Tag Archives: European Central Bank

Euro Leaders Ready For Another Vacation.

Europe is on the brink again. The region’s debt crisis flared today, as fears intensified that Spain would be next in line for a government bailout.

 

A recession is deepening in Spain, the fourth-largest economy that uses the euro currency, and a growing number of its regional governments are seeking financial lifelines to make ends meet. The interest rate on Spanish government bonds soared in a sign of waning market confidence in the country’s ability to pay off its debts.

 The prospect of bailing out Spain is worrisome for Europe because the potential cost far exceeds what’s available in existing emergency funds. Financial markets are also growing uneasy about Italy, another major European economy with large debts and a feeble economy.

Stocks today,  fell sharply across Europe and around the world. The euro slipped just below $1.21 against the dollar, its lowest reading since June 2010. The interest rate on its 10-year bond hit 7.56 percent in the morning, its highest level since Spain joined the euro in 1999.

Spain’s central bank said today that the economy shrank by 0.4 percent during the second quarter, compared with the previous three months. The government predicts the economy won’t return to growth until 2014 as new austerity measures hurt consumers and businesses.

On top of that, Spain is facing new costs as a growing number of regional governments ask federal authorities for assistance. The eastern region of Valencia revealed Friday it would need a bailout from the central Madrid government. Over the weekend, the southern region of Murcia said it may also need help.

Spain has already required an emergency loan package of up to €100 billion ($121 billion) to bail out its banks. But that aid hasn’t quelled markets because the government is ultimately liable to repay the money. It had been hoped that responsibility for repayments would shift from the government to the banks. But that shift is a long way off — a pan-European banking authority would have to be created first and that could be years away.

Yet it is far more than Spain’s struggle that has unnerved markets.

Greece is still struggling with a mountain of debt and international creditors will visit the country tomorrow to check on the country’s attempts to reform its economy. There is concern that officials from the European Commission, European Central Bank and the International Monetary Fund will find that Greece is not living up to the terms of its bailouts and could withhold future funds.

Italy has also been caught up in fears that it may be pushed into asking for aid. Italy’s economy is stagnating and markets are worried that it may soon not be able to maintain its debt burden of €1.9 trillion ($2.32 trillion) — the biggest in the Eurozone after Greece. Interest rates on Italy’s government bonds rose steeply Monday while its stock market dropped 2.76 percent.

The collapse in stock prices in Italy and Spain prompted regulators to introduce temporary bans on short-selling — a practice where traders sell stocks they don’t already own in the hope they can make a profit if the stock falls in price.

Pascal Lamy, director of the World Trade Organization, said after a meeting with French President Francois Holland that the situation in Europe is ‘‘difficult, very difficult, very difficult, very difficult.’’

Ireland, Greece and Portugal have already taken bailout loans after they could no longer afford to borrow on bond markets. Yet those countries are tiny compared to Italy and Spain, the third- and fourth-largest economies in the Eurozone. Analysts say a full bailout for both could strain the other Eurozone countries’ financial resources.

Spain has already received a commitment of up to €100 billion from other Eurozone countries to bail out its banks, which suffered heavy losses from bad real estate loans. Eurozone finance ministers signed off on the aid Friday and said €30 billion would be made available right away. But that incremental step cuts little ice with investors. If Spain’s borrowing rates continue to rise, the government may end up being locked out of international markets and be forced to seek a financial rescue.

 ‘‘Events since Friday have been a clear wake-up call to anyone who thought that the Spanish bank rescue package had bought a calm summer for the euro crisis,’’ analyst Carsten Brzeski said.

The Eurozone’s bailout fund, the European Stability Mechanism, has only €500 billion in lending power, with €100 billion potentially committed to Greece. Italy and Spain together have debt burdens of around €2.5 trillion. And the ESM hasn’t yet been ratified by member states plus Eurozone governments have made it clear they won’t put more money into the pot.

 

That once again pushes the European Central Bank into the frontline against the crisis.

On Saturday, Spain’s Foreign Minister José Manuel García Margallo pleaded for help, saying that only the European Central Bank could halt the panic. But the ECB has shown little willingness to restart its program to purchase the government bonds of financially troubled countries. The central bank has already bought more than €200 billion in bonds since May 2010, with little lasting impact on the crisis.

The central bank has also cut its benchmark interest rates to a record low of 0.75 percent in the hope of kick-starting lending. Yet many economists question how much stimulus this provides as the rates are already very low — and no one wants to borrow anyway.

There has been speculation the ECB could eventually have to follow the Bank of England and the U.S. Federal Reserve and embark on a program of ‘‘quantitative easing’’ — buying up financial assets across the Eurozone to increase the supply of money. That could assist governments by driving down borrowing costs as well.

But so-called QE is fraught with potential legal trouble for the ECB — a European treaty forbids it from helping governments borrow.

In the case of Greece, the country is dependent on foreign bailout loans to pay its bills. A cutoff of aid over its inability to meet the loan conditions would leave it without any source of financing — and could push it to exit the euro so it can print its own money to cover its debts. Really?

