The failure of the German Bund auction yesterday is being written off as being of relatively minor significance. It is not- it is critical. If the Federal German government is unable to attract bids for nearly half of the Bunds that they offer, it tells you that the rest of the credit market is also closed. Banks are unable to access even the interbank market, and we are seeing the system come under renewed strain.
Already we have seen the collapse of the Lithuanian bank, Bankas Snoras, which has also been dismissed as being of little significance. However, the fact is that there is now a serious liquidity drought across central and eastern Europe, and this is spreading. There are strong rumours of a major liquidity crisis in the Russian banking system- and again the failure and subsequent recapitalization of Bank of Moscow is being dismissed as being of minor significance, simply the result of the political fall of Yuri Luzhkov. In fact it may well be that the fall of Luzhkov was the result of the bank failure, not the cause.There is plenty of anecdotal evidence that Russian capital markets are under severe strain.
There is a cumulative body of evidence that suggests that liquidity in the European credit market as a whole is draining away and that the crisis is now testing bank balance sheets- even those with state guarantees- once again.
The fact is that despite the persistent pressure of policy makers to keep interest rates low, the markets are no longer prepared to put capital at risk when returns are being kept artificially low. In other words, there is likely to a significant rise in rates. In fact for the general customer this has already happened, but not yet for banks, which have been trying to take the opportunity to recapitalize themselves with higher margins. Now the regulatory need to bolster bank balance sheets is colliding head on with the renewed tightening of the market. If Germany itself is suffering a buyers strike, then it is clear that the Euro banking system is under severe pressure.
The pressure on sovereigns has eased a little with the advent of new governments in Rome, Athens and Madrid, but that has merely refocused attention to the banks themselves. The Eurozone banking system could be poised to break down without further emergency measures.
With German Bunds now trading around the level of Gilts, the crisis takes yet another lurch downward.