EUROPE'S LOW GROWTH IN EU AND EURO AREA

SEE ARTICLE BY MARTIN WOLF - http://www.ft.com/cms/s/0/4aa8cafe-3749-11e4-8472-00144feabdc0.html?siteedition=uk#axzz3Cy3Ue4wZ The ECB Balance Sheet has fallen to 2,012 EUR billions, a full third below its peak (3,102 EUR billions, June of 2012). About one quarter of this is committed to repairing the Euro Area banking system, and roughly half of this amount has been deployed at times as replacement bank deposits to cope with capital flight in Europe from South to North. Some capital flight may have reversed, and the severe imbalances in trade and payments between EU members may have narrowed slightly, but the adjustments are taking far too long thereby, with 'austerity measures' prolonging depressed growth rates. The EU is now a union of economic divergence between states and regions after six decades of convergence. If this continues the integrity of purpose of the EU will be dangerously discredited. Alongside whatever the ECB can do to through QE or to counter private capital flows whenever they are especilly destabilising, the EU Commission must also do more to compensate for demand and investment imbalances, doing so in everyone's interests. The Commission's budget should be doubled to provide sufficient firepower to cope with capital flows further exacerbating severe current account imbalances. The Commission is very aware of the growing divergence among national incomes, at least at the regional level, and requires a budget doubling (best if by its own bond issuance) to leverage a restructuring of trade & investment worth annually 1-2% of EU GDP. The prospect of this was stopped by knee-jerk resistance by some member-states ideologically opposed to significantly increasing the Commission's budget. The EU Commission budget is starkly inadequate, of a size in relation to the EU economy little different from that of the UN to the world economy. The decision not to grow the EU budget at a time of obvious economic crisis is leaving communitaire policy efforts to drag the Europe's growth rate up almost entirely to expanding the ECB's balance sheet for the Euro Area, why Martin Wolf sensibly focuses on QE. But, the ECB's willingness to sustain a sizable balance sheet expansion over enough years is politically uncertain, if certainly far better than letting the Euro Area linger much longer in both a politically parlous as well as an economically parlous condition, one, it now seems, not of adjustment and recovery but of long-run historically low growth, and not just by comparison with USA economy data. If the EU, the world's leading example of constructive internationalism, remains weakened and unable any longer to deliver convergence among all EU member states, then not only will it risk its own continuance, but it risks loss of belief in internationalism in the rest of the world, loss of belief in seeking international solutions to profoundly international problems. Internationalism, as we know and rely upon it today is not yet a century old, but is looking like a declining resource. We should fear the risks of going backwards for decades in world internationalism before we wake up to what has been lost and can move forward again?

EURO AREA EC STABILISATION FUND - OPERATIONAL?

Note: The following essay published in mid-July has continued to attract enormous interest, several thousand hits, including from the very institutions mentioned in the text! For this reason I have decided to fix typos and add one new comment, which is that the most efficient way for the fund to work is merely to operate as a standby guarantor and loss insurer for Euro Area state borrowing of a kind that in the UK or USA would be facilitated off-budget and off-balance sheet by using treasury bills and asset repo swaps, but which in the Euro Area cannot because the member states’ money market operations have been given over to the ECB.
Original July text version amended:
This EFSF, €440bn + €310bn IMF contribution, is the Euro Area's equivalent to TARP.
Klaus Regling is the chief executive of the European Financial Stability Fund (EFSF), two years after he stepped down as the European Commission’s most senior economy official. He is German, reflecting that Germany is supplying up to €148bn in debt guarantees, the largest slice of backing for the fund. The German national debt agency will help the fund to arrange the guarantees in July.
Sometime later this month (July 2010) the fund will become 'active' in theory when at least 90% of state guarantees are finalised. After borrowing, however quickly, or however long it takes, and then once it is able to begin lending it can issue loans only until June 13, 2013, i.e. only for three years, which is not nearly long enough to be realistic.
The 12 man tag team who will manage this will be in Luxembourg, probably in the glasshouse of the EIB.Euro governments provide guarantees to secure a Triple-A rating for EFSF and it will then with European Investment Bank (EIB) and Bundesrepublik Deutschland Finanzagentur (BDF) raise the funding to back the loans.
EFSF will borrow from markets to provide financial rescue funds to any indebted euro zone government needing cheaper debt - except the loans won't be cheap, not at all, and not when reputational risk of accepting IMF austerity packages is included, if that is what they will be?
If all €750bn is raised this year (v.unlikely) it will equal half again as much as all government gross borrowing in Europe in 2010 or all net borrowing after repaying maturing debt.
Who is going to write all the Medium Term Note paperwork along the lines of what private sector lenders normally require, with supporting financial account projections, a host of assurances, and then negotiate the borrowing rates?
Law firms and investment banks of course, I imagine, for a generous % fee. The scale and complexity of this is beyond both EIB and BDF in terms of their deal size experience, relationships, and their predictive analytics systems.
It is unlikely the borrowing can transpire on the basis of a few covering letters and government signed assurances, not when the Euro system's continuity is less than 100% certain, and not even though the total programme period is short, only three years?
This is another reason why governments want banks to borrow longer term, and to reduce competition for short to medium term needs such as to finance the EFSF.
The EFSF will have a staff of 12, a fact I shall repeat several times because I find it most incredible (worse than the 15 at UKFI ltd who manage £60bn of government bank investment in London, or the 15 who manage €20bn of structured finance at legacy Fortis). Tell it to any banker who knows what's involved professionally to staff up MTN programmes, even when using external advisors, and they will laugh until it hurts.
EFSF will have the help of EIB, IMF, ECB and BD Finanzagentur, so we hear. Are 12 core staff enough even merely to contract and relationship manage all of that, or enough even just to do PR and coordination, that is assuming they have a detailed roadmap of what to do, which I have good reasons to doubt?
The US similar scale of financial package, TARP, was staffed by 120 in 2008, then by 150, then plus another 200 staff on stability issues (by 2010), and that was only in the US Treasury. More staff were employed on TARP by the Federal Reserve and by its FDIC subsiudiary.
TARP is qualitatively different from EFSF, but only if one thinks that government finances are easier to understand than those of large financial groups, or that making agreements over loans and conditions with governments is easier than with banks or insurers or automobile manufacturers.It may not be the case that all of this huge amount will be required. It may be that EFSF will not have to commit all its funding. No doubt the proponents of TARP thought the same until the Lehman Brothers was spectacularly allowed to fail.
TARP took from Spring to Autumn of 2008 to get approved. The legislative process helped to detail it more fully - compared to the few pages setting out EFSF for political approval over a weekend rather than over 6 months in the case of TARP.
TARP allocated $250bn for buying preference shares of distressed banks, for example, but only spent about $180bn on that. Some loans amortised and the money rolled over.
Unexpected crisis funding came up, however, such as AIG, then FM&FM and GMAC. EFSF cannot be sure what unexpected requirements it may be called upon to deal with.
The ECB can help in providing liquidity support for EFSF if there are unexpected delays or other technical problems, much as it did recently by retiring nearly €500bn of liquidity on the one hand while extending €800bn on the other hand.
Perhaps the IMF standby contribution will not be called upon?
For EFSF's borrowers (governments in financial distress) there is only so much preferred stock in banks that can be bought without shareholder protests and nationalisation and European Commission approval hurdles involving considerable political overheads and politically arguing the economic uncertainties. Similarly, if buying bank assets (outright into ‘bad banks’), toxic or not, that should also be capable of being financed as a repo swap at central banks.