 

Germany’s economy minister, Phillip Roesler, said the prospect of Greece leaving the euro was now so familiar it had ‘‘lost its horror’’ and that he was skeptical Athens would meet conditions for continuing rescue money.

The deteriorating situation follows a summit June 28-29 that many hoped would convince markets political leaders were getting a handle on things. The summit agreed on easier access to bailout money and to set up a single banking regulator that could take the burden of bank bailouts off national governments. Yet many of those changes will take months or years to introduce — and there has been no increase in bailout money.

It is an echo of a similar summit in July 2011, when leaders agreed on a second bailout and debt reduction for Greece, only to see borrowing costs spike dramatically as leaders headed off for August vacations.

Stephen Lewis, chief economist at Monument Securites Ltd, said that ‘‘events are following a pattern often repeated in the course of the Eurozone’s troubles, in which the powers-that-be hail progress only to see confidence, almost instantaneously, plumb fresh depths.’’

Must be time for another vacation, I guess.

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How Much Trouble Could Big Banks Be In? Lots!

The future of the Euro and the Eurozone is bleak and will likely look like a series of prolonged, rolling crises that slowly evolve to reveal just how critically the financial health of each country is affected by their individual sovereign debt and their failing banks.

The inevitable result will be severe Eurozone-wide stress, emergency liquidity loans from the IMF and the European Central Bank and politicians from all the countries involved increasingly attacking each other  over allegations of blame and corruption. To no good end.

Even the optimists now say openly that Europe will only solve its problems when there are no options left and time has run out. Less optimistic analysts increasingly think that the Eurozone will break up because all the proposed solutions are essentially Pollyannaish jokes. Let’s say the realists are right, and Europe starts to dissolve. Markets, investors, regulators and governments can stop worrying about interest-rate and credit risk, and start worrying about dissolution risk.

More importantly, they need to start worrying seriously about what the repricing of risk will do to the world’s thinly capitalized and highly leveraged megabanks. European officials, strangely, appear not to have thought about this at all; the Group of 20 meeting last week seemed to communicate a weird form of complacency and calm.

So, for all of the European officials and the U.S. bankers, here’s what dissolution risk means:  If you have a contract that requires you to be paid in euros and the euro no longer exists, what you will receive is not real clear. See? That’s dissolution risk.

Let’s say you have lent 1 million euros to a German bank, payable three months from now. If the euro suddenly ceases to exist and all countries revert to their original currencies, then you would probably receive payment in deutsche marks. You might be fine with this — and congratulate yourself on not lending to an Italian bank, which is now paying off in lira.

But what would the exchange rate be between new deutsche marks and euros? How would this affect the purchasing power of the loan repayment? More worrisome, what if Germany has gone back on the deutsche mark but the euro still exists — issued by more inflation-inclined countries? Presumably you would be offered payment in the rapidly depreciating euro. If you contested such a repayment, the litigation could drag on for years.

What if you lent to that German bank not in Frankfurt but in London? Would it matter if you lent to a branch (part of the parent) or a subsidiary (more clearly a British legal entity)? How would the British courts assess your claim to be repaid in relatively appreciated deutsche marks, rather than ever-less- appealing euros? With the euro depreciating further, should you wait to see what the courts decide? Or should you settle quickly in hope of recovering half of what you originally expected?

What if you lent to the German bank in New York, but the transaction was run through an offshore subsidiary, for example in the Cayman Islands? Global banks are extremely complex in terms of the legal entities that overlap with business units. Do you really know which legal jurisdiction would cover all aspects of your transaction in the currency formerly known as the euro?

Moving from relatively simple contracts to the complex world of derivatives, what would happen to the huge euro-denominated interest-rate swap market if euro dissolution is a real possibility? Guess what? No one really knows.

But, what I am really talking about here is the balance sheets of the really big banks. For example, in recently released filings with banking regulators, JPMorgan Chase & Co. revealed that $50 billion in losses could hypothetically bring down the bank. JPMorgan’s total balance sheet is valued, under U.S. accounting standards, at about $2.3 trillion. But U.S. rules allow a more generous netting of derivatives — offsetting long with short positions between the same counterparties — than European banks are allowed. HA!

The problem is that the netting effect can be overstated because derivatives contracts often don’t offset each other precisely. Worse, when traders smell trouble at a bank that has taken on too much risk, they tend to close out their derivatives positions quickly, leaving supposedly netted contracts exposed. Remember the final days of Lehman Brothers?

When one bank defaults and its derivatives counterpart does not, the failing bank must pay many contracts at once. The counterpart, however, wouldn’t provide a matching acceleration in its payments, which would be owed under the originally agreed schedule. This discrepancy could cause a “run” on a highly leveraged bank as counterparties attempt to close out positions with suspect banks while they can. The point is that the netting shown on a bank balance sheet can paper over this dynamic. And that means that JPMorgan’s regulatory filings vastly understate the potential danger.

