Bank cut interest rates and lenders in the region brought funds home to meet new capital requirements.

Investor concern the euro is at risk is mounting as bond yields in the 17-nation bloc rise to records, costs to insure its members against default jump and ECB President Mario Draghi says providing a more powerful backstop for governments is outside his authority. Traders are favoring currencies of markets that don't need foreign capital such as Norway's krone as banks hoard cash amid the most expensive financing rates in more than three years.

"We've had a preference for the Scandinavian currencies, particularly the krone, because Norway has got the current account surplus, it's soundly managed and it's not an indebted country," Frances Hudson, who helps manage about $232 billion as a global strategist at Standard Life Investments in Edinburgh, said in a telephone interview on Nov. 24. "The ECB is going to be loosening its policy, which should take away some of the support for the euro."

Trade-Weighted Decline

The euro was down 1.5 percent in the 12 months ended Nov. 22 against a trade-weighted basket that includes the dollar, franc, yen and pound, said Bilal Hafeez, Deutsche Bank AG's global head of foreign-exchange strategy in Singapore. The decline was 2.7 percent when the greenback is excluded, he said.

Deutsche Bank recommended on Nov. 21 that investors sell the euro and buy the yen as markets lose confidence in European leaders' efforts to stem the debt crisis. The euro may weaken to $1.30 by the end of March, while the yen may appreciate to 72 per dollar by the end of the second quarter, from 77.73 last week, according to Hafeez.

The krone rose 3.5 percent against nine developed-market peers in the past 12 months, according to Bloomberg's Correlation-Weighted indexes. The euro slipped 1.1 percent and the dollar fell 2.7 percent, the gauge shows.

Deficit Nations

The euro climbed 1.1 percent to $1.3386 at 10:28 a.m. London time, after falling 2.1 percent last week, leaving it little changed this year. Against the yen, it strengthened 1.1 percent to 103.99 today. The shared currency fell 0.3 percent to 7.88279 kroner and was little changed at 1.2297 francs after last week falling 0.6 percent.

The U.S. had a current-account deficit of 3.24 percent of gross domestic product last year, compared with a euro-area shortfall of 0.45 percent, according to data compiled by Bloomberg. While Germany's surplus was 5.7 percent of GDP, Greece and Portugal had deficits of almost 10 percent.

Switzerland's current-account surplus is forecast to be about 12 percent of GDP this year, according to the median estimate of eight economists surveyed by Bloomberg. Norway, the world's second-largest natural gas exporter, will have a surplus amounting to almost 15 percent in 2011, a separate survey shows.

The best may already be over for the franc and the yen as the Swiss National Bank and the Bank of Japan limit gains to protect their nations' exports. The SNB capped the franc's rate at 1.20 per euro on Sept. 6 after the currencies almost reached parity in August, crimping economic growth.

Yields Surge

The yen appreciated to a record 75.35 per dollar on Oct. 31, spurring Japan to intervene for the first time since August. Japan's government needs to take action against the strength of the yen to protect jobs, Toyota Motor Corp. President Akio Toyoda said Nov. 7.

Europe's escalating crisis sent borrowing costs outside Germany to records this month. The yield on 10-year Spanish bonds rose to 6.78 percent on Nov. 17, the most since the euro's inception in 1999, while the premium France pays over Germany to borrow for 10 years reached a record 204 basis points, or 2.04 percentage points, the same day.

Investors are growing wary of even the highest-quality euro-zone sovereign debt as contagion from the crisis reaches the region's core members. Germany failed to get bids for 35 percent of the bunds it offered for sale on Nov. 23. The retained amount was the highest proportion of unsold 10-year debt since 1995, according to data compiled by Bloomberg.

ECB Remit

Chancellor Angela Merkel, 57, repeated her opposition last week to calls for common currency-area bonds. Draghi, who took over as president of the central bank this month, said on Nov. 3 that backstopping government borrowing lies outside the ECB's responsibilities.