In the US example, about $400bn of TARP was allocated to buy banks' loanbook assets and another $50bn to cover against bank insolvencies (funding gap finance and capital shortfalls).Unlike EFSF, which is trying to be a tiny office operation, TARP involved large (professional) staffing – with teams from US Treasury, Federal Reserve & FDIC, plus an audit unit, the Special Inspector General for the Troubled Asset Relief Program (SIGTARP).
EC programmes will require a similar independent audit agency – but, who will do this; is one being established, or is this the IMF's job?
In the US, there was also Congressional Oversight Committee on the job, but where is the European Parliament in this matter?
This is all complicated by the Euro Area for which the EFSF is to exclusively apply being light on governance, it being only a big sub-section of the EU?
How much authority should the European Commission and European Parliament have over a Euro Area somewhat exclusive matter? Are important institutional and democratic accountability or constitutional borders and ‘Chinese Walls’ being ignored, fudged or constitutionally overthrown?
Thank goodness, direct borrowers and indirect (underwriting) lenders are both OECD governments who may therefore be trusted entirely to remain solvent, absolutely…or not?
Regarding the USA's TARP, SIGTARP reported to Congress that it found that "Inadequate oversight and insufficient information about what companies are doing with the money leaves the program open to fraud, including conflicts of interest facing fund managers, collusion between participants and vulnerabilities to money laundering" - strong stuff, no punches pulled, and all in glaring light of day (media coverage and Congressional oversight).
The Euro Area Council (like the EU Council) deliberations are not transparent, and, of course, the ECB and IMF are both NGOs whose democratic accountability (transparent decision reporting) are not legendary.When the IMF lends on the basis of an agreed austerity package it has, in the past, turned up the gas (stiffer austerity conditions) to provoke the indebted emerging market governments to default on interest or payments so that the IMF can then legitimately claim on insurance cover and also exert penalty interest rates. That would not be an appropriate tactic in dealings with any OECD countries, let alone for EU states.
But, the question arises, what, if any, penalties are actually envisaged for dealing with default? The answer is probably none since matters will not be allowed to get to that extremis point; there is too much flexibility available.
The underlying borrowers, the banks who borrow from their governments, may face domestic penalties asserted by their national governments and regulators should they default or misapply the funds, and perhaps as recommended quietly by the IMF?The history of TARP is instructive and should be closely examined by all involved in EFSF.
The Senate Congressional Oversight Panel created to oversee the TARP concluded on January 9, 2009 (when it was also concerned about refloating the property market and maintaining or raising bank lending in the economy to help recovery), "In particular, the Panel sees no evidence that the U.S. Treasury has used TARP funds to support the housing market by avoiding preventable foreclosures" and "Although half the money has not yet been received by the banks, hundreds of billions of dollars have been injected into the marketplace with no demonstrable effects on (bank) lending."
These are problems already being discovered internationally, not least in the UK where there is an embarrassing mismatch between survey data among corporate and small firm borrowers and what banks are publicly saying they are doing most assiduously to lend more. Who believes the banks in this matter?
Such issues are not explicitly part of the EFSF, except that the manner whereby banks improve and build on their state-aided solvency and therefore of the underlying economic recovery underpinning both the banks return to predictable profitability and the predictability of governments ability to repay loans to schedule will be of very considerable interest.
IMF, ECB, EIB, EC and member states' central banks or Germany's Debt management agency do not have models, however, to be able to track the feed through effects (and none likely to be available for 1-2 years). There will be a lot of finger-in-the-air forecasting based on short term macroeconomic data – but three years is not long enough for macroeconomic data (or macro-prudential data) to be sufficiently revised (retrospectively) to be reliable i.e. accurate. Germany's glass HQ of its debt management agency.
Herr Dr Regling expects the eurozone’s €440bn fund to be given triple-A rating by August to allow it to borrow most cheaply (at German Bund or French Government Bond rates). But, triple-A is a long term solvency rating. We may be dubious about such ratings for such a short term programme. Therefore the ratings will merely be an aggregation of the member states' guarantees i.e. their sovereign ratings.
It is, of course, most likely that the three year time-frame will be extended to ten years, and then we can expect the EFSF to transmogrify into an indefinitely long term emergency resource.
One has to wonder what board, governance, staffing, systems of analysis, policy documents and procedures will be in place, and by when, to safely command a fund worth five times one year’s total European Commission budget?
Regarding when (more than how) the European Financial Stability Facility will operate, Regling as CEO dutifully answered: “We will be ready to act whenever the politicians tell us to act.”
We may imagine that this fund can only become speedily operational by trusting to the professional good sense of governments (the borrowers), and relying on how they in turn on-lend to stricken banks.
Each transaction that becomes a state aid scheme for banks will require detailed assessment by Commission experts followed by discussions to reach agreement with national supervisory regulators, central banks and governments. That may or may not interfere with the speed of granting EFSF loans.
The IMF will also be involved to dictate how budget austerity measures are affected. And the ECB in each case to make systemic risk assessments of banking market impacts in the Euro Area, and in each state and significant region.That would be sensible but oh so cumbersome. Such cumbersomeness is why the European Commission backtracked on engaging two sets of panel experts last Autumn (at a cost of a few €millions to do asset valuations of banks' loan collateral and predictive economic valuations over the cycle including competition issues). The EU state aid scheme assessment process and agreed legal requirements were set back a whole year at least. And now we cannot be sure exactly how all this validation and approval processing is to work? In effect, the process has been pushed back to member states, while in Brussels, DG Competition DG rules the roost. In fact, several DGs have become blurred, fuzzy and merged and yet are still floundering to find a solid baseline of policy-making and procedures.
One problem is lack of tools (models with appropriately full sets of economics and banking data). Another problem is lack of internal Commission confidence and self-belief in its internal ability to organise - any and all of that is serious.
Such self-doubts do not figure at the high levels of President van Rompuy and CEO Regling. They have yet to appoint a board for the fund. Hopefully, the cost of lawyers, accountants, raters, loan underwritings, external advisors, other insurance etc. will not approach 4% as is typical of M&A - i.e. €7-15bn a year maybe over 3 years, which is far more than enough to ensure the big 4 audit firms and bulge bracket investment banks will be getting themselves enthroned in this massive fund - an outcome, for lack of expertise, organisational resource working to detailed planning, and adequate support systems, on the professional scale that any such enormous financial undertaking would normally require to be put in place.
I ask, should the fund not have been handed to the ECB, out of which departmental adjunct the Euro Area Council could then build its own fully equipped meta-treasury (money market operations) department?
Setting up EBRD, EIB and other such institutions took years. They never started with just a football team size.
EFSF tasks are bureaucratically and analytically onerous. It takes six months of very efficient work to get away an MTN program of say €50bn, which is huge, but which can only be done by following down well trodden paths - in effect, rolling over deals with previous lenders.
I would say, if asked, that raising €750bn takes at least one year to get underway and all of two years to book, and that would be fast error-free working.
The three year timescale (from lending to repayment) is absurd, doubly so against a back-drop of Euro governments borrowing over €1 trillion gross (excluding EFSF) this year alone.
All might go easier if governments pay a little extra to bondholders to insist that the €700bn of maturing bonds to be repaid this year should be redirected in lending to the EFSF, but that's just my naive imagining.When Klaus Regling was a top German finance ministry official, he was responsible for negotiating regulations underpinning the set-up of the Euro, Europe’s common currency. Now he must road-fill the big holes left behind by that agreement such as the lack of a crisis resolution mechanism to rescue eurozone member states in a recession or in a financial crisis of the very type the Euro was originally conceived to safeguard against.
As chief exec of EFSF, Regling may hope that this will be “more show than tell” and that the fund will be little used in practice, as his political masters, the finance ministers of the European Union, no doubt hope. His governance, staffing and organisational infrastructure (the lack thereof) should not reflect that hope.
