Economics
The euro crisis
Is everything fixed?
Dec 16th 2011, 17:29 by R.A. | WASHINGTON
AT THE European Central Bank's last meeting, Mario Draghi did not announce any plans to scale up purchases of sovereign debt and, indeed, he indicated that previous statements interpreted as a promise to do so were in fact no such thing. He did, on the other hand, announce new measures to boost liquidity across euro-zone banking systems, including a facility through which banks can borrow unlimited amounts from the ECB, very cheaply, for up to three years. It quickly dawned on observers that banks might just use this borrowing to fund purchases of government debt, thereby addressing the crunch in sovereign debt markets. And I see that some writers are now arguing that this step actually amounts to the critical turning point in the crisis. Is it?
The wheeze, however, seems to have been too clever by half. Hours after Mr Sarkozy was urging banks to bail out governments, the European Banking Authority (EBA) released the results of its updated stress tests showing that European banks need to raise €115 billion ($149 billion) in extra capital, mainly to offset a fall in the value of their existing holdings of government bonds issued by troubled peripheral European countries.
The banks with the biggest capital shortfalls are those from Spain, Greece and Italy. Several may have to tap government bail-out funds to raise the capital, creating the circular prospect of governments bailing out their banks that are in turn supposed to bail out the government. Italian banks, for instance, will need €15 billion in additional capital; among them is UniCredit, Italy’s biggest bank by assets, which holds some €40 billion in Italian government debt and needs to raise almost €8 billion in capital. Spanish banks need €26 billion. Europe’s core has not been spared either. Banks in Germany, the euro area’s biggest creditor country, need additional capital and Commerzbank, Germany’s second-largest bank, may also find itself asking for government help to fill a €5.3 billion hole in its balance-sheet.
Banks around the periphery are in a difficult situation. If the sovereign fails, they fail and vice-versa. Given this, there might be some logic to a move to go all-in on the sovereign's debt: hope that funneling ECB loans into sovereign debt will take some pressure off the government, and that over time confidence will return and everyone's bets will turn out all right. On the other hand, markets and regulators are pushing against such a move, demanding that such banks raise capital and reduce exposure to risky debt. How much room do troubled governments actually have to force banks into such purchases? Outside of the periphery, the incentives are clear: cut exposure to the south. Banks there will do their best to raise capital, and will take advantage of cheap financing to roll over existing debts. Meanwhile, none of these banks are in a position to scale up lending to private businesses. The impact of the credit crunch on the real economy will make it very difficult to escape the current, nasty equilibrium.
Why, then, are short-term yields falling? Well, one short-term liquidity freeze-up has been averted, and maybe something good will happen before more bad news strikes. There are surely some banks using some of the liquidity to buy government debt, for any number of possible reasons. It will be easy to overinterpret moves between now and January, however. Volume is likely to be low, as activity winds down for the holidays. And importantly, falling short-term yields are not translating into big declines in long-term yields, a big upward swing in equities (for banks or anyone else), or a recovery for the euro. Unfortunately, it does not appear that the euro-zone crisis has been brought to an end.
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We will continue to see economic recession across the West, including Europe and the US because of this. I mean, come on, how broke must the US be to go after American cash in Swiss bank accounts which has been ignored for a hundred years. That IS desperate, and will constrict and impede the flow of money in and out of these countries. Our government intends to take this money advance for taxes - not for commerce. That's why the biggest capitalists in the world looked the other way for so long. Not anymore.
When I see machiavellian investors like George Soros demanding bail outs, followed by opportunistic purchases of MF Global EU debt sold well under market, I can't help but suspect that manipulations are in the works. It feels like a giant Ponzi scheme perpetrated on all of society. Unfortunately, there is always a price to pay and the poor are the first to feel it.
The ECB and European Governments need to move decisively to shore up confidence. So far, they've implemented only piecemeal ineffective measures - everyone knows they're not going to work. They have to get serious: They have to bring out the big guns that they've so far been unwilling to deploy. Until then, they will have minimal credibility and minimal success.
...anyway, if you need a laugh about this whole debt situation, check out www.debtcock.com
-its a bit crude, but absolutely hilarious!
Be sure to check out Berlusconi in the Wall of Shame
Greece's and Portugal's public debts are unsustainable. Full stop. Those losses have to be recognized, ie, the principal has to be cut and the cut part (for Greece, at least 50%) either replaced with good German debt or the banks have to be recapitalized. This will be painful (particularly for German taxpayers) but European investor confidence will return and Spain, Italy and Ireland will recover and be pulled bank from the brink - if they make good on pledges of reform.