JPMorgan’s balance sheet, using the European method isn’t $2.3 trillion, but closer to $4 trillion. That would make it the largest bank in the world. Holy Moly!

What are the odds that JPMorgan would lose no more than $50 billion on assets of $4 trillion, much of which is complex derivatives, in a euro-area breakup, an event that would easily be the biggest financial crisis in world history? Slim. And, None.

No one on these shores seems to see the storm coming. In an effort to forestall the impending global crisis, the Federal Reserve should be insisting that big U.S. banks increase their capital levels by suspending dividends, and set up emergency liquidity facilities with an emergency and across-the-board suspension of dividend payments, but it won’t. The Fed is convinced that its recent stress tests show U.S. banks have enough capital even though these tests didn’t model serious euro dissolution risk and the effect on global derivatives markets.

The Fed is dead wrong about that, and the pending Euro-crisis is very real. Our mega-banks are in no position to weather even the known storm, let alone the real storm when all the European counter-parties pony up to the bar with their real exposures, and the true sovereign debt gets exposed. Then, what do you think that means for smaller banks? 

How do you think that might affect the U.S. economic recovery? What is gold trading at? $1,575 an ounce?  Hmmmm.


Greece Is Lost, And So Is Europe.

There was much hoopla and relief on Wall Street and in European markets today as it appeared that Greece got some religion and voted a conservative party in to power.

A party who has contended that they would support the austerity requirements of the latest round of bailouts and keep Greece in the Union. So, to many investors, the European financial crisis appeared to have been abated for at least the time being, and maybe everything will turn out alright after all.

Here is the truth. Greece will be forced to return to the drachma and devalue, and the default will cause bank runs and money flowing into Germany and the United States as the only viable safe haven bets.  It doesn’t matter which party wins. Greece will default because there is no other choice regardless of anyone’s politics.

It will hit the European Central Bank, the banks on the other side of the derivatives contracts, all of the Greek banks who are really in default at present and being carried by Europe as well as the nation, and the Greek default will spread the infection in many places that we cannot imagine because so much is hidden and tucked away in the European financial system.

Not unlike, I suppose, Nouriel Roubini, the New York University economist, who said the subprime-debt sky was falling for a long time before it fell, I have been hammering this message home since early January.

Greece cannot afford to pay off their regional debt, and various schemes to avoid the bad guys from taking over will not work nor will the attempt to roll the problem over to the rest of Europe by Germany succeed.

One thing is for sure. The Germans will not allow their cost of funding to rise or their standard of living to decline to help the nations that have gotten themselves in trouble.

As a result, Europe is headed for a bad recession with lots of shocks to the system, and it will happen in the next four months unless there is debt forgiveness, or Europe keeps handing them money like they are a ward of the state. Neither is likely to happen.


European Commission Rearranges Deck Chairs As Europe Burns.

The European Commission proposed what has been characterized as far-reaching powers for regulators to deal with failing banks on Wednesday.

Is this a chilling picture? This tepid proposal, which recommends closer coordination between countries and increased powers to force losses onto bondholders, won’t take effect before 2014, which will be way too late for Greece and Spain, which appears on the brink of being forced to seek a Greek-style bailout, as it is obviously unable to refinance its indebted lenders.

Even if Europe were not on fire at the moment, there are a ton of hurdles to the banking union championed by ECB President Mario Draghi – which is basically a three-pillar plan to establish a central monitoring of banks (gee, I thought that’s what the ECB already did), a fund to wind-down big lenders (we call that a bail-out here in the U.S.) and a pan-European deposit guarantee (good luck getting anything done “pan-European” style.)

Smartly, and true to form, Germany has balked at signing up to a single European scheme that could see it shoulder the costs of a bank collapse in another country (and, why should they?), and Britain fiercely resists any attempt by Brussels to impose EU controls over financial services, which account for almost a tenth of its Wall Street like economy.

At least there are a couple of people who have noticed that Europe is burning:

Nicolas Veron of Brussels think tank Bruegel, says “Everybody’s energy right now should be focused on the current crisis. I’m not sure we can afford the luxury of thinking about a permanent framework when the houses are burning.”

Daniel Gros of the Centre for European Policy Studies think tank said while it was in everyone’s interest to prevent a repeat of the chaos that followed the collapse of U.S. investment bank Lehman Brothers, action was needed now.

“We need immediate decisions”, he said. “We have a crisis on our hands.”

The Commission’s stupid 156-page (draft) legislation, recommends giving supervisors powers to “bail in” or force losses onto bondholders of a failing bank so that taxpayers are kept off the hook, and forge closer links between national back-up funds to wind up cross-border lenders. They can’t even move off of draft.

Are they kidding?

“There was little appetite to create pan-European funds,” he said. “There would be mistrust among states in pursuing such cooperation.”

Translation: Nothing will happen.

Berlin, recognizing the panic in the details and knowing it is firmly in the driver’s seat, is in no hurry. Germany knows that Europe will not make any final decisions on strengthening economic policy coordination between member states until at the earliest, spring of 2013.