Knowing the money markets as I do, I know that they will seek to test the EFSF to destruction.
Why do we think Regling and the Euro Area Council sponsors think EFSF may be involve more marching than fighting? Because, Regling told the FT on the 13th, “We don’t know whether there will ever be a financial operation” and “Finance ministers hope not. But it was very important that this facility was created. It has had a positive impact on the markets.” If ever anything was a red rag to the markets, it is surely just such braggadocio statements.German voters, we are told many times, are worried the EFSF will become a a system for fiscal transfers from wealthy states of EU North to the profligate EU South. If the northern voters knew what keeps them employed they would welcome such transfers, but that’s not how they have been led to think.
Potential investors are, according to the FT, skeptical about the high credit rating that Herr Regling is confident the stabilisation fund deserves. This is just silly. Everyone should welcome the development in theory and not fuss about the ratings; who trusts ratings agencies anymore anyway; publicly not the ECB, European Parliament, or the EC, and not the big banks?
Herr Regling is anxious to reassure everyone - good. He said in an interview in Frankfurt, “This is a crisis mechanism. The EFSF is a temporary arrangement ... That is very different to creating a permanent fiscal transfer mechanism.” Who will give me positive odds on that? Actually, this is not an obvious bet for the reason that reputational damage of borrowing from EFSF and incurring IMF austerity measures, or just the whiff of same, could prove a major disincentive.
Herr Regling (great name; it means formal rite of passage, to put discipline into a physical change, also invocation of a spirit, and as head of EFSF about whom there will be an opera one day, Regling von den Nibelungen): He is my age, 59, Chief executive of EFSF since July 1, served as head of the German finance ministry’s international policy department; played a role in the euro's introduction and drafting the EU Stability & Growth Pact.
At the time (mid to late ‘90s) when I visited his economists in Brussels, when I was curious why the Euro was being planned and introduced without the help of any external consultants, they told me it would be a disaster to delay the Euro's introduction, a disaster not to do it at all, and a disaster to go ahead with it! But, after 5 years, they said, we should all have learned how to reform it and make something better.
Now, ten years on, we are only starting, if at all, to reform the S&GP. I calculated in 1997/8 that, over the first 5 years of the Euro, banks would lose €500bn in gross trading profits and eke that back out of higher loan margins and fees and charges from mainly small firms first, then from big firms later, and consequently unemployment would rise in Europe by 5 millions against trend – these forecasts proved to be most accurate.
Today, 29% of Euro Area unemployment is in Spain. Will the EFSF make a dent in that or elsewhere? Will Regling and the EFSF (in the details of its operations) in effect change the workings of the Stability & Growth Pact sufficiently to form the basis for permanent reform? Is Regling up for this?Regling worked as an economist for 35 years, including for the European Commission and the IMF. He was well known in Bundeskanzler Helmut Kohl’s government in the 1990s, and has close ties to many senior officials in Berlin therefore as well as in Brussels. Maybe he can carry enough persuasiveness backed by the €750bn to bring about major reform? The first such reforms should include not measuring deficits and debts merely gross, not net, or in ratios only to GDP, not GNP, and not by ignoring the general stance of each of the EU economies (such as three basic types: trade deficit credit boomand property-led, trade surplus-led net industrial or energy exporters, or roughly external balance neutral)!
On the European principle that what ten Americans do one European can do, EFSF will operate from a Luxembourg office with c.12 staff, with Germany’s debt management agency serving as the “front office”. Even the UK's FI Ltd. to oversee arm's-length ownership of RBS and LBG banks have three more staff than this! Has ever so much money been managed by so few?
€750bn is more relatively 'free' funds than IMF, BIS or most central banks have, and they need more than 12 people just to set up and maintain the simplest of computer systems! EFSF will obviously be a spreadsheet, email and otherwise paperless office. Any advisors bidding to provide some heavyweight analysis in support of EFSF will have an easy procurement process to negotiate. In an office of 12, nothing can be done except on a buddy system grapevine.
Malta will provide €400m. If I know Malta that can’t be without a few jobs for Maltese, at least 2 surely? But, if extended to the 18 other guarantors, on that basis, the staffing alone should be 1,000, and by then we might get a serious organisation doing seriously detailed work?
The EFSF has been described all round as a “shock and awe” package to reassure markets over mounting sovereign debt. But, money and bond markets are not in the game of receiving reassurance - they are in the game of cage-rattling the Euro system to seek to keep bond yields volatile to thereby profit by.
As far as the financial markets are concerned, provisions have been built into the facility to ensure that it gains triple A status from the credit rating agencies and could therefore borrow at most favourable interest rates. Hmmm? What is the risk management policy? Where in the EFSF is there an ALCO and independent risk officers, pr the computer systems for tracking, and all such matters that any rating agency would look at before rating a bank?
Of course, EFSF is only supposed to be on the model of an SPV (Special Purpose Vehicle) as in a asset-backed securitisation bond issue i.e. a few lawyers and accountants supported by external bankers, more lawyers and accountants and auditors. EFSF will have standby liquidity for smoothing cash-flows just like a real SPV, and a cash reserve built up from fees charged to countries using the facility. While, as another cushion, member countries have also guaranteed to pay up to 20% more than their agreed shares of the fund.
We can imagine 5% fees (say €20bn - €35bn), which would be a substantial standby fund, but might that not defeat the object of providing cheap funding? A 1% fee would be hardly enough to do more than pay for external advice, underwriting and insurance costs.
Investors have questions about the structure of the EFSF - who is their counterparty? - and about the solvency of EFSF's debtors - and the precise details of each state guarantor's guarantees?
The prospectuses (not prospecti) will be hundreds of pages on which will ride the security for hundreds of millions of Euros per page perhaps? It is not suddenly a ten pager if EFSF has a triple-A rating tomorrow. How long will it keep that, and what is the probability of a series of downgrades over the next three years? There are few people capable of answering that question systematically.Herr Regling said ministers have promised to do whatever is needed to make sure he gets triple-A. There's the rub. What can that be and are there limits? Total guarantee means the contributing governments have to take the potential debt onto their books – but, that they won't do.
The whole point of this is that EFSF should be off-budget, off-balance sheet, hence the SPV format, an insolvency-remote vehicle – but, is it? Such status (risk grading) is normally achieved not by assessing collateral (or guarantees for all losses) but by assessing the credit quality of the underlying assets, the beneficiary borrowers, and here we enter the world of macroeconomics as well as each borrower country's banking sector (relative to the economy in which it operates).
Are the 12 staff of EFSF professional financial geniuses or paper-shuffling Eurocrats, or both?
Will IMF forecasts or ECB liquidity guarantees furnish sufficient underwriting to each borrower state's central bank or finance ministry? There are unpredictable creditor as well as debtor risks.
We have a complexity here of risk and constitutions and time factors and governance all of which needs to be explained in excruciating legally binding fiduciary detail.
Lenders to EFSF have their own ALCO rules and risk assurance process to navigate.
Not even the ECB can issue standby postdated encashable cheques or depository credit to the value of €100s of billions, can it?
How is all this to be short circuited and managed by a staff of 12, imagine Seven Samurai and five support staff? The main work is to be done by Germany's Debt Management Agency and the EIB (European Investment Bank).Herr Regling has sought to reassure the markets that the German Constitutional Court in Karlsruhe will not decide to uphold complaints that the EFSF facility violates the German constitution and or EU treaties. Right! Legal Risks; must be page 612 of the prospectus.
He admitted that doubts about the court’s future ruling were an important issue in the assessment of the rating agencies. Right, Moody's, Fitch and S&P have risk models, not for what happens before EFSF gets triple-A and starts borrowing, but for afterwards when suddenly some loans might be called in early?