OR, the ECB can massively expand QE and create inflation, thus inflating ALL debts. This is no freebie, of course, but it does spread the pain out among ALL European citizens (instead of just Germany).
It's as simple, and as painful, as that.
I can understand not issuing syndicated "eurobonds", euro denominated when things look desperate, but portions of local bank holdings could be traded in for new underwritten paper. While localities might want to support their own banks, and international operators can handle trade receivables, regional superbanks with clean sheets may be unwanted or unwilling to buy up the whole lot. It should be up to the locality to decide how much paper they issued to be converted to syndicate backed paper.
OK I'm not an economist so please permit me to ask what may be a dumb question. From what I understand of the Bretton Woods agreement in 1944 it was decided to peg everyone else's currencies (that were participating) to the dollar and allow their central banks to exchange excess dollar holdings for gold at $35/troy ounce. My question is, how in the world did all those brilliant economists like Keynes and White and the rest not see what would happen? That such a system will only work if gold on the open market hovers right around $35/troy ounce and that when it starts to rise significantly above that, say to $40 or $45/troy oz., it gives an irresistable incentive to those that hold large dollar stockpiles to trade them in for gold at $35/troy oz. and turn around and sell it on the market for whatever the going rate is?
I know they say hindsight is 20-20 but come on now. Couldn't someone have foreseen that it was a train wreck waiting to happen as soon as gold stayed for a while considerably above $35/oz.? What could have made them think the going rate for gold on the world markets would remain at $35 forever? Thank you for your time and your patience.
-Brian
This doesnt fix the sovereign debt problem-- its a step in the right direction, but the missing link is the banks 'willingness' to buy sovereign debt. Sure, you provide me ready access to a printing press, but what on God's earth would possess me to purchase sovereign debt? For one, its clearly a toxic asset, and #2, I will soon have to abide by the new tier 1 capital ratios.
ECB has intention to provide loan to PIIGS is not ultimate solution, as economy of PIIGS has not capability to repay.
So the best way is to come-out from financial crisis is to implement the suggestion on fiscal measures to extend the confidence of investors that the country has ability to pay through domestic resources.
Recently the American government is also willing to increase the tax based to shift the investment avenues.
ECB-IMF both have reservation about financial guarantees that PIIGS lacking the industrial growth in his economy to earn the income through trading. They want to improve the fiscal discipline to maintain the financial confidence.
The answer to your question is very simple. One need only look to see where our 10 year note closed on Friday. At 1.85% it is the lowest yield close since October 4th. The yield on our 10 year has dropped 20 basis points this week. The bond market has gotten this crisis right at almost every turn. And at a new low yield weekly close, its telling us that things may be about to get worse.
i was quoting the US bond market which continues to benefit from flight to quality. Its one of the only places left to go.
Why did yield of short-term Italian bonds fall? Could it be the news that the Italian parliament passed Monti's austerity plan by an overwhelming majority of 402 to 75? A clear demonstration by the country that it has the political will to fix its finance inspires greater confidence on its bonds. It's not that hard to understand. Fundamentals matter. I don't understand this insistence to attribute all changes in market sentiment to central bank financial engineering.
Crisis is over.
Nothing here to see.
Carry on.
it is just the beginning
To see from where we are standing
We are living in a special time. We get to watch the Eurozone proceed with the pointless intransigence of Spain in the Low Countries, of Britain in the American Colonies, of France under Napoleon III and Germany under Kaiser Willy.
Watching this level of self-destructive stupidity is a rare historical priviledge.
"Given this, there might be some logic to a move to go all-in on the sovereign's debt: hope that funneling ECB loans into sovereign debt will take some pressure off the government, and that over time confidence will return and everyone's bets will turn out all right."
Go all in...everyone's bets...
I've been fiddling in the markets long enough to remember when such decisions were called investments or at worst speculations.
I find it faintly amusing that now such all decisions are described in almost universally in gambling terms.
The hands of the ECB are tied. Its recent acquisition of toxic paper from both Greece and Ireland could ultimately have a large negative impact on its balance sheet. As well, it is battling inflation levels that are above the 2 percent target, making it very difficult to lower interest rates to stimulate demand as shown here:
http://viableopposition.blogspot.com/2011/12/ecb-caught-between-rock-and...
On top of the aforementioned conundrum, the recent announcement that the ECB would accept single-A rated paper as collateral from the region's banks, could load their balance sheet with even higher levels of toxic assets that could make it difficult for them to stimulate should Part 2 of the Great Recession take hold.
So banks are in trouble because they hold too many sovereign debts of dubious worth. So let's lend the banks more money, so that the banks can buy even more sovereign debts of dubious worth? *That's* going to fix things?
This may provide some short-term help, but it makes the long-term problems worse...