"What makes you think that becoming the lender of last resort for governments is what you need to keep the euro region together?" Draghi said in Frankfurt after the ECB unexpectedly cut rates by a quarter percentage point to 1.25 percent. "That is not really in the remit of the ECB."

The euro's performance against the dollar this year has been masking the severity of the debt crisis, said Jeffrey Gundlach, who runs DoubleLine Capital LP in Los Angeles. That's why the firm stopped selling the euro and in the summer purchased credit-default swaps on French debt, which profit if the price of the nation's debt falls, said Gundlach. DoubleLine's Multi-Asset Growth Fund has beaten 94 percent of its competitors in 2011.

Weaker Euro

The cost of protecting France's bonds against non-payment for five years with credit-default swaps reached 256 basis points at the end of last week, up from 84 basis points at the start of August, according to CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market.

John Taylor, the founder of currency hedge fund FX Concepts LLC in New York, said the euro area has "an unbelievable group of problems." He said he is betting against the shared currency, in an interview on Bloomberg Television's "In the Loop" with Betty Liu on Oct. 26.

The company's Global Currency Program is down 17.8 percent this year through October, according to the FX Concepts website. Taylor said on Bloomberg Television on Oct. 11 the euro will end the year at $1.20, before falling to parity.

Benefit of Weakness

A weaker euro may help the region's economy by making exports more competitive. European industrial orders fell the most in almost three years in September, led by Germany and France, a European Union report showed on Nov. 23. London-based Markit Economics said the same day a composite index based on a survey of purchasing managers in manufacturing and services industries in the region shrank for a third month in November.

"A weaker euro would actually be a good thing, not a bad thing for the euro zone" because it would support growth, said Michael Darda, chief market strategist in Stamford, Connecticut, at MKM Partners LP. "The periphery needs a dramatically weaker currency, while German probably doesn't."

Japan had a current account surplus of 1.585 trillion yen ($20.4 billion) in September, the Finance Ministry said Nov. 9. The economy grew an annualized 6 percent in the three months ended Sept. 30, the first expansion in four quarters, the Cabinet Office in Tokyo said Nov. 14, as exports recovered from a record earthquake in March.

No Japan Concern

Japan "has the highest public debt to GDP at more than 200 percent but no one is concerned about the debt situation in Japan because they don't rely on foreign financing," Niels Christensen, chief currency strategist at Nordea Bank AB in Copenhagen, said in a telephone interview on Nov. 17.

That may change. Standard & Poor's indicated last week it may be preparing to lower Japan's sovereign grade from AA-, saying Japanese Prime Minister Yoshihiko Noda's administration hasn't made progress in tackling the debt burden.

European banks are repatriating funds to boost "high quality" assets that can serve as a buffer against an escalation of the debt crisis. Policy makers said last month that banks must meet the Basel Committee on Banking Supervision 9 percent capital requirement by mid 2012, meaning banks must find 106 billion euros ($130 billion), according to the European Banking Authority.

European investors brought home 65.9 billion euros in August and 11.6 billion euros in September, according to ECB data compiled by Bloomberg.

Attracted by Surpluses

Investors are also being drawn to countries with surpluses as the ECB lowers borrowing costs to counter sputtering growth.

The gap between euro-zone and Swiss benchmark rates is 1.25 percentage points, compared with an average of 1.56 percentage points from 2002 through 2008. Norway kept its overnight deposit rate at 2.25 percent in October.

Draghi said after this month's ECB decision the region will probably fall into a "mild recession." Governing Council member Luc Coene said an additional rate cut by the ECB is probable if current trends continue, De Tijd reported last week.

Euro-area GDP will grow 0.5 percent 2012, down from 1.6 percent this year, according to the median forecast of analysts surveyed by Bloomberg. Swiss growth will be 1.1 percent in 2012, with Norway at 2.1 percent and Japan at 2.5 percent, separate surveys show. The U.S. expansion will be 2.2 percent.