But, Regling thinks a ruling against the facility is “highly unlikely” to have any practical effect on potential bondholders, because German participation in the scheme had been formally approved by the Bundestag in Berlin.
And some early motions failed, but that's not to say further motions could not be put. If the EFSF does lend to any government, it will be at a premium to its cost of borrowing: Regling said this would be “comparable” to the charge on Greece of 300 basis points when it borrowed €110bn from Eurozone governments earlier this year. OK, but then in assessing the on-lending as bank state aid, the rule is no favours; loans must be priced at market rates. The hope must therefore be that the prevailing market rates come down, and then that the loans are fixed-rate for three years, which could mean substantial profit for the EFSF - could it? Yes, the premium (profit) would accumulate and should be repaid to governments guaranteeing the funds loans, confirmed Herr Regling personally.
The EFSF will operate in Luxembourg with a dozen staff, and Germany’s Debt Mmanagement Agency (Bundesrepublik Deutschland Finanzagentur) that is used to managing up to €40bn a quarter in issuance (in packets of €5bn) will function as a “front office” for the EFSF, issuing any bonds, while the European Investment Bank (€232bn capital, €103bn loans to infrastructure projects and small firms, 1,000 staff) will provide “back office” accounting and legal functions.
Let's hope the EFSF does not become a lender generating €700bn in borrowings and loans – it could overwhelm these hitherto cuddly, and ethical if somewhat prosaic, banking institutions. It would be unpleasant to witness them haggling across the table with a bunch of salivating investment bankers like me.
Here for the less scrupulous salesmen is the EIB's org chart:At German insistence, Eurozone governments agreed to give the EFSF only a three-year life.
Herr Regling said the facility would close after three years if it made no loans, which sounds like the best incentivisation to make loans. “If there is a financial operation its life will be extended until the last loan is repaid,” he said. Herr Regling told the FT the fund is a temporary crisis mechanism but could be extended beyond its intended three-year lifespan if any loans to eurozone governments remained outstanding beyond June 2013.
Let’s hope no one involved becomes unusually rich?
Governments can borrow if they agree to adopt reform programmes designed by the IMF, European Commission and the European Central Bank. This extends the role of both the Commission and ECB in ways that I expect borrowers would fiercely wish to resist, hence any borrowing will be a clear signal of desperation!
Furthermore, borrowing states will pay a charge comparable to that levied on Greece when granted an emergency bail-out this year, i.e. 300bp! “It does not mean there is an ATM machine. Everyone agrees that countries only get money when they accept conditionality,” Regling added. With the results of stress tests on European banks imminent, Mr Regling said the fund would not be used directly to shore up ailing banks, but that governments drawing on the facility can use the money for bank recapitalisation. And, presumably, to replace funding provided earlier?
But, again, the issue arises that borrowing from EFSF may be such a last resort that any states borrowing from it will suffer downgradings in every other respect, because this would signal extreme cash-flow problems, and therefore the cost of doing so could be unpredictable and many times higher across the rest of the economy?
Greece is already in such a junk rating position. Can we imagine Spain, Portugal, Ireland or Italy going down this route. I suggest not.
The Spanish Cajas simply doubled their liquidity recently from ECB to about €130bn instead of seeking it from the Spanish government, who might then think to apply to the EFSF.
Herr Regling does not believe in transparency and would therefore resist political oversight such as by the European Parliament. But it is very unlikely that we will not all find out immediately who needs this expensive money (despite IMF conditions) as soon as any requests are formally made or merely informally discussed!

Note that one way to use the money (or the triple-A promise of it) is as surety guarantees, as standby insurance, to underwrite countries' borrowings. But the fund itself is so far merely or mainly guarantees. Hence a publicly announced set of state gurantees becomes potentially a meta-set of further guarantees for state borrowing.

Note for constitutional legal eagles: There are interesting issues to be explored in the loss of constitutional separation of powers and responsibilities between the ECB and European Commission, and other fudging that is another reason for calling EFSF a temporary emergency measure. I for ione predict that EFSF or something very like it will become permanent and still be here ten years from now.

see also (1 October 2010): http://www.qfinance.com/blogs/ian-fraser/2010/10/01/we-need-a-stronger-efsf-to-stop-the-piigs-from-slip-sliding-away-sovereign-debt-crisis

EUROPEAN STABILISATION BANK PROPOSAL

Meeting Of Heads Of State Or Government Of The Euro Area, Brussels, 7 May 2010
- the President of the European Council, Mr. van Rompuy, has convened Heads of State or Government of the Euro area for a meeting on the evening of 7 May in order to finalise the adjustment programme negotiated by the Commission, the ECB and the IMF with the Greek government and the financial support to Greece, as well as to draw the first conclusions on this crisis for governance of the Euro area.
Statement By The Heads Of State
• During the implementation Of The Support Package For Greece in February and in March, we committed to take determined and coordinated action to safeguard financial stability in the euro area as a whole.
• Following the request by the Greek government on April 23 and the agreement reached by the Eurogroup on May 2, we will provide Greece with 80 billion euros in a joint package with the IMF of 110 billion euros. Greece will receive a first disbursement in the coming days, before May 19.
• The programme adopted by the Greek government is ambitious and realistic. It addresses the grave fiscal imbalances, will make the economy more competitive, and will create the basis for stronger and more sustainable growth and job creation.
• The Greek Prime Minister has reiterated the total commitment of the Greek government to the full implementation of these vital reforms.
• The decisions we are taking reflect the principles of responsibility and solidarity, enshrined in the Lisbon Treaty, which are at the core of the monetary union.
Response To The Current Crisis
• In the current crisis, we reaffirm our commitment to ensure the stability, unity and integrity of the euro area. All the institutions of the euro area (Council, Commission, ECB) as well as all euro area Member States agree to use the full range of means available to ensure the stability of the euro area.
• Today, we agreed on the following :
• First, consolidation of public finances is a priority for all of us and we will take all measures needed to meet our fiscal targets this year and in the years ahead in line with excessive deficit procedures. Each one of us is ready, depending on the situation of his country, to take the necessary measures to accelerate consolidation and to ensure the
sustainability of public finances. The situation will be reviewed by the Ecofin Council on the basis of a Commission assessment by the end of June at the latest. We have asked the Commission and the Council to strictly enforce the recommendations addressed to Member States under the Stability and Growth Pact.
• Second, we fully support the ECB in its action to ensure the stability of the euro area.
• Third, taking into account the exceptional circumstances, the Commission will propose a European stabilization mechanism to preserve financial stability in Europe. It will be submitted for decision to an extraordinary ECOFIN meeting that the Spanish presidency will convene this Sunday May 9th.
• we have decided to establish a European stabilization mechanism. The mechanism is based on Article 122.2 of the Treaty and an intergovernmental agreement of euro area Member States. Its activation is subject to strong conditionality, in context of a joint EU/IMF support, and will be on terms and conditions similar to the IMF.
• "Article 122.2 of the Treaty foresees financial support for Member States in difficulties caused by exceptional circumstances beyond Member States' control. We are facing such exceptional circumstance today and the mechanism will stay in place as long as needed to safeguard financial stability. A volume of up to 60 billion euro is foreseen and activation is subject to strong conditionality, in the context of a joint EU/IMF support, and will be on terms and conditions similar to "In addition, euro area Member States stand ready to complement such resources through a Special Purpose Vehicle that is guaranteed on a pro rata basis by participating Member States in a coordinated manner and that will expire after three years, respecting their national constitutional requirements, up to a volume of 440 billion euros. The IMF will participate in financing arrangements and is expected to provide at least half as much as the EU contribution through its usual facilities in line with the recent European programs.

