Swaps are soaring in Ireland, Portugal, Spain, Greece, and now Belgium. The market has correctly figured out there will be haircuts on senior bank debts. The problem is the ECB wants a free lunch but no haircuts until 2013, hoping of course the need for haircuts goes away in a few years.

Central bankers cannot and will not win this battle of nerves. The market is bigger than the Central bank.

Market Screams For Haircuts Today

In country after country the crisis is spreading because fools at the ECB want to delay haircuts.

Just ask Let’s ask Christian Noyer, governor of the Bank of France, or ECB president Jean-Claude Trichet.

Christian Noyer said “As far as I’m concerned, I exclude that there will be haircuts in the future”.

Jean-Claude Trichet warned German Chancellor Angela Merkel not to “unsettle bondholders”.

No-Scissors Bluff Fails

Unfortunately for the ECB, the market’s reaction to the no-scissors bluff of Christian Noyer and Jean-Claude Trichet was to suggest a need for haircuts in Belgium.

As evidence that hair grows best when and where you least want it, please consider European Crisis Spreads to Core as Belgian Bond Yields Surge

Europe’s sovereign crisis is spreading to the heart of the 16-nation bloc as investors question Belgium’s ability to cut the euro region’s third-highest debt load, overshadowing its economic performance.

The extra yield investors demand to hold Belgian 10-year bonds instead of benchmark German bunds of similar maturity widened to 139 basis points at 5.10 p.m. yesterday in Brussels, the most since at least 1993. The cost of insuring Belgian government bonds rose to a record for a second day, according to CMA prices of credit-default swaps.

The European Union’s 85 billion-euro ($111 billion) rescue package for Ireland has failed to quell market turmoil as investors shift their focus from peripheral states to countries such as Belgium, whose capital is home to the EU’s political institutions. While the country’s economy has been among the region’s growth drivers this year, inconclusive elections left it without a government, raising concerns on its budget outlook.

“Belgium has moved to the foreground as investors ask themselves ‘who’s next?’ to ask for help,” said Carsten Brzeski, an economist at ING Groep NV in Brussels and a former European Commission official.

Europe Debt Fears Hit More Secure Countries

The New York Times reports Europe Debt Fears Hit More Secure Countries

Despite the commitment of 200 billion euros, or $260 billion, in bailout funds to Europe’s two most stricken nations — Greece and Ireland — institutional investors were unimpressed with the rescue effort this weekend of Ireland and continued to sell bond holdings in the weaker euro-zone economies.

But what is worse for the European Union and an increasingly stretched International Monetary Fund is that investors have begun to disgorge some of their positions in Belgium, Italy and even Germany.

“We have created more doubts than existed before,” said Paul De Grauwe, an economist in Brussels who advises the president of the European Commission, José Manuel Barroso. “The interest rate now being charged for Ireland is a vote of no confidence for the package and it has obviously been inspired by a notion that we should punish our sinners. If we don’t succeed in containing this thing it could lead to a disaster in terms of the euro’s survival.”

Ireland Will Default

Ireland cannot possibly pay back its debt. It needs to shrink its deficit from 30% of GDP to 3% of GDP while going on a massive austerity program and having to pay back obscene loans at 5.8%.

Because of the austerity program Ireland cannot possibly grow at 5.8%. Heck it highly unlikely to grow at all. It cannot afford the interest, let alone the principal.

The market has figured this out whether the ECB and EU have or not.

Market Won’t Wait For Haircuts

With scissors in hand, Minyanville professor Peter Atwater says European Leaders Should Focus on the Banks, Not the Sovereigns

As Bloomberg notes this morning, the bank run has now extended from Ireland to Portugal. Yet again, credit is a coward and is fleeing uncertainty. Depositors, like bondholders, know that the intertwined European government/bank network needs less, not more debt and that someone is ultimately going to get a haircut. And with Ireland already implementing “burden sharing” and the EU suggesting that the barbershops will clearly open in 2013, there is little incentive to stick around to see when that happens.

And that is Europe’s problem. The market is saying “when” not “if” any more.

To stop the spreading contagion, European leaders need to stop focusing on the sovereigns and start focusing on the banks. As we have already seen, troubled sovereign nations can be kept alive for an extended period of time, but banks can’t.

But rather than growing sovereign double leverage even further — in which a troubled nation, like Ireland, borrows from the EU to put equity capital into its banks — if the EU is serious about stopping the growing banking contagion, it is going to have to consider its own pan-European TARP/FDIC program for Europe’s largest banks.

And whether Europe has the stomach for that we’ll soon find out. But until Europe divorces banking strength from sovereign strength, they will both go down together.

Stress Test Failures

The last European bank stress test back in July showed that 84 out of 91 banks were well capitalized, including the two largest Irish banks. According to the BBC, Irish finance minister Brian Lenihan “welcomed the increased transparency that the EU-wide test had brought to the banking system”.

Anyone who could think clearly knew those stress tests were a scam, purposely designed so that nearly any bank could pass. The results are now in, and it took less than 4 month to show just how absurd those stress test findings were. Allied Irish Banks and Bank of Ireland now await bailouts from the EU and IMF.

Another Stress Test Scam Coming Up

Another stress test is planned, but the EU (may or may not) publish the results. Presumably if the reports are good the EU may publish them, but they won’t if the results are bad.

In yet another truth-is-stranger-than-fiction moment, the Wall Street Journal reports Fresh Round of ‘Stress Tests’ Planned for European Banks

As market sentiment toward the euro zone sharply deteriorates, European officials are planning a new round of bank “stress tests” that they say will be more rigorous than the widely discredited exams conducted earlier this year.

But the tests are already subject to bickering between countries. While some European leaders are pushing for next year’s tests to be broader and more transparent than last summer’s exercise, the agency that will oversee the tests says it might opt not to publicly disclose the results at all.

Straight From the Twilight-Zone

That hair-raising announcement seems like it is straight out of the Twilight-Zone. The EU clearly admitted a need for an honest stress test while simultaneously admitting fear of publishing one.

On that admission, can anyone possibly believe the results of the next test, assuming they even publish it? And what will it say if they don’t?

This bizarre state of affairs can hardly inspire confidence. However, it may increase the demand for scissors, not exactly what the EU wants at all.

Mike “Mish” Shedlock
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