"Whichever way you look the picture is turning negative for the euro," Deutsche Bank's Hafeez said in a telephone interview on Nov. 24. "We think the crisis will be ongoing. We have the cyclical downturn in Europe. Eventually the ECB is going to have to step up. All of those things will be negative for the currency."

To contact the reporters on this story: Lukanyo Mnyanda in Edinburgh at; Liz Capo McCormick in New York at

To contact the editors responsible for this story: Daniel Tilles at; Dave Liedtka at

November 27, 2011

Europe’s banks feel funding freeze

Europe's banks feel funding freeze
Financial Times, 8:49pm Sunday November 27th, 2011

By Tracy Alloway in London
The funding hole for European lenders is deepening following a sharp fall in bond issuance as market turmoil leads to a region-wide credit crunch

Read the full article at:

November 25, 2011

Safra to Buy Sarasin Stake From Rabobank - Bloomberg

Safra to Buy Sarasin Stake From Rabobank - Bloomberg

-- The MasterFeeds

Global stocks have recorded their tenth consecutive daily decline Belgium downgrade reverses rally - FT

The S&P 500 has lost 7.6 per cent in just the past six sessions as eurozone fiscal woes fed into global growth fears

Global stocks have recorded their tenth consecutive daily decline

Belgium downgrade reverses rally - FT

By Telis Demos in New York

Friday 18.15 GMT. Global stocks have recorded their tenth consecutive daily decline after a Wall Street rally fizzled on worries about Italian banks and sovereign debt.

Belgium’s sovereign rating was cut by Standard & Poor’s just before the US’s early close on Friday at 18.00 GMT. Its rating was slashed from double A plus to double A, with a negative outlook.

Earlier in the session, benchmark Belgian debts had widened again to record levels versus German paper, a premium of 360 basis points. That came despite Germany’s paper touching their highest yields since August.

S&P cited “renewed funding and market risk” on Belgium’s financial sector, already strained by Dexia’s nationalisation earlier this year, and “increasing likelihood...that economic growth will slow, given the deleveraging of the European financial sector”.

The S&P move also came just a few minutes after Fitch had downgrade 8 mid-sized Italian banks, and placed them on negative watch as well. Earlier, Italian debt-watchers were nervous after an auction of short-term paper by Italy saw good demand but euro-era record yields.

The result was bad enough to prompt Ignazio Visco, Bank of Italy governor, to say it was “not a balanced indication of the current economy”, according to Reuters.

The FTSE All-World index is now down 0.4 per cent, as the S&P 500 in New York erased an opening-bell gain to close down 0.3 per cent at 1,158.67, its low for the week and lowest point since 10 October.

The S&P has endured its worst week since September, while the All-World is flirting with “correction” territory this month, down 9.4 per cent since 11 November.

Earlier, yields on ten-year Italian notes hit 7.61 per cent, up 29bp, moving further north of the critical 7 per cent threshold. Germany also reiterated its opposition to the introduction of a eurozone bond and its reluctance to see the European Central Bank get more involved in tackling the crisis.

“The pace at which the eurozone crisis is escalating is frightening,” said Nicholas Spiro, managing director of Spiro Sovereign Strategy. ”The ‘break-up’ genie has been let out of the eurozone bottle and is feeding a run on the bond markets of the weakest countries.”

The cost of swapping euros into dollars is near the highest levels since the credit crunch shock of 2008, while yields on Italian 10-year bonds, which have often been used by traders as a gauge of eurozone fiscal anxiety, are up 20 basis points to 7.30 per cent.

Trading overall is thin and volatile after the US Thanksgiving holiday, followed by a half-session in New York on Friday. The FTSE Eurofirst 300 had surged in the last hour of trading, ending 0.9 per cent higher after being softer all session.

But most so-called risk assets continue to struggle to make significant headway. Commodity prices are mixed on worries about slowing demand for raw materials following this week’s softer than expected US gross domestic product data and a weaker Chinese manufacturing survey.

