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Out of 17 auctions for German government bonds so far this year, seven tenders undersold after failing to attract enough bids. The latest shortfall came Wednesday, when the government could sell only €3.208 billion ($5.06 billion) of a €4 billion new bond due in 2040. It carried an average yield of 4.91%, up from 4.45% in January.

Germany Pays More in Debt Issue

The German government had to sweeten the yield on its latest debt offering Wednesday, showing that even those European governments with relatively healthy budgets are struggling to overcome tight bank liquidity and market scepticism about economic and fiscal risks.

Out of 17 auctions for German government bonds so far this year, seven tenders undersold after failing to attract enough bids. The latest shortfall came Wednesday, when the government could sell only €3.2bn ($5.1bn) of a €4bn new bond due in 2040. It carried an average yield of 4.91%, up from 4.45% in January.

Countries such as France and Italy have to pay even higher interest rates than those on the benchmark German bonds to attract investors. Spain, which suffered its first budget deficit in three years for the first half of 2008, this month had to pull an issue of 15-year bonds because of tight market conditions.

The credit crisis hasn’t stopped governments from raising the money to fill budget gaps. But the cost of selling bonds has risen, particularly for countries such as Italy and Spain, where markets deem fiscal risks to be higher. Their difficulties could increase as economies continue to shrink, widening budget deficits and increasing perceived risk.

Investment banks - the usual customers for government debt - have become pickier about debt from countries like Spain, Italy and Ireland, where sharp economic slowdowns appear to present the most direct threat to budgets.

The Italian government now has to pay a yield on 10-year government debt that is half a percentage point higher than on comparable German government bonds, called bunds. That is double the spread of 0.2 to 0.25 of a percentage point that prevailed before the onset of the global credit crisis last August.

In market terms, it means that the Italian government has to pay 5.134% interest on its 10-year debt while the German government pays only 4.633% on a comparable issue. Similarly, the spread between Spanish and German 10-year bonds is about 0.3 percentage point. A year ago, the yields were almost even.

Germany’s economy has so far avoided the rapid slowdowns seen in the UK. and Spain, although recently it has seemed more likely to succumb to the strong euro’s impact on Germany’s exports. Chancellor Angela Merkel said Wednesday she saw slowing growth ahead, but still no signs of a recession. She stuck to current government forecasts, which call for 1.7% growth in 2008 and 1.2% growth in 2009.

“I think we might be able to see a very good year,” she said, referring to growth in 2008. “All prognoses for 2009 are significantly lower,” she added.

But now, even Germany apparently has to worry about the global liquidity crunch that has drained the funding institutional investors need to buy up debt.

“In general, it is a bit more difficult compared to before to sell their debt in auctions,” said Laurent Fransolet, head of European interest-rate strategy with Barclays Capital.

While markets are building in risk premiums, few currently believe any European governments will be in serious want of funding. Nor are any governments saying they expect to end 2008 with excessive funding gaps.

Stefan Olbermann, a spokesman for Germany’s Finance Ministry, said the German government isn’t putting too much thought into the matter. “At the end of the day, this is a problem for the markets,” he said, arguing that yield levels are determined by demand.

“There is reduced demand for paper in general,” said Simon Penn, an analyst with UBS. “From the corporate perspective, there has definitely got to be some sort of yield enhancement. What savings there are, are going to higher-quality paper.”

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The SEC’s emergency order to enhance investor protections against “naked” short selling in 17 financial institution securities has reduced short sells by about 70 percent for the targeted symbols, and 90 percent of short selling of Fannie Mae and Freddie Mac securities.

SEC Emergency Order Leads to Dramatic Drop in Short-Selling of Fannie Mae and Freddie Mac Securities

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Financial regulators are interested in harnessing market information and market discipline to improve the supervision and performance of financial institutions. Recent growth in the market for credit default swaps (CDS), derivative instruments that allow for the trading of credit risk, presents the possibility of a new and important source of such information. The current paper explores the potential role of the rapidly expanding CDS market in providing market information relative to Fannie Mae and Freddie Mac (the Enterprises). Since there is an inherent link between CDS and bonds, a preliminary question is whether the CDS market provides information not captured in the bond market. With respect to the Enterprises, this question takes on added importance in light of the previous research that failed to find default risk signals in bond market and stock market information. Thus, if CDS markets only replicate bond market information, little reason exists to invest additional regulatory resources monitoring them. To explore this topic, the paper first summarizes theory and evidence linking CDS pricing and bond pricing. This summary focuses on reasons why and evidence that the information from these markets may differ. The paper then documents a CDS dataset purchased from Markit Group, noting certain data limitations, and explores the behavior of CDS prices for the Enterprises and for other large U.S. financial institutions. In the process, the paper explores the relationship between CDS and bond pricing for the Enterprises.
The evidence indicates that CDS market participants evaluate and price the credit risk associated with the Enterprises differently from bond market participants. In particular, CDS market participants do not always price the credit risk associated with the obligations of the Enterprises lower than the credit risk associated with other large financial firms. In addition, a significant amount of the variation in the price of credit risk on the Enterprises’ subordinated debt is not explained by the pricing of credit risk on their senior debt, a very different result than found in bond market data.

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Short sellers have best month in more than 7 years
It’s an emergency! The SEC’s endangered species list

Longer data range with a few reference points:
1: Kerviel panic, fed cuts 75 bp
2: Bear Stearns panic

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“The market is starting to look at the senior debt of the GSEs as approaching full-faith-and-credit obligations of the U.S. government,” said Ken Hackel, managing director of fixed-income strategy at RBS Greenwich Capital in Greenwich, Connecticut. “That is a large book of debt to effectively transfer to the U.S. balance sheet and increase the government’s liability.”