The Centre for European Policy Studies’ Gros said only an acceleration of the crisis would prompt German Chancellor Angela Merkel into faster action.

“If it is a slow grind, where the German economy is not visibly affected, it will be hard for her to do that. It has to be so urgent that there is an emergency summit of leaders and that she returns home and says: ‘there was no choice’.”

If you knew that it would come to that, and you were Angela Merkel, what would you do?


George Soros Calls It Like It Is.

Billionaire George Soros delivered a speech today that absolutely nails the European financial crisis. If you want to read the whole speech, in all its brilliance, you should go to his website, http://georgesoros.com/interviews-speeches/.

It accurately and simply explains how the European Union got itself into the current mess, and what it needs to do to get out of it.  Here are excerpts:

I contend that the European Union itself is like a bubble. In the boom phase the EU was what the psychoanalyst David Tuckett calls a “fantastic object” – unreal but immensely attractive. The EU was the embodiment of an open society –an association of nations founded on the principles of democracy, human rights, and rule of law in which no nation or nationality would have a dominant position.

The process of integration was spearheaded by a small group of far sighted statesmen who practiced what Karl Popper called piecemeal social engineering. They recognized that perfection is unattainable; so they set limited objectives and firm timelines and then mobilized the political will for a small step forward, knowing full well that when they achieved it, its inadequacy would become apparent and require a further step. The process fed on its own success, very much like a financial bubble. That is how the Coal and Steel Community was gradually transformed into the European Union, step by step.

Germany used to be in the forefront of the effort. When the Soviet empire started to disintegrate, Germany’s leaders realized that reunification was possible only in the context of a more united Europe and they were willing to make considerable sacrifices to achieve it.  When it came to bargaining they were willing to contribute a little more and take a little less than the others, thereby facilitating agreement.  At that time, German statesmen used to assert that Germany has no independent foreign policy, only a European one.

And then came the moment that German, formerly at the forefront of a federated Europe, stopped the progress dead in its tracks…

The process culminated with the Maastricht Treaty and the introduction of the euro. It was followed by a period of stagnation which, after the crash of 2008, turned into a process of disintegration. The first step was taken by Germany when, after the bankruptcy of Lehman Brothers,

Angela Merkel declared that the virtual guarantee extended to other financial institutions should come from each country acting separately, not by Europe acting jointly.

It took financial markets more than a year to realize the implication of that declaration, showing that they are not perfect.

This is a really huge point to grasp, because a nagging question has been: Why did the market think of Spain/Greece/Italy/Etc. as being risk-free sovereigns at one point, and then decide that they were not risk free and subject to credit risk.

Soros answer: Because they were essentially risk-free so long as the arc was always towards more integration. That ended when Merkel made that declaration.

Despite the fact that the Euro crisis has been happening for at least 3 years now, there are still many who can’t articulate the roots of it as well as Soros does in these two paragraphs:

The Maastricht Treaty was fundamentally flawed, demonstrating the fallibility of the authorities. Its main weakness was well known to its architects: it established a monetary union without a political union. The architects believed however, that when the need arose, the political will could be generated to take the necessary steps towards a political union.

But the euro also had some other defects of which the architects were unaware and which are not fully understood even today. In retrospect it is now clear that the main source of trouble is that the member states of the euro have surrendered to the European Central Bank their rights to create fiat money. They did not realize what that entails – and neither did the European authorities. When the euro was introduced, the regulators allowed banks to buy unlimited amounts of government bonds without setting aside any equity capital; and the central bank accepted all government bonds at its discount window on equal terms.

Commercial banks found it advantageous to accumulate the bonds of the weaker euro members in order to earn a few extra basis points. That is what caused interest rates to converge which in turn caused competitiveness to diverge. Germany, struggling with the burdens of reunification, undertook structural reforms and became more competitive. Other countries enjoyed housing and consumption booms on the back of cheap credit, making them less competitive. Then came the crash of 2008 which created conditions that were far removed from those prescribed by the Maastricht Treaty. Many governments had to shift bank liabilities on to their own balance sheets and engage in massive deficit spending. These countries found themselves in the position of a third world country that had become heavily indebted in a currency that it did not control. Due to the divergence in economic performance, Europe became divided between creditor and debtor countries. This is having far reaching political implications to which I will revert.

His key warning:

In my judgment the authorities have a three months’ window during which they could still correct their mistakes and reverse the current trends. By the authorities, I mean mainly the German government and the Bundesbank because in a crisis the creditors are in the driver’s seat and nothing can be done without German support.

We need to do whatever we can to convince Germany to show leadership and preserve the European Union as the fantastic object that it used to be. The future of Europe depends on it.

And, my money is on Germany showing a different sort of leadership and withdrawing from the European Union and from the currency. From their point of view, it is really their only way out of this mess.


Euro Banks Running Scared.

Not a good signal.

Europe‘s troubled banks accelerated efforts to pull loans from countries around the world, including Australia, towards the end of last year as the euro-zone debt crisis intensified. Figures released by the Swiss-based Bank of International settlements show Europe’s banks cut more than $8 billion (USD)  from the Australian economy as they began to feel the funding squeeze at home. During the second half of last year, most European banks began selling down their international loan portfolio or simply turned off the lending tap, the Swiss-based Bank of International Settlements (BIS) said.