Copper is down 0.3 per cent to $3.27 a pound and Brent crude is off 1.5 per cent to $106.20 a barrel. Currency traders are displaying mixed risk appetite, with the dollar index up 0.5 per cent. But growth-focused plays, such as the Aussie dollar, are also higher.

The early source of traders angst was clear. The single currency has hit a seven-week low of $1.3213, as signs of stress remain in the bloc’s sovereign debt complex and financial system. It is currently down 0.6 per cent at $1.3261.

The market is also keeping an eye on German paper after the poor auction on Wednesday. The amount Berlin has to pay to borrow for 10-years – currently 2.27 per cent, up 7 basis points – is still near historically low levels. But the more than 30bp jump in a few days has raised fears among some that the contagion is spreading to Berlin.

On Friday German 10-year yields fell 1bp to 2.24 per cent by the end of the day, but not before touching 2.286 per cent, their highest level since August.

Earlier, Asian shares extended losses as European leaders failed to soothe investor fears about the region’s worsening debt crisis. Financial stocks were particularly hard hit across the region, pushing the FTSE Asia Pacific index down 1.1 per cent.

Hong Kong’s Hang Seng index slid 1.4 per cent while the Shanghai Composite index slipped 0.7 per cent. Australia’s S&P/ASX 200 index was off 1.5 per cent as miners took a knock. Tokyo’s Nikkei 225 rallied off its lows but still lost 0.1 per cent, leaving the benchmark at a fresh two-and-a-half year low.


Trading Post

Thanksgiving turkeys were not alone in getting stuffed this week. When US investors returned today from their short break they faced a stock market that has been most definitely feeling the worse for wear of late, writes Jamie Chisholm.


The S&P 500 has lost 7.6 per cent in just the past six sessions as eurozone fiscal woes fed into global growth fears.

Though arguably “oversold” – the S&P’s relative strength index was at 37 before Friday’s market bounce – some other technical indicators remain concerning.

At 1,162 the benchmark has swiftly breached support at 1,225, 1,200 and around 1,170. This leaves it below the 200- and 50-day moving averages, the latter of which may now be seen as resistance. Pessimists are talking of a possible test of October’s trough below 1,100.

Bulls, however, may point to the Vix index’s stability around the 34 mark – at Wednesday’s close – as a sign that traders are not as anxious as headlines suggest.

But as Bob Pisani, CNBC commentator, points out, the “fear index” is a bit off message at the moment, with thin markets and fewer trading days during the festive season leaving investors unwilling to stump up so much for protection.


Additional reporting by Jamie Chisholm in London. Follow his market comments on Twitter: @FTGlobalMarkets

Belgium downgrade reverses rally -

November 23, 2011

Global Stocks Hit 6-Week Low

Global Stocks Hit 6-Week Low

By Dominic Lau

LONDON (Reuters) - World stocks hit their lowest in six weeks on Wednesday and crude prices fell after and manufacturing in regional heavyweight Germany contracted for a second straight month in November, and at a faster rate, as export demand slumped.

Safe-haven U.S. Treasuries, German Bunds and gold were in demand as investors fled riskier assets.

"The souffle we hoped we were going to eat is collapsing in front of us. We had hoped for a soft China's November factory activity shrank the most in 32 months, reigniting worries of an abrupt slowdown in the world's second largest economy.

The slump in China's factory sector came a day after the number one economy, the United States, cut its third quarter growth figure.

The euro zone debt crisis continued to sap investor confidence, hitting the euro, landing in China, better figures out of the United States and progress in Europe," Justin Urquhart Stewart, director at Seven Investment Management, said.

The euro was down 0.4 percent at $1.3456 after a newspaper said France, Belgium and Luxembourg were in talks on how to provide temporary state debt guarantees for failed financial group Dexia (DEXI.BR), stirring worries France will face a further fiscal burden.

