Schumpeter

Business and management

The emergency summit in Brussels

Back from the brink, but still close to the edge

Jul 21st 2011, 23:03 by P.W.

EUROPE as a project tends to lurch forward through crises. That’s been unnerving for investors and markets as one eleventh hour follows another in the saga of the sovereign-debt crisis ensnaring Greece, Ireland and Portugal. Ahead of this week’s emergency summit, nerves were certainly jangled, as the crisis that has flared up over Greece’s need for a second bail-out threatened to spread to the much bigger economies of Italy and Spain with their ten-year government bond yields soaring to euro-era highs. Expectations of a breakthrough in the impasse over how Europe should respond were low, not least since Angela Merkel, the German chancellor and the euro area’s reluctant paymaster, had sought to dampen them.

Maybe that was all masterly stage-management because the summit cheered up markets even before the "i"s had been dotted and "t"s crossed on the final communiqué. A draft statement circulating on Thursday afternoon, even as the 17 euro-area leaders were meeting, had already started to quell the darkest fears, spurring a relief rally. The final communiqué spelt out a package that did rather more than had been expected.

The new bail-out will add another €109 billion ($157 billion) in official help to the first bail-out, worth €110 billion, which is still being disbursed. Moreover, interest rates on new lending from the European Financial Stability Facility (EFSF), the euro area’s rescue fund, will be more lenient (interest rate roughly 3.5%) while the maturity of the loans will be doubled from the current 7.5 years to 15 years.

On top of this, private-sector holders of Greek government bonds will contribute a net €37 billion. The statement does not specify the measures, referring instead to “a menu of options further strengthening overall sustainability”. One might be an exchange of existing bonds for new ones worth less than the old ones on paper because they will pay lower interest and stretch out longer. But the mooted reduction in their net present value (ie, the sum of their discounted cashflows) was reportedly only 20%: for a haircut, bald this will not be.

A default by any other name
The trim will nonetheless be treated as a default by credit-rating agencies. Yet this now looks likely to be less of a disaster than previously feared. For months the European Central Bank has been arguing vehemently against any policy that brought about a Greek default. The ECB’s insistence that if one occurred it would not accept Greek bonds as collateral for lending threatened to close down the Greek banking system, currently in hock to the ECB, potentially forcing Greece out of the euro area. But that won’t happen now because Jean-Claude Trichet, the bank’s president, won assurances from European leaders that the collateral will get “credit enhancement” to allow Greek banks to continue to get financing worth around €100 billion from the ECB.

If Mrs Merkel and her finance minister, Wolfgang Schäuble, have got their way over a restructuring, allowing them to say that the European (in fact mainly Greek) banks are footing the bill as well as German taxpayers, they have given ground over the remit of the EFSF. Earlier this year Germany stoutly resisted demands to make the rescue facility more agile and multifaceted, insisting that it be restricted to handing over bail-out money to countries like Greece and Ireland already in special measures. Now it will be given a much freer rein, extending lines of credit to other countries on the basis of a precautionary programme and propping up banks through loans to governments. Moreover, it will be able to intervene in secondary markets to avoid contagion, a power Germany was loth to give it.

But if the Germans have conceded on the “flexibility” of the EFSB, they have held their line on its size. As before, it will rise from an effective lending capacity of around €250 billion to €440 billion later this year once the new arrangements have been ratified by 17 euro-area states. And they have also stood firm on its backing: the creditor countries will continue to stand behind the EFSF on an individual basis, with each lending country responsible only for its share of the guarantees. There has been no step forward to the common euro bond, backed by “joint and several” guarantees, that many believe will be essential to resolve the crisis in the long run.

The emergency summit may have done enough to settle the Greek problem for the time being. But it could yet cause shudders in the rest of the euro area as investors with exposure to other countries worry about taking a hit. And although European leaders insisted that their remedies for Greece were “exceptional and unique”, Ireland and Portugal may think otherwise.

At best, Europe has won a breathing-space. But so much can still go wrong, not least in Greece, whose chances of getting on top of its towering debt without a much bigger restructuring still look remote. By going for a modest restructuring now (which will also include a small programme of debt buybacks) European leaders will find it harder to impose a more stringent one in the future, leaving European taxpayers footing even more of the bill if Greece can’t get its debt under control. The euro area may have taken a step back from the brink, but it is still perilously close to the edge.

Read on: More on the emergency euro-zone summit from Charlemagne, Free exchange, and Democracy in America.

(Photo credit: AFP)

Readers' comments

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warriorjoy

@ Robert North
Just declare yourself a Bank and the EU will surely send you your money back.
We cant have any of those financial institutions losing money can we!
Though you may get paid back a little slower.

Robert North wrote:
Damm it...Lehmann like moment averted, there go all my EUR shorts.