This coincided with a period in which many large Australian companies were attempting to refinance loans they had locked-in during the global financial crisis.

“Pressures on European banks to de-leverage increased towards the end of 2011 as funding strains intensified and regulators imposed new (capital) targets,” BIS said in its March quarterly review released Friday morning.

The report found it was largely an orderly exit by European banks, with other global banks and bond markets able to step in to replace financing. This helped local businesses avoid a credit squeeze. Senior Australian bankers told Business Day that Asian banks have become more active in terms of financing large corporates in the Australian market. At the same time, US banks have started lending again.

“Come the second half and with all the problems that were going on, you started to see a lot of European banks pull back and repatriating capital, whether it was to France or other parts of the region,” one institutional banker with a major Australian lender said. “European names just aren’t in the transactions that traditionally they’ve been in.

Towards the end of last year, European banks had been unable to raise funds on wholesale markets and for those banks rolling over short-term loans, costs surged back to levels last seen at the height of the financial crisis. While Australian banks were still able to raise funds through the year, it was these same pressures on global money markets that have seen financing costs run up, which have forced some to hike interest rates for borrowers.

Still, a massive injection of funds by the European Central Bank into the region’s banking system has helped ease strains on financial markets and economic activity. The offer of more than 1 trillion worth of cheap loans to Europe’s banks since December has helped improve funding conditions, the BIS said.

The BIS figures, which cover the period from June to the end of September, show French banks pulled more than $4.5 billion (USD) worth of loans from the Australian economy.

Italian, Irish and Spanish banks each cut their exposure by hundreds of millions of dollars.

At the same time, Australian banks aggressively cut their exposure to some of Europe’s troubled economies, pulling billions of dollars in funds from Belgium, France and Spain. Global banks also sharply reduced their exposure to Europe and the Middle East, the report found. What this tells us is that the European banks are pulling back to contain their exposures Internationally, while repatriating capital around the European Central Bank, a sure sign that the European Banks sense trouble at home. And, soon. 


The Slow Train Wreck Continues.

Monti Presses Ahead Amid Warnings Euro Crisis Is Far From Over

David Blanchflower, a professor at Dartmouth College and a Bloomberg Television contributing editor, talks about the global labor market, wages and central bank policy. He speaks with Tom Keene on Bloomberg Television’s “Surveillance Midday.”

“Optimism should not give us a sense of comfort or lull us into a false sense of security,International Monetary Fund Managing Director Christine Lagarde said today in a speech at the China Development Forum in Beijing. “We cannot go back to business as usual,” she said, urging vigilance on oil prices, debt levels, and the risk of slowing growth in emerging markets.

An easing of the crisis offered breathing room for Monti to seek an Italian labor-market overhaul and for euro-area ministers aiming to bolster euro bailout funding before a meeting at the end of the month. Still, urgency was underscored by an IMF warning that the Greek bailout held “exceptional risks” that could prompt a “disorderly” exit from the monetary union unless additional help is prepared.

‘Sovereign Default’

“The materialization of these risks would most likely require additional debt relief by the official sector and, short of that, lead to a sovereign default,” IMF staff wrote in a report released March 16. “In the absence of continued official support and access to” refinancing by the European Central Bank, “a disorderly euro exit would be unavoidable,” it said.

With billions of euros committed to hold Greece afloat and investors looking to see whether contagion could spread to Spain or Italy, the fragility of rescue efforts were reflected in bond yields last week. Spain’s 10-year yield climbed 20 basis points to 5.20 percent, the second weekly gain, while the yield on similar maturity Italian debt rose three basis points to 4.86 percent.

Investors have been encouraged by the Italian prime minister’s efforts to rein in the country’s debt since his government of non-politicians replaced Silvio Berlusconi’s administration last year.

Monti’s labor overhaul will include a revision of firing rules and an expansion of jobless benefits. The rules, which will distinguish between workers removed without just cause and those fired for disciplinary or economic reasons, are among the most contentious. Under article 18 of the Italian labor code, employers have to compensate and rehire any worker ruled to have been fired without just cause by a labor court.

Month’s End

Monti met yesterday with Confindustria head Emma Marcegaglia, Labor Minister Elsa Fornero, CGIL union leader Susanna Camusso, CISL union chief Raffaele Bonanni and UIL union head Luigi Angeletti, a spokesman for Confindustria said. The Italian leader has said he wants to pass labor legislation by the end of the month.

“We’ll get an agreement within about a week, although there may be some small changes to the present proposal before it’s all done,” Erik Nielsen, chief global economist at UniCredit SpA (UCG) in London, wrote in a note to clients today.

Even as focus shifted beyond Greece to other parts of the euro area, the IMF’s continuing concern about the Greek package illustrated the difficulty of implementing changes that officials in Brussels and Athens had been negotiating for months. Greece remains “accident prone,” the Washington-based institution’s staff said in the report.