According to Bloomberg and CMA DataVision:

The cost of protecting against losses on Treasuries soared to a record on concern that the U.S. government faces higher liabilities with its support for Fannie Mae and Freddie Mac, credit-default swaps show.

Contracts on U.S. government debt increased 2 basis points to 22 basis points at the close of trading in London, according to CMA Datavision, after earlier reaching as high as 24. The 10- year contracts exceeded a previous record of 20 basis points yesterday. Five-year contracts were unchanged at 16 basis points.

In normal times, the spread is less than 2 basis points.

U.S. Treasury Credit-Default Swaps Increase to Record, CMA Says

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US government steps in to rescue mortgage giants

Rescue Sought for Fannie and Freddie

Each company now has a $2.25 billion credit line, set nearly 40 years ago by Congress. At the time, Fannie had only about $15 billion in outstanding debt. It now has total debt of about $800 billion, while Freddie has about $740 billion.

So the original, 40 year old, credit line was 2.25/15 = 15% of outstanding debt, to go back to that ratio requires $231 billion for fannie and freddie….

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Note: chart includes pre-market, time is london time , regular session starts at 14:30

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Treasury Default Swaps Reach Record on Fannie, Freddie Concern

via CMA DataVision

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Fannie, Freddie plunge on rescue report

In Large, Red, Friendly Letters it Reads, “Don’t Panic!” (GSE Edition)

Bankers Use Secret Clinics, Nurses to Beat Breakdowns

‘CEOs provide an attractive alternative to other structured products’

Google Gets Answers as Staff Bets on GMail, ‘Star Wars’ Success

Hedge Funds Moving Into Indexing Marketplace

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Insolvency risk is low for most bond insurers, making it unlikely that they would have to make large payments to terminate credit default swap contracts, Moody’s Investors Service said on Wednesday.

Most bond insurers have capital cushions well above minimum levels, and for struggling insurers, regulators are unlikely to take preemptory action that might worsen their financial condition, Moody’s said in a report.

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The use of the euro in foreign exchange reserves held by countries outside the euro area, increased moderately by around 1½ percentage points between December 2006 and December 2007 owing to positive valuation effects. When measured at constant exchange rates, the share of the euro in global foreign reserves decreased by almost 1 percentage point over the same period. Recently released IMF data, covering the first quarter of 2008, confirm the trend of a slightly increasing share of the euro when measured in current exchange rates, but a slight fall when a correction is made for valuation effects.

ECB: Review of the international role of the euro

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It is the OCC’s view that bank derivatives businesses are appropriately concentrated in these large national banks because they have the resources, including risk management expertise and control systems, to control derivatives-related risks in a safe and sound manner.

OCC Supervision of Derivatives

Our supervisory goal is to ensure banks have sound risk governance processes given the nature of their risk-taking activities. At these large banks, resident teams of OCC specialists in capital markets and credit risk, supplemented by PhD economists trained in quantitative finance, engage in evaluations of the suite of risks arising from derivatives activities in general, and also credit derivatives activities specifically.

Central Counterparties and Exchanges

One initiative under consideration by supervisors and industry participants is the development of a central counterparty for the clearing of credit derivatives. This is a concept that would enhance risk mitigation by providing for multilateral netting among the major dealers. A central counterparty could facilitate the management of counterparty credit risk exposures and reduce operational risks across the industry. The central counterparty would manage both counterparty credit and operational risks by truncating the volume of trades among counterparties via a multilateral netting process and by implementing forward-looking margin requirements. Multilateral netting permits long and short positions among multiple counterparties to “net down” to a much smaller volume of open transactions because the central counterparty serves as the seller to every buyer, and the buyer to every seller. With a smaller volume of contracts to be tracked and managed left outstanding, the clearinghouse helps to reduce operational risk.
A clearinghouse model provides a central counterparty and involves ownership guaranty funding and participant margin structure to protect against counterparty credit risk. Given a variety of system, standardization, risk analysis, and pricing issues that may need to be resolved, a clearinghouse might initially have limited application to only index trades and there may be additional challenges that would need to be addressed as it progresses to other credit derivatives products.
Another issue under consideration is an exchange concept for credit derivatives.
It is our understanding that the introduction of an exchange structure to the OTC credit derivatives market would require significant standardization and potentially transform the nature of that market. Given the proven success of the OTC derivatives markets to deliver customized financial products, and current market-based efforts underway to address credit and operational risks, we do not see a need for the OCC to favor one solution over another.

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OCC’s Quarterly Report on Bank Trading and Derivatives Activities First Quarter 2008

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Ambac trading halted in New York after shares slide to $1.04

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Tighter credit conditions are forcing leveraged speculators and oil producers with weak credit to close out short positions in crude oil futures, Goldman Sachs said.

Open interest in New York Mercantile Exchange light sweet crude oil futures has been declining since the third quarter of 2007, a phenomenon Goldman says is likely due to the credit squeeze that began to grip global markets at that time.

“The short side of the market has a greater need to cover in response to deleveraging and decreasing credit terms,” wrote a Goldman team led by Giovanni Serio and Jeffery Currie.

Open interest in the NYMEX light sweet crude contract fell to a 15-month low last week at 1.3 million contracts, according to Reuters EcoWin.

The credit crunch may be further skewing the oil market toward the upside by preventing some cash-strapped long players from liquidating positions as many are likely using substantial gains in oil as collateral for other investments, Goldman said.

A similar phenomenon is occurring on the physical side of the market, where weaker oil refiners are being forced to cut inventories due to the high cost of credit, Goldman said.

Independent refiner Tesoro Corp said last week it would cut its inventories by 10 percent in an effort to reduce working capital requirements and cut borrowing.

Tight credit driving shorts out of oil market - GS

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