The conclusions of the Eurozone financial council and central bank governors meeting which took place in Wroclaw, Poland these past two days resulted in no major new commitments or measures. Given the rapid pace of events, this non-decision is likely to feed the flames of a financial disaster later this month, and into October.
The date of the decision of the eventual disbursement of the sixth Greek instalment of the first bail-out package was pushed back to mid-October at the earliest, pending a Troika review at the beginning of October. Greece was asked to provide more details on its fiscal consolidation plan, which is code for introducing yet more measures.
No decision was taken on two other critical issues: alternatives for EFSF capitalisation, and capital support for the European banking system. This is likely to be the greatest policy-making fault on the European, and global levels, and will soon put Europe further behind the policy curve, where it’s been all along.
US Treasury Secretary Tim Geithner was invited to this meeting and made two important proposals:
(a) that Europe leverage the capital of the European Financial Stability Fund (EFSF) in the same way the New York Federal Reserve was able to leverage its assets to deal with the 2008 banking crisis, and
(b) that Germany and other rich nations provide, directly or indirectly, additional financial stimulus. This could have been provided by the European Central Bank, had German resistance to its bond-buying programme not been as vehement.
Geithner’s recommendations were shot down. The EFSF capital expansion will continue to wind its slow way through European capitals, with a final decision hopefully made in October. Jean-Claude Juncker was quoted by Reuters as saying that
"We are not discussing the expansion or increase of the EFSF with a non-member of the euro area," he told reporters. He also ruled out any further fiscal stimulus, something Washington has also called for. "Fiscal consolidation remains a top priority for the euro area," he said.
The difference with US policy-making at the height of the financial crisis in 2008 could not be greater. Not only did the Federal Reserve and the US Treasury launch a massive financial stimulus (TARP, TALF), quantitative easing, and emergency liquidity assistance (ELA) programmes, but they extended this to all banks, not just American banks. I found these comments unacceptable:
· Has Europe forgotten the emergency liquidity assistance provided by the US Federal Reserve to European banks such as Royal Bank of Scotland ($84.5 bln); Hypo Real Estate Holdings ($28.7 bln), Dexia, and Societe Generale?
· Has Europe forgotten the fact that the TARP funds bailed out European AIG counterparties such as Deutsche Bank and others at face value in 2008-2009?
· Is Europe ignorant of the fact that the Fed provided a massive recapitalisation of European banks via the QE2 programme, and that 8 of 22 primary dealers are European?
It’s fully indicative of the provincial approach taken by European policy-makers on this subject. Instead of listening to one of the point men on the US crisis, this turned into yet another “Europe vs. USA” moment.
Geithner also made one extremely good comment this week:
“What is very damaging (in Europe) from the outside is not the divisiveness about the broader debate, about strategy, but about the ongoing conflict between governments and the central bank, and you need both to work together to do what is essential to the resolution of any crisis,” he said.
“Governments and central banks have to take out the catastrophic risks from markets … (and avoid) loose talk about dismantling the institutions of the euro.”
No comment necessary: he is exactly right.
So why are we sleepwalking into disaster? The following reasons apply. I’ll probably be repeating them in one form or another each week.
1. Europe has not gotten a handle on the Greek debt crisis, or Greek contagion. Greece’s slippage on fiscal consolidation is insignificant and is fully explained by rational policy choices. We have already seen the massive erosion of market confidence at the end of last week: this is now set to continue as a result of an extremely poor Troika management of the situation. On the other hand, Greece’s overshot on higher taxes and lower expenditure forced by recent Troika decisions will push the country into depression. Instead of looking for ways of saving the Greek bail-out, Troika policy and public comments appear to be ready to destroy it.
2. Italy and several other Eurozone countries are facing a credit rating monitoring starting this week. In my opinion, the outlook is negative. A ratings downgrade of Italy may be averted, but is unlikely. I forecast a 55-65% chance of a ratings downgrade. This will set off yet another financial firestorm, both in terms of bond yields of other at-risk countries, as well as in shares of banks exposed to Italy. Beware a run on France.
3. Progress of ratification and expansion of EFSF lending is too slow, too low and now hindered by German decision-making based on the decision of the German High Court.
4. The European Central Bank has not been fully allowed to extend emergency liquidity assistance or buy bonds, again largely due to German decision-making. This means that the prime function of Europe’s Central Bank has been hobbled.