Greek Election

Greece Flag

The IMF reduced its contribution to the second Greek bailout because the operation poses what staff called “unprecedented financial risks” to its finances. One of the risks identified was the upcoming Greek election, to be held in April or May.

Lagarde has pushed European governments to boost their bailout fund in an effort to protectSpain and Italy from contagion. Euro finance ministers may decide to increase the region’s crisis fund to a total capacity of 692 billion euros when they meet on March 30, a euro-area official said March 16.

The ministers, who will meet in Copenhagen, are weighing what to do with the temporary European Financial Stability Facility and its permanent successor, the European Stability Mechanism. The 692 billion-euro figure represents the most attainable compromise between 500 billion euros, if policy makers change nothing, to a maximum of 940 billion euros, the official said.

Chancellor Angela Merkel on March 16 left the door open to boosting the euro-area backstop, saying a decision on reinforcing the firewall will be made before IMF meetings next month. Ministers have discussed “combination possibilities” for the EFSF and the ESM ahead of their meeting.

“What’s clear is that we need to settle on a position with a view to the IMF’s spring meeting because the topic will surely come up and because there have been offers by the international community,” Merkel said. “You can count on us setting the course by the end of March.” Assuming Greece is not gone by then.


Is This The End Of Yesterday?

She watched it all crumble away
Is this the end of yesterday?
“Lord, I hope so” is all he said

              – Endgame – “Rise Against”

 

The Next Greek Tragedy

European leaders are falling all over themselves to tell us that the Greek default does not in any way suggest that it is possible for another country to default.

Kiron Sarkar makes the following points, with which I agree, so let’s jump to him:

Spain unilaterally set its 2012 budget deficit at 5.8% of GDP, much higher than the 4.4% previously agreed with the EU. The budget deficit came in at 8.5% last year, once again higher than the target of 6.0%. A ‘discussion’ between Spain and the EU is inevitable, especially as (to date) the EU has insisted that Spain stick to its prior commitment. Quite an interesting development, particularly as it has come on the same day that 25 out of 27 EU countries (excluding the UK and the Czech Republic) signed up to the ‘fiscal compact’ which, once approved by each country’s national Parliament (Ireland will need a referendum), will introduce the German-inspired ‘debt brake’ into their constitutions – basically commits the 25 EU countries to reduce borrowings and, indeed, balance their budget deficits.

“Spanish unemployment rose by a massive +2.4% MoM in February, with youth (under 25) unemployment over 50%, yep that’s 50%. The EU has a tough task. If it offers concessions to Spain, expect Portugal, Ireland, etc., etc. to submit their own ‘requests.’ However, I just can’t see how Spain can meet its prior commitment. Officially, GDP is forecast to be -1.0% to -1.7% this year, though in reality the actual outcome will be closer to (indeed may exceed) the more pessimistic forecasts.”

And the report from Portugal is not much better. This from Lew Rockwell (Feb. 3, 2012):

“Things are also unraveling very quickly in Portugal. Now there is talk that private investors will be required to take a ‘haircut’ on Portuguese debt as well.

“The following is from a recent article in the Telegraph…

“‘A report for the Kiel Institute for the World Economy said Portugal would have to run a primary budget surplus of over 11pct of GDP a year to prevent debt dynamics spiralling out of control, even in a benign scenario of 2pct annual growth.

‘Portugal’s debt is unsustainable. That is the only possible conclusion,’ said David Bencek, the co-author, warning that no country can achieve a primary budget surplus above 5pct for long. ‘We won’t know what the trigger will be, but once there is a decision on Greece, people are going to start looking closely and realize that Portugal is the same position as Greece was a year ago.'”

“Sadly, that article is exactly right. Portugal is marching down the exact same road that Greece went down. The yield on 5-year Portuguese bonds is now up to an all-time record 19.8 percent. A year ago, the yield on those bonds was only about 6 percent. This is the same thing that happened to Greece. A year ago, the yield on 5-year Greek bonds was about 12 percent. Now the yield on those bonds is more than 50 percent.”

The world is facing a debt crisis unlike anything ever seen before, and Europe is right at the center of it.

french strikes1 A massive strike meant to paralyze France

Italy can pull out of its tailspin, but it will need help from the ECB in the form of debt issued at lower than current market rates. But if you give it to Italy, must not you do the same for Spain and Portugal? And while their economies are markedly worse, their government debt-to-GDP ratios are nowhere near as bad. And don’t even get me started about France, which becomes a crisis of biblical proportions by the middle of the decade. Let me note that France is not Greece. It actually is too big to save. France will make a difference when it enters its problem period. And the probable election of Hollande does nothing to alleviate any concerns.

There are only two ways that countries in Europe can get their deficits under control and begin to shrink their debt-to-GDP ratios. They can either grow GDP faster than the growth of their debt, or reduce their debt. How can Spain, with 20% unemployment and a projected 6% deficit, grow enough? Certainly not in the next few years. Portugal has the same problems. Austerity at the levels they will need will soon make growth even less likely, but borrowing more money is going to mean ever higher interest rates, unless the ECB is willing to print or Europe is willing to tax northern European countries to bail out the southerners. Try selling that one in an election campaign, or for that matter, anytime.