The dollar, which has been benefiting from recent investor unease, rose 0.3 percent against a basket of major currencies (.DXY) after hitting its highest in six weeks.

"Dexia and the Chinese flash PMI are the two factors that are driving a risk-off trade," said Jeremy Stretch, head of currency strategy at CIBC World Markets.

"Euro flash PMIs are not looking good and this will not help matter either. Model funds are looking to buy dollars and investors will be looking to sell into any rebound in the euro."

World stocks measured by the MSCI All-Country World Index (.MIWD00000PUS) fell 0.5 percent to their lowest level since October 10.

The global gauge was down for the eighth straight session, its longest losing run since late July and early August when the two-year-old euro zone debt turmoil spread to Italy. It has lost 13.6 percent this year.

Europe's FTSEurofirst 300 (.FTEU3) dropped 0.4 percent, while Japan's Nikkei average (.N225) eased 0.4 percent.

Brent crude dropped 0.7 percent to trade just above $108 a barrel, while copper prices slipped 0.3 percent to above $7,300 a tonne.

Gold added 0.1 percent after rising 1.1 percent the previous session. The precious metal has risen nearly 20 percent this year, on track for its 11th straight year of gains.

(Additional reporting by Brian Gorman and Anirban Nag in London)

November 22, 2011

Young Bankers See Aspirations Cut Short

Young Bankers See Aspirations Cut Short

Being young on Wall Street once meant having it all: style,
smarts and too much money to spend wisely. Now,
twenty-somethings in the finance industry are losing both
cash and cachet.

Three years after the global financial crisis nearly
brought Wall Street firms to the brink, the nation's
largest banks are again struggling. As profits wane, layoffs
have claimed thousands of jobs and those still employed have
watched their compensation shrink. These problems are set
against the morale-crushing backdrop of the Occupy Wall
Street movement, which has made a villain of a once-lionized

Much of the burden of Wall Street's latest retrenchment
has fallen on young financiers. The number of investment
bank and brokerage firm employees between the ages 20 and 34
fell by 25 percent from the third quarter of 2008 to the
same period of 2011, a loss of 110,000 jobs from layoffs,
attrition and voluntary departures.

November 21, 2011

MF Global shortfall doubles to $1.2bn -

MF Global shortfall doubles to $1.2bn

The estimated hole in MF Global’s customer accounts has doubled in size to $1.2bn, astonishing traders as the investigation into the broker’s failure enters its fourth week.

The new figure, from the bankruptcy trustee for MF Global’s US brokerage, is equivalent to almost a quarter of the $5.45bn in client funds that the company was required to hold separately from its own funds.

The shortfall has blemished futures markets and left thousands of traders with insufficient margin deposits. Failure to separate customer and house funds is a violation under US law.<
“It’s as serious a situation as one can imagine in these markets,” said Mario Cometti, a lawyer representing MF Global customers. “If such an incredibly tremendous shortfall could have occurred, then there’s obviously huge problems with oversight.”

Estimates of the shortfall have fluctuated since the broker-dealer filed for bankruptcy on October 31 after failing to douse fears over its exposure to European sovereign debt. The Commodity Futures Trading Commission was first told the deficit totalled about $900m, but more recently put it at $600m.

MF Global, which was run by former New Jersey governor Jon Corzine, appears to have acted desperately in its final days and dug into customer funds to meet margin calls in a bid to save the company for a sale, people familiar with the government investigation said.

Investigators have spent weeks reviewing accounts at the firm and other financial institutions. MF Global’s records are sloppy and incomplete, people familiar with the matter said, requiring them to rely on third parties.

Alongside federal authorities, a team led by bankruptcy trustee James Giddens is probing MF Global.

“At present, the trustee believes that even if he recovers everything that is at US depositories, the apparent shortfall in what MF Global management should have segregated at US depositories may be as much as $1.2bn or more,” the trustee said on Monday, stressing “these are preliminary numbers that may well change”.