5. European banks need an urgent recapitalisation, estimated by the IMF to be in the region of EUR 200 bln. The European policy response has been to ignore this. The recent stress tests do not take a realistic sovereign bond mark-down into effect. There are also any number of toxic debts in the European system, not least of which are commercial real estate.
6. Economic growth is slowing due to market contagion, consumer fear and lower capital spending. Chinese weakness is visible: all signs (oil prices, shipping rates, Chinese port traffic) point to an anaemic or declining global economy. Far too much of UK and French growth remains attributed to unreasonably high property values.
7. With the summer over, unemployment in Europe and America is likely to increase.
8. The chances of another “Black Swan” event remain elevated. Whether this will be a run on European bank deposits or contagion in French bonds or a conflict in the Persian Gulf is unknown. But it is likely just around the corner. The lack of coordinated policy and the lack of financial reserves in the European banking and sovereign funding systems means that Europe is exposed.
9. Over the longer term, European political differences are increasing, while domestic political stability is increasingly fragile. Neither Angela Merkel nor Nicholas Sarkozy enjoys a strong political position. Italian politics remain fragmented. Barack Obama enters another pre-election period. Decision-making in the next 12-18 months will be even worse than usual. We see this most vividly in the CDU-FDP-CSU imbroglio on a Greek default.
I know believe that no matter which scenario plays out, the greatest threat will be a liquidity and solvency crisis in the European banking system. Given the roller-coaster bank share prices in the last month, this opinion is widely shared.
If anyone knows of a stable bank in a stable country (Norway? Canada?) with no exposure to European bonds and no dodgy derivatives contracts or rogue traders or large amounts of Florida property loans, I’m looking to shift accounts.
© Philip Ammerman, 2011
Here are my comments to some of your points:
1. "Europe has not gotten a handle on the Greek debt crisis, or Greek contagion. Greece’s slippage on fiscal consolidation is insignificant and is fully explained by rational policy choices..."
I disagree. The problem is the lack of trust, which is fully the fault of Greece.
3. "Progress of ratification and expansion of EFSF lending is too slow, too low and now hindered by German decision-making based on the decision of the German High Court."
We'll, that's democracy for you. I, for one, is rather pleased we still have a little bit of it left in Europe.
4. "The European Central Bank has not been fully allowed to extend emergency liquidity assistance or buy bonds, again largely due to German decision-making. This means that the prime function of Europe’s Central Bank has been hobbled."
From what I recall, the role of the ECB was never to buy junk-reated bonds; nor to accept junk-rated bonds as collateral. I believe there are very good reasons for this.
5. " European banks need an urgent recapitalisation, estimated by the IMF to be in the region of EUR 200 bln. The European policy response has been to ignore this. The recent stress tests do not take a realistic sovereign bond mark-down into effect. There are also any number of toxic debts in the European system, not least of which are commercial real estate."
I fully agree.
6. " Economic growth is slowing due to market contagion, consumer fear and lower capital spending. Chinese weakness is visible: all signs (oil prices, shipping rates, Chinese port traffic) point to an anaemic or declining global economy. Far too much of UK and French growth remains attributed to unreasonably high property values."
7. " With the summer over, unemployment in Europe and America is likely to increase."
Andreas, thanks for your comment!ReplyDelete
Regarding the Troika: Please check points 3-4 of this post: http://www.philip-atticus.com/2011/09/greece-troika-and-missing-eur-17.html
In all the reports on events in the past 2 weeks, I note two common points:
a. There is a blanket reference to Greece's need to implement the July 21st. agreement. There is nothing more specific than this. Yet less than 45 days have passed since July 21st (when all this broke), and there is nothing more specific. The July 21st Agreement is massive, and is meant to be implemented by 2015. So more detail is needed if we are to take this seriously.
b. The Troika has never established what HASN'T been implemented to any serious degree, or at least if hasn't been published openly.
Regarding EFSF: I estimate that minimum recapitalisation would need to be on the order of EUR 2 trillion to make a serious impact on market sentiment. And the ECB doesn't have to buy toxic bonds - as the Fed did with Maiden Lane. There are plenty of other ELA options on offer at the Central Banking level. The ECB could, and should, play a more active role in point 5, as you agree.
Exactly as predicted, unfortunately. S&P downgraded Italy today. Unless the Eurozone takes action fast, things will get out of hand very quickly indeed.ReplyDelete