http://www.zerohedge.com/news/european-black-swan-sighted

European Black Swan Sighted

Submitted by Tyler Durden on 11/20/2011 14:51 -0500

• Black Swan
• Bond
• CDS
• European Central Bank
• Flight to Safety
• France
• Greece
• Italy
• Portugal
• Yield Curve

While everyone's attention was focused intently on peripheral European bond spreads last week and the incessant call for ECB intervention, a dramatic (and contagiously panic-worthy) move occurred in the European Investment Bank (EIB) bonds.
For those unfamiliar, the EIB is the EU's IMF-equivalent and is the largest international non-sovereign lender and borrower. Technically, it is defined as "the European Union's long-term lending institution established in 1958 under the Treaty of Rome. It supports the EU’s priority objectives, especially European integration and the development of economically weak regions."
5Y Euro-denominated AAA-rated EIB bond spreads crashed wider, blowing past the 2009 record highs and clearly indicating that European capital flight is in full swing.

The IMF-like entity, supported by a small capital base of deposits backed by promises of huge capital injections by sovereign nations, has massive exposure across Europe (and elsewhere). EUR382.4bn of senior unsecured debt and (according to Bloomberg - chart below), EUR2.5bn of deposits (admittedly backed by supposed promises to make whole loan commitments) does not make for a sound AAA-rated firm in our humble opinion.

Clearly investors think the same this week and are starting to worry about the same self-referencing, self-supporting house-of-cards that caused the EFSF to be written off as unworkable.

It is clear that the contagion is spreading as Bund yields start to underperform (no capital flight to safety within the Euro-zone) and furthermore, as the chart above shows, the stress on the EFSF has now spread to the EIB's publicly tradable debt.
It is no wonder given the size of their loan portfolio and who it is being lent to:

Spain, Italy, France, Portugal, and Greece all in the Top 10 with simply enormous outstanding debts relative to the capital in-house to cover potential losses (let alone any MtM or economic risk budgeting).

The debts outstanding, much as with any major investment bank, are denominated in multiple currencies and the yield curves below show the differentiation of those curves by major currency.

The next few months/quarters/years has huge supply from the EIB as it rolls its major debt load and while it maintains its AAA-rating - and therefore appears very attractive from a carry-per-regulatory-risk-capital perspective, we suspect the professionals are already unwinding their exposure very rapidly.
The next few months have over EUR20bn in maturities (and EUR6bn in interest payments) and so we will get plenty of opportunities to judge how new issue premiums will adjust secondary markets.
The following chart (of the USD-denominated EIB debt yields) should be enough to prove that both systemically (yield curve shift higher) and idiosyncratically (potentially speculative-driven negative bets as bear flattening is occurring) the AAA-rated EIB is facing some significant stress and should it need to make capital calls (to maintain its AAA-rating), is Spain, Italy, France, and Greece going to step up to their promises...

There are no CDS trading on this reference entity (yet) but given the still-relatively-tight nature of the bond spreads, we suspect specialness is not an issue and borrow is possible. The 2s5s bear-flattener looks the lowest vol trade but at such low costs of carry, outright is perhaps just as attractive on a reduced size trade. The compression in the EFSF-EIB trade also looks attractive.
Charts: Bloomberg

http://krugman.blogs.nytimes.com/2011/11/19/blooey/

"Blooey

Two weeks ago I wrote about the Blooey Factor:

I would consider the margin question part of a broader issue, which I think of as Shleifer-Vishny, after their classic paper on the limits of arbitrage (pdf). Their point was that a fall in the price of some asset, even if it should in principle present a buying opportunity if the fundamentals haven’t changed, may actually be self-reinforcing instead if there is a limited class of leveraged investors who buy that asset. Why? Because the capital losses those investors suffer may force them to pull back instead of piling in.
I can see this happening here. Most Italian debt may be held by stolid domestic players, but at the margin are financial institutions that are quite possibly going to be forced to cut their holdings if Italian interest rates rise, because this will reduce the value of the bonds they already hold. So things could quite possibly go blooey in the very near future.

Today’s Times:

Nervous investors around the globe are accelerating their exit from the debt of European governments and banks, increasing the risk of a credit squeeze that could set off a downward spiral.
…
Experts say the cycle of anxiety, forced selling and surging borrowing costs is reminiscent of the months before the collapse of Lehman Brothers in 2008, when worries about subprime mortgages in the United States metastasized into a global market crisis.

Also:

The eurozone infection this week moved decisively from the periphery of the continent to its core.
Many investors are no longer just fretting about the possibility of a default here or there. They are now starting to worry about the chances of the euro itself breaking up. Bond markets may be putting as high a probability as 25 per cent on a split, according to Citi analysts.

And what is the new president of the ECB doing? Lecturing people on the need for discipline.
By the way, some commenters have been accusing me of crying wolf, because I’ve been warning about Eurogeddon for several weeks and the euro hasn’t collapsed yet. Geez. Eurozone capital markets have basically frozen; nobody is buying debt either of many governments or of many banks. This doesn’t bring the roof down overnight, but it will if this goes on for months."