Because of the current willingness of European leaders to tap their taxpayers and of the European Central Bank to print money, a crisis has been averted, at least for the moment. For that, the US and the world can be grateful. The probability of a recession this year in the US is falling, as a crisis in the EU could have been the trigger that pushed a slow economy into recession.

But let’s make no mistake. The sovereign debt crisis is not over. Not in Europe, not in Japan, and not in the US. It is in a lull period. And don’t give me that old shibboleth, “The market is telling us that the crisis is over.” The market knows a lot less than many pundits believe. What did the market know in mid-2007? Not very much, although the warning signs were clear, at least to some of us.

Sadly, the focus of the crisis will now move on to other countries in Europe. The economic arithmetic of the peripheral countries is not much better than that of Greece only a few years ago. The pronouncements and assurances from European leaders are about the same as they were a few years ago. Total European debt is at 443%, well above US debt of 350%. European banks are leveraged over 30 to 1, at least double that of US banks, which are nerve-wracking enough.

 

It is the time of the Endgame. There will be contagion. 


The Slow Train Wreck!

Greece will reap fast relief from a historic €200 billion ($266 billion) debt restructuring sealed Friday, but the default isn’t likely to end the debt-strapped country’s epic financial problems.

A panel of market participants ruled later in the day that the restructuring constitutes a credit event and would trigger insurance-like contracts that pay off if creditors suffer losses. On Friday, ratings firms Fitch and Moody’s declared Greece in default.

The restructuring will cut some €100 billion from the face value of Greece’s obligations. Yet, Greece remains mired in a long recession; unemployment is at 21%; and even after the write-off, the debt level is well in excess of a year’s economic output.

“Their problems are much greater than the solution that is in front of them,” says Pawan Malik of Navigant Capital in London. “Greece’s ability to come back to the market as a functioning and solvent sovereign is very doubtful.”

Markets aren’t hopeful, and that suggests Greece may face another restructuring—one that could well hit taxpayers of the countries that have been its rescuers.

I read this as the beginning of the end for the Eurozone – France, Spain and Italy are the next big ones to fall. This is like the Icelandic faux prosperity circa 2006, when in fact, Iceland owed more than 800% of its GDP in debt. Every penny (or Krona) went to service debt and it still couldn’t get it done. Went from darlings of International investment savvy to the crazies of finance overnight. Greece, and its people are simply screwed.

Greece said €197 billion of the €206 billion in eligible bonds would be swapped into a package of new securities. That counts both creditors who volunteered for the exchange and those who will be forced into it by the so-called collective-action clauses that Greece had inserted into most of its bonds.

A panel convened by the International Swaps and Derivatives Association determined late Friday that Greece’s use of the collective-action clauses had breached the rights of bondholders, and authorized payouts on the contracts.ISDA said an auction would be held March 19 to determine how much holders of the contracts would be paid. There is a total of $3.2 billion in outstanding contracts, after subtracting the contracts bought and sold by the same firm. The payouts would total no more than that sum. It is beginning to sound like $3.2 Billion is just chump change or rounding errors.

Greece offered the €9 billion in holdouts two weeks to change their minds. At least some of those could be pulled in by other collective-action clauses that Greece said it will try to use.

Evangelos Venizelos, the Greek finance minister, told reporters Friday that the holdouts were “naive” in thinking they would be paid in full.

For Greece, the restructuring means immediate relief. For each €100 in bonds, creditors get €15 in high-quality, short-term bonds issued by the euro zone’s rescue fund, and €31.5 in new Greek bonds that mature 11 to 30 years in the future.

The biggest immediate benefit to Greece is that its problems are put off until another day. It has a €14.5 billion bond due March 20, and it doesn’t have money to pay it.

That bond in its entirety has been forced into the swap, and Greece’s first principal payment on it will now be in 2023.

The swap also cuts Greece’s annual interest burden, which rose to about €16.4 billion last year. Greece will have less debt on which it must pay interest, and the rates are generally lower that what it has been paying.

GREECE

But the deal has costs. For one, it imposes billions in losses on Greek banks, which will need to be recapitalized, and on Greek pension funds, which will need to be replenished. And the €30 billion used to provide the cash-like bonds to creditors has to be borrowed from the rescue fund. On Friday, euro-zone finance ministers said Greece would get that, along with another loan of €5.5 billion to cover accrued interest payments to creditors.

The swap clears the way for the euro zone to approve billions more in aid loans that Greece needs to cover a persistent budget deficit.

Private creditors have agreed to tender Greek debt, paving the way for a second multi-billion euro bailout.

Euro-zone finance ministers are meeting next week in Brussels, but a senior euro-zone figure, Luxembourg Prime Minister Jean-Claude Juncker, said on Friday that the path was clear for approval of fresh bailout loans for Greece.