The prolonged search for the missing money has revived debate over whether US futures traders should have protections similar to those stock investors enjoy when a brokerage fails. The Securities Investor Protection Corporation, created in 1970, has a reserve that covers securities customers for up to $500,000.

Daniel Roth, president of the National Futures Association, a US regulator, said: “I don’t think you can rule anything out at this point, including an SIPC-type insurance programme. Everything’s on the table.”

Gary DeWaal, general counsel at futures brokers Newedge, added: “I think every good idea should be on the table post-MF, and this is just one.” But he warned that such insurance could be impractical because the value of futures positions changes constantly.

See the whole story here:
MF Global shortfall doubles to $1.2bn -

Credit Suisse Goes For Broke: Predicts End Of Euro, Escalating Bank Runs On "Strongest European Bank


Just because Credit Suisse bankers are people too (even if 1% people, but still people), and just because they know too damn well that "no ECB intervention" means "no bonus", and very likely "no job", they go for broke and join Deutsche Bank, JPM, RBS, and everyone else (but, again, not Goldman), in predicting the end of Europe unless Draghi does his rightful duty and remembers that without banker support he will also be lining up at the jobless claims office very soon. Of course, being a Goldman boy, Draghi will only do what Lloyd tells him to. Either way, here is Credit Suisse's rejoinder to the global Mutual Assured Destruction tragicomedy, which now makes Honk (as Lagarde calls him) Paulson's overtures to congress seem like amateur hour. "We seem to have entered the last days of the euro as we currently know it. That doesn't make a break-up very likely, but it does mean some extraordinary things will almost certainly need to happen – probably by mid-January – to prevent the progressive closure of all the euro zone sovereign bond markets, potentially accompanied by escalating runs on even the strongest banks. That may sound overdramatic, but it reflects the inexorable logic of investors realizing that – as things currently stand – they simply cannot be sure what exactly they are holding or buying in the euro zone sovereign bond markets...One paradox is that pressure on Italian and Spanish bond yields may get quite a lot worse even as their new governments start to deliver reforms – 10-year yields spiking above 9% for a short period is not something one could rule out. For that matter, it's quite possible that we will see French yields above 5%, and even Bund yields rise during this critical fiscal union debate." Of course, the explicit message is: help us ECB-Wan Kenobi, you are our only hope. The implicit one is: do it, or we pull the trigger and blow it all up to hell.

Full note:

The "Last Days" of the Euro


We seem to have entered the last days of the euro as we currently know it. That doesn't make a break-up very likely, but it does mean some extraordinary things will almost certainly need to happen – probably by mid-January – to prevent the progressive closure of all the euro zone sovereign bond markets, potentially accompanied by escalating runs on even the strongest banks.


That may sound overdramatic, but it reflects the inexorable logic of investors realizing that – as things currently stand – they simply cannot be sure what exactly they are holding or buying in the euro zone sovereign bond markets.


In the short run, this cannot be fixed by the ECB or by new governments in Greece, Italy or Spain: it's about markets needing credible signals on the shape of fiscal and political union long before final treaty changes can take place. We suspect this spells the death of "muddle-through" as market pressures effectively force France and Germany to strike a momentous deal on fiscal union much sooner than currently seems possible, or than either would like. Then and only then do we think the ECB will agree to provide the bridge finance needed to prevent systemic collapse.


We think the debate on fiscal union will really heat up from this week when the Commission publishes a new paper on three different options for mutually guaranteed "Eurobonds", continue at the summit on 9 December and through a key speech by President Sarkozy to the French nation scheduled for the 20th anniversary of the Maastricht Treaty (11 December).


While these discussions may give some short-term relief to markets, it seems likely that the process of reaching agreement will involve some high stakes brinkmanship and market turmoil in subsequent weeks. (Not unlike the US debt ceiling debate this summer, or the messy passage of TARP in 2008.)