Greece Sovereign Crisis Resolved?

Martin Wolf's essay in today's FT (http://www.ft.com/cms/s/0/de21becc-57af-11df-855b-00144feab49a.html) is excellent. This discusses the cost benefits of the agreed $143bn multilateral loan to the Greek Government, much of which is really required to help secure the balance sheet solvency of Greek banks.
The data provided is also interesting. Note the table showing the difference between gross and net national debt, showing what is typically the case that one fifth to one third of national debts are internal to governments and should not really be considered when assessing national debts. In the UK's case, for example, when gross National Debt has reached 80% ratio to GDP, its net debt is only half this, and one wonders if that also includes another quarter of the debt currently owned by the Bank of England as a result of quantitative easing - probably so.A GREEK TRAGEDY
The definition of Greek Tragedy is a form of art based on human suffering that paradoxically offers its audiences pleasure. There is a large audience for the sovereign debt crisis of Greece that is taking perverse pleasure in holier than thou statements as if Greece may be classed in the same basket of felon's heads as Lehman Brothers! Righteous commentators blame Greece for being irresponsibly spendthrift and to link the state of public finances of UK to Greece etc. They are both right and wrong, but more wrong than right. Greece alongside Ireland were praised during its years of high economic growth for contributing positively to EU and Euro Area growth, punching much above their weight etc. Greece, under the assumed protection of the single currency and EU membership was merely operating a credit-led growth policy based on banks growing their mortgage business fast and lending to property developers, similar to the USA, UK, Ireland and Spain. Greece did so perhaps too enthusiastically and ran the highest trade deficit in the OECD financed by selling securitised loans to foreign investors and borrowing from foreign banks plus diaspora and tourist receipts.
Greek banks also invested massively on growing bank networks in nearby emerging countries to the benefit of developing those countries. The Central Bank of Greece tried to order the Greek banks to cut back on property exposure and lend more to productive industry and help reduce the trade deficit. But, as in UK, USA and elsewhere this is like asking addicts to volunteer for rehab. The advice was ignored when the same advice in Spain was responded to by the banks there, if somewhat late.
Arguably, the problems derive from Greece believing there is security is doing what much bigger countries were doing like USA and UK such discounting the risks of historically high trade deficits so long as these could be financed (the so-called "new paradigm for economic growth' overcoming boom & bust). It is hypocritical to blame Greece alone for its problems. When the Credit Crunch erupted it seemed for nearly 2 years that the fragility of Greece could remain below the radar of the bond markets. Greek bankers told each other that the Credit Crunch would probably by-pass them so long as Greece was counted among emerging countries when those were viewed positively. This was, of course, a massive self-delusion.
Credit-boom growth was hugely positive in transforming the living standards and quality of life in Greece, allowing it to catch-up fast, like Ireland, with EU per capita GDP average. Ireland operated an extreme credit-boom catch-up growth too with banks lending too much to mortgages and property, even more than UK banks that lent 70% of domestic loans to mortgages and property. The differences were that Ireland ran the highest trade surplus in the EU while extremely paradoxically also the highest payments deficit, and the UK generated a large financial services external surplus to off-set its more trade deficit. Greece was hoping to emulate the UK by how its banks were investing in cross-border retail banking but failed abysmally to get its banks to support export industries, while its main competitive advantage, its huge shipping fleet increasingly operated in tax, borrowing and GDP terms off-shore. Greece's enormous trade deficit is as much a long term failure caused by the choices of banks of who and what to lend to as by government, but also very much an outcome of false assurances from the EU and the models they followed of the USA, UK, Spain and Ireland. Germany's position in the whole matter is self-serving and hypocritical too insofar as its trade surpluses require there to be countries running deficits. It's excessive lending to business borrowers instead of mortgage and consumer borrowers leaves its banks vulnerable to funding costs so that the worse the sovereign risk costs of deficit countries are the lower are the borrowing costs of its banks and corporates. Greece is a mere pawn in a bigger global game. The main points of Wolf’s article are:
After months of costly delay, the eurozone has come up with an enormous package of support for Greece. By bringing in the IMF, at Germany’s behest, it has obtained some additional resources and a better programme. But is it going to work?
It is a package of €110bn ($143bn) (over a third of Greece’s outstanding debt), €30bn of which will come from the IMF (far more than normally permitted) and the rest from the eurozone, enough to take Greece out of the (borrowing) market for more than two years.
Greece promises to reduce government borrowing by 11%/GDP over 3 years, on top of cuts already taken earlier, with the aim of to reach 3%/GDP deficit by 2014 (13.6%/GDP in 2009). Cuts are 5¼%/GDP annually for 3 years. Pensions and wages will be cut then frozen for 3 years. Seasonal bonuses abolished. Tax rises = 4%/GDP. Gross national debt will peak at 150%/GDP.
This is far less unrealistic than the first deal. The fantasy of a mild contraction this year followed by steady growth is gone. There will be cumulative decline in GDP of 8% (rough forecast). The new plan sets 2014 as the target year instead of 2012.
There is to be no debt restructuring; and the ECB will suspend the minimum credit rating required for the Greek government-backed assets in its liquidity operations, thereby offering a liquidity window to Greek banks.
The alternative was default in paying debt interest, but it would have to narrow its primary budget deficit (before interest payments), by 9-10%/GDP immediately, far more brutal than Greece has now agreed. With default, the Greek banking system would collapse. It can instead gain the time to eliminate its primary deficit more smoothly.
It is likely that Greece will however have to run a primary budget surplus of 4.5%/ GDP, with revenue of 7.5%/GDP devoted to interest payments. Will the Greek public bear that burden year on year? With huge fiscal retrenchment without exchange rate or monetary policy offsets, Greece is likely to experience a prolonged slump. Would structural reform work e.g. huge fall in labour costs to gain a prolonged surge in exports to offset the fiscal tightening, or a hugely higher financial deficit of the private sector? That seems inconceivable. If nominal wages fall steeply, the debt burden would worsen.
Greece is being asked to do what Latin America did in the 1980s, which led to a lost decade, the beneficiaries being foreign creditors. As creditors are now paid to escape, who will replace them? This package will surely fail to return Greece to the market, on manageable terms, in a few years. More money will be needed if debt restructuring (forgiveness and or longer maturity and or lower rates) is ruled out.
For other eurozone members, the programme prevents an immediate shock to their fragile financial systems. It is overtly a rescue of Greece, but covertly a bail-out of banks – and unclear that it will help other member states now in the firing line.
Investors could well conclude that the scale of the package required for tiny Greece and the overwhelming difficulty of agreeing and ratifying it, particularly in Germany, suggest that further such packages are going to be elusive. Other eurozone members might well end up on their own. None is in as bad a condition as Greece. Several have unsustainable budget deficits and spiking debt ratios. In this, their situation does not differ from that of the UK and US. But they lack the same policy options.
This Greek Tragedy, in short, is not over nor confined to Greece. For the Eurozone, two lessons - first, it has a choice – either it allows sovereign defaults, however messy, or it creates a true fiscal union with strong discipline and funds sufficient to cushion adjustment in crushed economies – Mr Willem Buiter (Citigroup Chief economist) recommends a European Monetary Fund of €2,000bn; and, second, adjustment in the eurozone is not going to work without offsetting adjustments in core countries. If the eurozone is willing to live with close to stagnant overall demand, it will become an arena for beggar-my-neighbour competitive disinflation, with growing reliance on world markets as a vent for surplus. Few are going to like this outcome.