The International Monetary Fund‘s chief, Christine Lagarde, said she would propose to the fund’s board that the IMF provide Greece with an additional €18 billion in aid loans over the next four years, on top of the €10 billion in IMF money still to be spent from the first bailout.

Perhaps most crucially, the deal makes Greece largely indebted to other euro-zone countries, and European and international institutions.The euro-zone countries, the IMF and the European Central Bank will be, by far, Greece’s largest creditors. Private bondholders will have roughly €63 billion. Thus, the bulk of any future problems in Greece will become the problems of public entities, not of financial-market players.

These public entities, to increase the chances that they will be repaid, have put Greece on a diet of fiscal austerity. That move has stunted the domestic economy.

On Friday, Greece’s statistics agency said gross-domestic product in the fourth quarter of 2011 fell 7.5% from the year-earlier period, worse than a previous estimate of 7%. Soaring unemployment has bred strong resentment of the austerity policies, and Greece faces elections as soon as this spring. Here it comes folks.

The new bonds that Greece will issue Monday to settle the exchange haven’t begun trading, but on Friday several banks were beginning to offer prices on them, according to people familiar with the matter. The bonds that mature in 2042 were initially quoted between 17% and 22% of face value, according to traders with knowledge of the matter. That suggests creditors see a high likelihood of more Greek losses.

So, bottom line is there is no way Greece can emerge nor is there any way the Eurozone can emerge still intact. I am shocked at the charade. Remember Iceland? Anybody? Huh?


Greece In The Red Zone.

Failure of Greek debt deal could cost $1 trillion!

Decision day for the Greek debt crisis is drawing near, and insiders are predicting that if things go awry it could cost the world economy $1 trillion.

Greece’s credit rating was cut to selective default by Standard & Poor’s after the bell on Monday, reflecting the implementation of collective action clauses (CACs) on its debt.  Greece is in the middle of one of the largest sovereign debt restructurings ever and needs to secure significant private sector participation rate; CACs are designed to forcibly increase that rate.

According to S&P, the Greek government retroactively inserted CACs into the documentation of certain series of its sovereign debt on February 23, two days after the Troika agreed on the terms for a second bailout package.  This retroactive implementation substantially changed the terms of the deal and diminished investors’ bargaining power in the face of a restructuring, causing the downgrade, S&P said.

Greece needs to fulfill certain conditions in order to receive the next tranche of money and avoid a disorderly default.  Among those is the successful implementation of the so-called PSI (private sector involvement) deal, which is supposed to be voluntary.  In practice, Greece is executing a bond restructuring that will see bondholders take an approximately 70% haircut on the net present value of their bonds while the average maturity will be significantly extended, reducing shorter-term funding requirements.

For the PSI to succeed, the Troika (made up by the EU Commission, the ECB, and the IMF) is expecting Greece to secure the participation of 95% of private bondholders.  Experts at Barclays believe Greece could come short, and thus would use retroactive CACs that could require a 66% participation rate to force all bondholders to take the deal.

“In our opinion, Greece’s retroactive insertion of CACs materially changes the original terms of the affected debt and constitutes the launch of what we consider to be a distressed debt restructuring,” read S&P’s post-market release.

Consummation of the debt exchange would result in a credit upgrade, S&P announced, and would take Greece’s credit rating to CCC.  “In this context, any potential upgrade to the ‘CCC’ category rating would reflect our view of Greece’s uncertain economic growth prospects and still large government debt, even after the debt restructuring is concluded.”

A failure to secure a high enough participation rate could well lead to an outright default, S&P warned, given the Hellenic Republic’s lack of access to capital markets.  Bondholders have until about March 12 to participate, according to S&P.

Greece faces a hard deadline of March 20, date when it is scheduled to pay €14.5 billion in bond redemptions.  On Monday, German members of parliament passed a bill approving the second Greek bailout.  After Angela Merkel’s victory at the polls, investors will have to keep their eyes on Dutch and Finnish parliamentary votes on the bailout.

In a confidential memo that has just surfaced, the industry group representing bond holders has said that the consequences of such a default could be $1 trillion in losses. “When combined with the strong likelihood that a disorderly Greek default would lead to the hurried exit of Greece from the Eurozone, this financial shock to the [European Central Bank] could raise significant stability issues about the monetary union,” the International Institute of Finance’s memo said, according to a copy posted on a Greek news website.

Even with the potential damage, it is not clear if all the bond holders will sign on, and Greece said it will only go ahead if it gets 75% participation. Many of the bonds are currently held by hedge funds who bought them up on the cheap and who are now disappointed with the level of the cuts that Greece is insisting they take. The IIF put out a statement Monday listing all the bond holders who are willing to take the deal.

Bloomberg estimated that they only account for 20% of the total participants needed. Greece’s finance minister told Bloomberg Television this is the only chance bond holders will get. “This is the best offer because this is the only one, the only existing offer,” Evangelos Venizelos said.

If they don’t take it, today’s stock market declines are going to look like small potatoes.