EU officials have hatched a plan to make banks and bondholders take losses for risks, not now of course, but after 2013. In the meantime, taxpayers will shoulder 100% of the losses for bank lending stupidity. On this confidence inspiring news, European bonds rallied sharply.

Bloomberg reports EU Bank Writedown to Exclude Pre-’13 Debt

The European Union may exempt bank debt issued before 2013 from proposals forcing investors to take losses at failing lenders, said a person familiar with the plan.

Excluding the debt is designed to prevent lenders’ funding costs from rising, said the person, who declined to be identified because the discussions are private. The exemption could be extended if banks struggle to raise funds, the person said. The law would need approval from national governments and the European Parliament before taking effect.

Michel Barnier, the EU’s financial services chief, has promised to propose draft rules to end the need for taxpayer bailouts of failing banks.

Under draft proposals obtained by Bloomberg News, holders of long-term unsecured senior debt in a collapsing bank would be first in line to take losses once a lender’s capital and other subordinated debt is exhausted. Long-term bonds would be those with a maturity of more than one year.

A spokeswoman for the European Commission declined to comment on the draft law.

Short-term debt, with a less than one-year maturity, and derivatives should only be written down by regulators as a last resort if losses from longer-term debt aren’t “sufficient to restore the capital of the institution and enable it to operate as a going concern,” according to the draft.

“Exempting short-term debt and derivatives may be justifiable, but this would increase the use of systemically risky derivatives and excessive levels of short-term debt that contributed to the ongoing crisis,” said Sony Kapoor, managing director of policy advisory firm Re-Define. Taxing them “may help alleviate some of these distortions.”

Three Key Provisions

  1. Taxpayers would be screwed for all losses up to 2013
  2. The year can be extended
  3. Writing down Derivatives is a last-resort

French Bond Yields Drop Most on Record; Italian Bond Yields Drop Below 7%

Please consider French Yields Drop Most in 20 Years, Spain Bonds Rise

France’s 10-year yields fell the most since 1991 as the nation sold 4.3 billion euros ($5.79 billion) of bonds due between 2017 and 2041. Spanish notes rose for a fourth day as it auctioned 3.75 billion euros of securities, the maximum target. Italy’s 10-year yields fell below 7 percent for the first time in a week as European Central Bank President Mario Draghi signaled the ECB may do more to fight the crisis as long as governments push the euro area toward a fiscal union.

“There’s a generally brighter sentiment at the moment and Spain’s was a very good auction with strong demand,” said Norbert Aul, a European rates strategist at RBC Capital Markets in London. “There’s still fuel in the tank from policy actions and the ECB will offer more next week.”

French 10-year yields dropped 27 basis points, or 0.27 percentage point, to 3.12 percent at 4:01 p.m. London time. The 3.25 percent bond due October 2021 rose 2.205, or 22.05 euros per 1,000-euro face amount, to 101.030.

Ten-year Spanish rates fell 51 basis points to 5.72 percent after falling to 5.70 percent, the lowest since Nov. 9. Similar- maturity Italian yields declined 36 basis points to 6.66 percent, dropping below the 7 percent level for the first time since Nov. 24.

Spain 2-Year Government Bonds

Italy 2-Year Government Bonds

Portugal 2-Year Government Bonds

Germany 2-Year Government Bonds

Since the market likes a free lunch at taxpayer expense it’s no wonder the debt markets rallied somewhat. However, to what extent the market will believe “no losses” and for how long remains to be seen. Spreads to Germany are still enormous across the board.

If this idea of “no losses” was believable, 2-year Spanish and Portuguese bonds should trade at the same yield as Germany.

It is interesting that Portuguese debt did not rally today. With a no loss guarantee, Portuguese 2-year debt is the leveraged-bet bargain of a lifetime at 18%.

The market clearly does not believe this “no loss” idea and neither do I.

Mike “Mish” Shedlock
Click Here To Scroll Thru My Recent Post List