The crises now unfolding confirm the wisdom of those who saw the euro as a highly risky venture. These shocks are not that surprising. On the contrary, they could have been expected. The fear that yoking together such diverse countries would increase tension, rather than reduce it, also appears vindicated: look at the surge of anti-European sentiment inside Germany. Yet, now that the eurozone has been created, it must work. The attempted rescue of Greece is just the beginning of the story. Much more still needs to be done, in responding to the immediate crisis and in reforming the eurozone itself, in the not too distant future.

DANGER WARNING: WHEN BOND ISSUERS PLAY FOR TIME

The famous British economist A.C.Pigou, whose equilibrium theories became part of the neo-conservative view of monetarism, was a KGB agent-recruiter and passionate climber. He knew it can be as dangerous in deciding how to descend a difficult mountain as to climb it; the inclination is to use the same hand and foot holds coming down as were made going up. All holds that sap your strength or might give way under strain have to be correctly judged as merely temporary, not a fit subject for betting on the better purchase value of delaying decisions. When poor health meant he could no longer risk taking potential recruits climbing he entertained them instead to cream teas by the river as his suitability test. In both tests he who hesitated was lost.
A STITCH IN TIME SAVES NINE
Bank and Corporate bond issuers are repeating the mistakes of the credit crunch by hoping for lower spreads if they delay a few weeks or months! This is irresponsible and dangerous! How did such postponements trigger the credit crunch and recession?
One analogy comes from the question behind Obama's health care reform: if medicines cost money and are expensive, and instead of taking doses regularly as prescribed do you save money by waiting longer between dosages; do you risk a worse sickness?
It is inevitable that in business the main medicine is money, and the medicine cabinet is the bank.
Just as many medicines deal only with symptoms while buying time for the body to heal itself, so too does borrowing buy future time to pay for investments made now. As the world trade imbalance became extreme between credit-boom economies, that ballooned household debt backed by rising property wealth, and export-led economies, that suppressed household wealth and lent heavily to industrial companies, banks in both types of economy became over-lent, one to property, the other to production. We know how household and finance lending grew enormously in credit-boom economies, but so did it too in export-led economies e.g. Germany. Germany and China with the world's highest trade surpluses and described as awash with savings, do not have great financial resources internally. Their banks are also vulnerable from lending too much to business as UK and US banks lent too much to property. China has desperately tried to maintain its growth by expanding credit and now is rightly frightened about this, about how poorly Chinese manufacturers can service their debt and is cutting back. The credit crunch put a stop to the previous extreme imbalance in the pattern of world trade and its deficit financing. In credit-boom economies the banks went global, serving an international market (globalisation) that is only partly evidenced by banks' assets in ratio to home country GDP.BANKS POSTPONE DECISIONS AND FALL INTO WORSE LOSSES: examples
1. Economists saw the economic cycle peaking in 3Q 2005 and cyclically turning down a year later. To global macro-economists (of which there are precious few) the extreme imbalances in world trade were obviously unsustainable for much longer. Investment returns in property especially fell below bank deposit rates, and GDP growth in credit-boom economies slowed. Property markets peaked: sales dried up; prices falling patchily at first, then nationwide in the USA. Bankers smoothed the problem by upping issuance of securitised bonds to make mortgage lending self-financing short term and in credit derivatives leveraged up to chase paper-profits in unrealised asset gains as net disposable incomes and savings fell. Any banks who could borrow more by issuing bonds did so. They postponed the onset of 'Anglo-Saxon' credit recession by 1-2 years.
2. US and UK banks had $30 trillions of foreign balance sheets a ratio of 50% to world total output and 100% of world trade - that dominated the world's trade imbalances financing and international funding of banks round the world. They postponed withdrawing that liquidity until 2008-09 when it shrank by $3 trillions. The following graphic only shows the dominance of UK and US banks in private customer lending.3. After June 2007, when asset backed securities issued by banks were day after day downgraded following Moody's fixing its false ratings model. Moody's had graded half of all securitised asset-backed loans. Fixing its model and then regrading all of these sent the market values of the banks' bonds tumbling and directly triggered the credit crunch of interbank lending becoming too expensive to sustain banks' interest margins. Banks needed typically 1.5% lending margins. When margins fell to 0.5% (50bp), the banks sought 150bp from fees alone from lower quality tranches ABS. When the quality of bank bonds became exposed, bank shares weakened internationally and continued falling for 22 months. From August 2007 the interbank market for financing banks' funding gaps became expensive. 4. In Summer '07, Northern Rock with £110bn assets and the highest funding gap (between deposits and loans) based on growing aggressively several times faster than the growth of deposits, found, like many banks, that it could not book forward refinancing at rates to maintain its aggressively low interest rate margin and tried to postpone doing so in hope that funding rates would soften, but its board insisted on going to Bank of England for liquidity support - that became public thanks to the BBC. There was a run on the bank that became a worldwide news spectacle.
5. Q1'08 Bear Stearns collapsed when it failed to meet collateral margin calls. Other banks like Citicorp, HBoS, UBS, WaMu, M-L, and others face short-seller attack based on rumours they cannot economically refinance their borrowings at a price needed to maintain their lending margins, especially in corporate loans.6. Many banks bet that the fall in bank shares and in asset backed securities and credit derivatives would be temporary because underlying net cash flows remained strong e.g. Lehmans and RBS buying more stressed assets because they looked cheap, and Barclays trying to do so but luckily failing! UBS dumped loss-making assets into customers' 'profits-only' savings accounts! But they were wrong and had under-estimated the impact on their balance sheets and capital of write-downs and growing loan-loss provisions. Some banks had backed their contrarian wishful thinking by maximising their leverage to the extent of breaking the rules and limits on capital reserves and risk diversification, most especially Lehman Brothers. September '08, Merrils, AIG, Lehman Brothers, and HBoS, followed by RBS and Fortis, and others need emergency saving; they have hit absolute cash-flow insolvency. Lehman (with £0.8tn of claims against it) is allowed to collapse and $2.5 trillion of failed trades (were sellers had gone short) hit money markets. Central banks have to balloon their balance sheets (both sides) to save national and international banking system.
7. The inter-bank funding market spread, already expensive but slowly falling, in Q3 & Q4 '08 spiked and funding dried up almost totally - The Credit Crunch - requiring central banks to step in and replace private funders by taking banks' loanbooks (securitised or simply 'covered) as collateral for central bank counterparty assets.
At the time I said, and in hindsight it became clear, that had banks accepted the higher cost of funding refinancing as their notes became due, which would have proved temporary, their realised profit fall or losses (also temporary) and capital reserve loss, would have been a mere fraction of the losses they did incur.
The banks would have had to rapidly and radically adjust their business models. They resisted this or simply did not know how to or even lacked the management authority within their sprawling financial conglomerates to do so?
CORPORATE BOND ISSUERS
Denied bank loan growth and suffering balance sheet deteriorations, corporate borrowers found themselves having to offer junk bond rates at 9% typically, or double the spiked rates that the banks had refused to accept! Since April 2009 equities began recovering and bank funding rates softened, but in expectation that rates will significantly fall further, now many companies are deferring the renewal of committed revolving credit facilities.
Instead of simply accepting the price today, they are speculating, betting, living in hope that an improving market leads to better pricing, terms, and maturity. They have rapidly it seems failed to draw the lessons of, or forgotten, how at the peak of the credit crisis, revolving credit facilities - to fulfill their purpose as standby liquidity in the case of unforeseen events or to maintain the current balance of both sides of their balance sheets. As companies faced acute operating stress,drying of the bond, securitization and commercial paper markets, that meant changes in bank lending capacity and behaviour, revolving credit became the most critical factor in
corporate liquidity, just as it did for banks.