One paradox is that pressure on Italian and Spanish bond yields may get quite a lot worse even as their new governments start to deliver reforms – 10-year yields spiking above 9% for a short period is not something one could rule out. For that matter, it's quite possible that we will see French yields above 5%, and even Bund yields rise during this critical fiscal union debate.


Moreover, this could happen even as the ECB moves more aggressively to lower rates and introduce extra measures to provide banks with longer-term funding. And US bond yields may fall – or at least not rise – despite improving US growth data through end-year. Equally, global equity markets and world wealth could follow a more muted version of their early Q1:2009 sell-off until the political brinkmanship is resolved – see exhibits below.


In short, the fate of the euro is about to be decided. And the pressure for the necessary political breakthroughs will likely come from investors seeking to protect themselves from the utterly catastrophic consequences of a break-up – a scenario that their own fears should ultimately help to prevent!

Emerging Markets Cannot Fully Decouple

Nouriel roubini comments on the interaction between the growth in emerging and developed markets, population growth, increased demand for resources - energy, metals and agriculture - and climate change.
Related ETF, iShares MSCI Emerging Markets Index ETF (EEM)

Nouriel Roubini is an American economist. He teaches at New York University's Stern School of Business and is the chairman of Roubini Global Economics.

Moody's Warns On French Rating Outlook - CNBC

a 100 basis point increase in yields roughly equates to an additional three billion euros in yearly funding costs.

"Elevated borrowing costs persisting for an extended period would amplify the fiscal challenges the French government faces amid a deteriorating growth outlook, with negative credit implications," Senior Credit Officer Alexander Kockerbeck said in Moody's Weekly Credit Outlook dated Nov.21.

Moody's Warns On French Rating Outlook

A rise in interest rates on French government debt and weaker growth prospects could be negative for the outlook on France's credit rating, Moody's warned in a report on Monday, adding to pressure on European debt markets.

Worries that France has the weakest economic fundamentals among the euro's six AAA-rated countries have drawn the euro zone's second largest economy into the firing line in the debt crisis this month.

The rating agency said the deteriorating market climate was a threat to the country's credit outlook, though not at this stage to its actual rating.

"Elevated borrowing costs persisting for an extended period would amplify the fiscal challenges the French government faces amid a deteriorating growth outlook, with negative credit implications," Senior Credit Officer Alexander Kockerbeck said in Moody's Weekly Credit Outlook dated Nov.21.

"As we noted in recent publications, the deterioration in debt metrics and the potential for further liabilities to emerge are exerting pressure on France's creditworthiness and the stable outlook (though not at this stage the level) of the government's Aaa debt rating," the Moody's note read.

The yield differential between French and German 10-year government bonds rose above 200 basis points last week, a new euro-era high.

Moody's said that at that spread level, France pays nearly twice as much as Germany for long-term funding, adding that a 100 basis point increase in yields roughly equates to an additional three billion euros in yearly funding costs.

In early Monday trade, the French 10-year spread was up about 20 basis points at 167 bps following publication of Moody's report but remained well short of the 202 bps hit last week.

The CAC 40 index, which was down 1.7 percent in opening trade, was down 2.2 percent after an hour of trade.

"With the government's forecast for real GDP growth of a mere one percent in 2012, a higher interest burden will make achieving targeted fiscal deficit reduction more difficult," Moody's said.

On Oct 17, Moody's said it could place France on negative outlook in the next three months if the costs for helping to bail out banks and other euro zone members overstretched its budget.

"The French social model cannot be financed if the French economy's potential is not preserved.

With further weakening GDP growth the political scope for the government to generate further savings in this case would be tested," Monday's note from Moody's said.

The agency said the management of the euro area debt crisis complicated the government's fiscal consolidation efforts.

The stress on banks' balance sheets can lead to further increases of liabilities on the government's balance sheet when further state support to banks is needed, it added.

Copyright 2011 Thomson Reuters. Click for restrictions.

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