Draw-down of revolving credit commitments was historically considered a red flag viewed as a precursor to bankruptcy. As bank credit tightened and undrawn overdrafts were cut in the credit crisis, covenant violations, revolving credit maturities, or simply the capacity and willingness of banks to fund their commitments undermined the accepted practice of incorporating undrawn revolving credit capacity into an aggregate liquidity number.
As the uncertainties of the crisis grew, drawing down on revolving credit agreements became more commonplace and was often viewed as a prudent strategy as opposed to an unequivocal warning sign. At the depth of the crisis, revolving credit commitments extended by the banks became often limited to 364-day or two-year facilities as a result of bank capital ratio stress and negatively viewing corporate credit risk.
Corporates found that bank facilities only provided short-term liquidity protection and added to refinancing risks that in a prolonged period of high uncertainty (in trade, business and capital markets) undrawn credit facilities no longer offered long-term standby liquidity to weather the economic cycle and/or other credit risks.
BANKS RESTRUCTURING (SHRINKING) BALANCE SHEETS
Banks' balance sheets behave pro-cyclically, ballooning in cycle peak years, then suddenly shrinking in recession shcok and being slow to grow again in recovery years.
In the initial two years of the economic upswing after 2001 it was not loan demand, but reduction in bad loss provisioning that drove banks' earnings, followed by sharp rises rising on the warm air of the newsflow on corporate profits, plus aggressive cost-ratio cutting.
The rise then levelling out of loan demand and credit defaults falling to low default rates (dramatically lower default risk, easiest to achieve when new loans are easy or cheap), junk credit spreads fell from around 20% to below 8%. Unsurprisingly, bank share prices doubled in 2003 in six months, smartly outperforming the broader market.
Capital investment and bank lending to support this grew in the export-led countries. Utilisation rates in the US, Germany and Japan all moved higher along with profits for the corporate sector.
The UK and USA household credit cycle peaked in 2005. When recession was obvious by end of '07 and into '08, corporate debt expanded for a while even when the household sector's began to slow and residential property prices fell. Then, beginning with property developers, corporate debt looked very risky. But, the embarrassment of the corporate sector appears deeper but shorter lived than the household sector. UK and
US house prices appear now in Q1 '10 to be slowly on the rise. With greater backlog of orders, US firms are no longer cutting working hours, and unemployment rates are only edging higher after having moved up substantially in '09. In the UK, unemployment is a third less than normally be expected.
Some rise in consumer confidence is feeding through to the housing market, but based on a preponderance of buying properties at heavy discount and a lot of bank-owned properties being held off the market. Home sales are off their lows and, most importantly for banks, house prices appear to be forming a bottom. With a sharp reduction in loss provisioning, bank earnings ought to rise through 2010.
The steep yield curve is currently exceptionally helpful for the banks; about half of bank assets are lent at long- term rates, and 3-month LIBOR is c.50bp. As banks hold the line against growing loans (that fell 8% in 2009 by US and UK banks), banks can add to their Treasury holdings to further benefit from the yield curve. UK and USA Bank holdings of Treasuries have risen by $half a trillion over the past year and will increase substantially more to build up capital buffers.
In doing so, however, shrinking their loan books, the banks are not helping economic recovery. They are putting their narrow interests first and using new regulatory requirements to do so. Corporate bond issuers appear to be joining in the deleveraging, which means delaying capital investment, and now on top of this also delaying new net corporate bond issues?

EUROPEAN MONETARY FUND

European Commission President Jose Manuel Barroso at a media conference on Europe 2020 at EC HQ Brussels, March 3, 2010. The European Commission will eventually announce ways to safeguard the stability of the 16 nations that share the euro, to stem problems such as Greece's debt crisis from threatening Europe's currency union.
16 states are in the Euro Area (also called Eurozone) and are requested by Germany and France to consider creation of a "European Monetary Fund," a fund that could help euro-member countries converge more on the Maastricht Treaty criteria, which apply as ceilings for all EU members, not just those in the Eurozone. Germany and France first announced they were considering a European Monetary Fund on 8th March, describing this thinking as seeking new safeguards against the kind of eurozone instability created by Greece’s debt crisis. Support for an EMF for the Euro Area to be modelled on the IMF, was revealed at the weekend by Wolfgang Schäuble, German finance minister, who told Welt am Sonntag newspaper that Berlin wanted more eurozone policy co-ordination. This is absurd from a practical economic perspective - if all Euro countries followed Germany's policy lead i.e. export-led growth, then unemployment will remain high and Germany's policy would have to change.The idea of EMF is a good political move! It heads off the embarrassment to the Euro Area Council and the ECB of Greece seeking help from the IMF, and if any other Euro Area states, such as Portugal, Ireland or Spain, do the same. It also heads off criticism especially of the European Central Bank (ECB), which ought to be fulfilling that same function, and provides another route for funding by EU states and private banks to route soft loans indirectly. All expect sovereign crises to be inevitable, the inevitable result of governments taking on some of the burdens of private over-indebtedness.
Sovereign debt crises are associated with countries that have very high national debt to GDP ratios. But that is not the issue; it is trade deficits and private and government cross-border borrowings i.e. loan pricing pressures from lenders. Japan’s debt ratio of about 190%/GDP is very high, but because it is has a large trade surplus it is a net creditor nation. The US with National Debt of 83%/GDP with most of the world's trade deficit is a debtor nation, but secured by the $US dollar's global currency role denominating more than half of all trade and international financial transactions. The Greece crisis is also deficit-led, but small in EU or global terms. It will not cause lasting damage to the Euro or European Monetary Union, but ushers in some long-run changes within the Euro Area that may go in one of two ways, either towards severe growth tightening or towards more flexibility? The Euro Area as a whole has a 'national' debt ratio of 78%/GDP (the line towards which the UK is now headed). But those above that line that have high trade deficits (not Italy despite its over 100%/GDP debt ratio) i.e. Spain, Ireland and Greece (which may be joined by the UK) all planning unprecedented tightening - the next five years will be a test of political-economic courage for all European leaders. So far they do not appear to be able to disengage from domestic sabre-rattling or flag-waving - it is like an economic phony war. Will it turn into a real ideological war over economic policy and beggar-the-neighbours or cutting off noses to spite faces real economic damage? The IMF has been given such a role by G20 in which the EU is a full participant. nevertheless it is embarrassing for the Eurozone to be shown politically prevented from helping member states in difficulty while the IMF can do so. The Greece sovereignty crisis is probably only the first of several.
This EMF idea comes hard on the heels of Greece saying it will appeal for IMF help if Euro Area states and the ECB cannot help it with loans. Some €26bn of ECB short term (1 year) loans were provided to Greek banks. They have to be repaid starting in June, and cannot be simply rolled over because the ECB decided to stop issuing any more such short term loans in December last. Further loans have been agreed but on conditions of public sector spending cuts that are causing protest riots and strikes almost daily in Athens and elsewhere. Greek banks and the central bank need about $200bn to cover trade deficit and funding gap financing. US commercial banks hold $156bn of Greek banks' notes. Private sector borrowing should not be confused with public sector, or the latter if it is high looked at without considering the context, such as the tag placed on this chart. If structured like the IMF, the EMF could provide some stability tools that the euro needs, and that the ECB in Frankfurt is, for political rather than economic reasons, constrained from providing. The European Bank for Reconstruction and Development (EBRD) in London seems to be overlooked in this? EMF is also a sign of Europeans wanting to decouple from what they perceive to be Anglo-Saxon finance and economics.
The Greek crisis has weakened the Euro. If more Euro states seek loans from the IMF that is a further threat to the Euro.
When the currency was born in 1999, it was obvious to all that one weakness was the lack of a federal political entity supporting the ECB. To fill this gap in terms of states' budget deficits and debts, all EU states signed the Maastricht Treaty that set limits of 3% ratios to GDP as the ceiling for annual budget deficits. But, enforcement penalties were ambiguous. The markets are finding a way to exert the punishment and still arbitrage between different EU and Euro Area members even though a single ECB central rate and single currency denominated bonds was supposed to stop markets from differentiating and attacking any of the member states individually - that was the purpose of the Euro. It is not working so long as the ECB is not acting on behalf of the whole Euro Area regardless of different budget settings and different growth strategies. Policy differences should be addressed outside of the ECB, not inside. Would an EMF be any different; would it be less picky and less political?
The problem boils down to some countries pursuing export-led growth (mainly Germany) and others credit-boom growth rquiring them to finance rising trade deficits e.g. Grece, UK, Ireland, Spain. While Germany focused on integrating its Eastern regions and on exports, but doing nothing otherwise to stimulate domestic growth, other countries grew by bank borrowing and lending secured by rising property values and needing to sell securitised banking assets and borrowing to finance their trade deficits, of which Greece had proportionately the highest. From the perspective of Portugal, Spain, and Greece, and a few others, they considered themselves to be in economic catch-up mode, and following the example of Ireland's property credit boom.Note the stagnant and falling property prices of Germany showing how it traded the idea of household home-ownership and household wealth for export-led growth i.e. keeping domestic consumer demand depressed, going for high savings and international creditor status instead of what might be called democratic prosperity - the stated goal followed by USA, UK etc.
Yet, so long as this seemed to be working, the credit boom economies of Spain, Greece, Ireland were praised for their above average contribution to total EU and Eurozone growth. There was no concern expressed in EU economic reports about these countries trade deficits or eventually unsustainable housing booms until the asset bubbles burst. A clear demarcation arose between the centre of the EU and its periphery. But this is no different from the picture worldwide, and where cerdit-boom economic growth translates not into high public sector or national debt, but very high private sector debt - that is the real long term problem that economics and its politics have to now consider centre-stage and not leave lingering in the background as hitherto.
When you click on the next graphic to see it full size, you should be amazed to see the differences in size of countries dictated by how much has been loaned to, borrowed by, private sector. Note how small countries are proportionate to their population and economic size e.g. even Japan and shockingly China (which since this graphic has doubled private sector loans, but still this remains small. Proportionately small lending to the private secotr shows economies that are externally very dependent and that have done relatively less or little in deepening and broadening their domestic economies in terms of per capita incomes and actual per capita household wealth. Europe's Mediterranean countries - now called the "PIGS" (Portugal, Italy, Greece and Spain) - are accused of having less fiscal discipline than Germany. This is unfair in the case of Italy, whose problems derive from opposite reasons to the others; Italy did not follow credit-boom growth, but at the same time found it could not generate an export-led growth model like Germany's. Italy, like France, kept its external account roughly in balance. The 'I' in PIGS should stand for Ireland. The advent of the euro gave Ireland, Spain, Greece and Portugal low real interest rate shocks, that fuelled credit-booms - and were for years highly beneficial, but could not continue in 2008 and 2009. The result was gigantic housing and other property asset bubbles. Italy had modest productivity performance and grew its economy to overtake that of France in GDP and trade, if falling behind Germany at a rate of almost 3% a year. Italy's budget discipline was good, but carrying a high national debt ratio. Its banks remained extremely prudent - too much so! Greece (and Cyprus), with the far to go to catch up with the EU GDP per capita average did so rapidly. But the result was a trade deficit approaching 20% ratio to GDP, by far the highest in the OECD.
Greek banks became heavily borrowed and invested strongly in bank subsidiaries in SE Europe to whom the banks lent about $150bn. Other EU countries' banks also invested in growing banks in central Europe and Russia, providing total liabilities of about $1.5 trillions. The EBRD, ECB and others are much concerned about how the central European economies are performing and whether the banks are remaining solvent.
With the EMF proposal, it should be possible to design a fund that solves this problem - but, only if it is able to build up a substantial balance sheet of probably at least €500 billions, when it would overtake the EBRD and rival the ECB in funding.
If the EMF behaves like the IMF (and World Bank) it could force Greece and any other country that needs loans from the fund to restructure their economies and budgets. This would involve cutting back the public sector, capping wage rises, undermining labour unions, and possibly privatizations of public utilities - condiions that would do more than blow the froth of economic growth! The second achievement of such an EMF could be the creation of a bank bailout process that is at least as onerous as required by European Commission rules to protect fairness in the Single Market. There is an irony here that the Single Market and a single currency do not allow member states (regions) to divert from a rigid average or lowest common denominator norm.
Last week, ECB decided to maintain some support for the Euro Area banking system in light of the Greece controversy. ECB President Jean-Claude Trichet said, "We considered it was exactly appropriate taking into account the present situation." When pressed on what present situation he meant, he said he meant concerns over Greece. For at least the next 7 months, funds to keep banking operations running smoothly over seven-day periods would continue to be available in unlimited quantities at the ECB's rate, currently 1pc. But that does not change the repayment deadlines of the Greek banks! Athens' need to raise €20bn (£18bn, $27bn) in April and May to finance expiring debt is likely to widen spreads above the 300bp that Greek bonds incur above equivalent German Bunds.
On ECB overnight money, Trichet said the rate banks charged each other would not rise much in the short run. The overnight rate is currently at 0.32pc and the ECB regards this as very cheap money. Actually, of course, the insurance spreads on Greek debt and bank debt remain high at about 300-400bp, and while they should fall over the years, they may rise again in the coming months. Although bond spreads have narrowed since the launch of the latest austerity package that is the cause of splits within the governing party, street protests and Thursday's strikes, Greece currently has little choice but to pay 300bp more than the equivalent German bond – a premium that Greek government officials rightly say is unsustainable.From next month the ECB will return to the pre-crisis practice of offering three-month loans to the banks at a variable, instead of a fixed rate. When the 7 months are up, the ECB will decide whether and how to bring overnight rates back to normal condition of slightly above the benchmark rate. By then the banks aided by the ECB will have to have financed the ECB's "exit" strategy - of particular importance to Irish banks, the heaviest users of ECB loans of more than €50bn(January). As ECB soft loans end, interbank interest rates will rise before the ECB raises its own rate.
Irish banks used last 12-month loan at a fixed 1pc offered by the ECB in December. Banks must repay the first of these fixed loans in July - a total eurozone repayment to the ECB of €442bn, actually a reverse swap, taking collateral back and giving back ECB bills plus interest and fees. From other sources at the same time they will need to borrow finance to fill their funding gaps at that time, which will have grown by over €400bn.
The ECB described this process as a new stimulus measure, described as lending back "covered bonds" it bought during the crisis, saying this will help banks borrow funds on the market. If Orwell was alive and writing today he would describe such language-spin of the banks as 'newspeak'. The credit crunch was essentially banks unable to use their covered bonds to borrow against from other banks at economically viable rates i.e. at margins below what they can safely lend to customers at. The banks have to hope that for some reason interbank lending will in the next few months turn positive from negative and at spreads that are realistic for borrowers to accept.With the bonds markets continuing to be jolted by sovereign risk news, part of the recovery in equities has to be a flight from bonds? The long 9 months of recovery in fixed income assets prices extending to sub-investment grade and sub-prime RMBS has come to an end. Price spread volatilities including credit risks are 15-40%.
The media are complicit in such misdirections. The Bank of England decided this month, for a second month, not to resume what the media persist in calling its "money-printing" programme of buying government debt from banks. Apart from the purchases being designed not to be from banks, having called its actions as Quantitative Easing, it may be no wonder that the news media try to explain this by calling by the misnomer "printing money".