Courtjester

@Schumpeter

"the creditor countries will continue to stand behind the EFSF on an individual basis, with each lending country responsible only for its share of the guarantees"

If this were to be true, even in default of a creditor country, could you please explain how they the bonds issued by EFSF will be AAA rated, or attractive to the market? If Greece is to borrow at 3.5% for 15 or more years, and France borrows at 3.8% for the same period, where does the difference come from?

Can one of the quants explain who it works?

jomellon

My dears it is the dollar that is the dying turkey...

1) Total debt

Japan and the U.S. have significantly higher debt than the euro-zone.
Public debt in percent of economic output (2011)

Euro-zone: 87.7 percent

U.S.: 98.3 percent

Japan: 236.1 percent.

2) Fiscal discipline

Fiscal discipline is better in the euro zone than in the U.S..
2010 budget deficit as a percentage of economic output

Euro-zone: 6.0 percent

U.S.: 11.2 percent

3) Debt reduction

The euro-zone countries are reducing their budget deficit faster than the Americans.
Projected budget deficit in 2012

Euro-zone: 3.5 percent

U.S.: 8.6 percent

4) Job market

The labour market in the euro area countries has suffered less from the crisis than those in the U.S..
Increase in unemployment from 2007 to 2010

Euro-zone: 2.5 percentage points

USA: 5.0 percentage points

5) Savings ratio

The problem-states of the euro-zone economy as a whole save more money than about Britain and the United States.
Savings rate as a percentage of economic output

Spain: 18.9 percent

Italy: 15.9 percent

United Kingdom: 12.1 percent

U.S.: 10.3 percent

6) Stability

The euro is more stable than the dollar.
Inflation from June 2010 to June 2011:

Euro-zone: 2.7 percent

U.S.: 3.6 percent

Audentes

If Greece does not default on or restructure its debt with some economic reform attached to it, I don't see this as anything else than throwing money down a drain. Where do they expect to get the money from anyway? Are the European taxpayers, already fed up with the whole union, going to pay? Or are they just going to print more money, devaluing the Euro, creating higher inflation?

sikko6

Robert North wrote:
GMT Damm it...Lehmann like moment averted, there go all my EUR shorts.
-----------------

Don't be too fast. Soon Greek debt alone will exceed trillion euros. All euro zone debt will reach zillions!

sikko6

Atlas_Shrugged wrote:
GMT Well done. In twelve months Northern Europe will become bancrupt, too.
---------

You are naive. They are already bust!

TheGrimReaper

Is it worth bailing out Greece once more ? For so far, the last €110 billion package dramatically failed to bolster the economy. The Economist has from the crisis outset onward advocated a rapid restructuring of the Greek's unsustainable debt, and put an emphasis on the euro-zone members' inappropriate response to the issue.

What Greece currently needs to placate the popular mutterings is to be relieved from the heavy debt burden she is being coping with since the 2008 global bust. The European economies' latest proposal is meant to elude an ominous Greek bankruptcy, which won't pass unnoticed as many too-big-to-fail Eurocountries still hold a fistful of the Greek's bonds and assets. By enabling Greece to refund in a second bail-out plan, Europeans solely postpone the critical deadline farther, but insidiously tighten the noose around Greece's enfeebled neck. Their gesture, deemed as a "politically symbolic decision of forward solidarity", may quickly backfire, for they only protract a crisis. Metaphorically, they only quell the house glowing ablaze without settling a resilient firewall around it.

ZeFox

@Morani ya Simba
I live in cuckoo land and not all is as clear-cut as it would appear from the outside. Switzerland has to import much of its skilled labor for making said cuckoos from other countries. The locals are not reproducing and when they do they dont study hard enough. Much of this foreign labor stays long enough to stockpile some of the golden cuckoo eggs and then departs enriching their country of origin. Of course people seeking to evade taxation do stay. But my long term view is that as the Europeans gradually get their act together, the attractiveness of hoarding all your eggs in cuckoo land will decrease. Then the talent, vitality and years of investment in infrastructure will pay off. All it takes is to fix the accounting. But this was meant to happen right from the start. The fathers of the Euro ignored it simply for political reasons but they knew full well that at some point irresponsible borrowing would have to come to a screeching halt. It s not such abig issue. 300 billion? Big deal. There is 500 million of us in the EU. That greek debt amounts to 600€ per capita and GDP per capita stands at 25´000€ Europe-wide. Merkel and Sarkozy handled it quite well, building up the tension, getting the european voters to understand: this is it or else...you buy a loaf of bread with a wheelbarrow of cash.

Dapples

Europe may indeed tend to "lurch forward through crises". In older days this crisis would have meant war and destruction. While the EU/Euro project is far from ideal it is a hell of a lot better then the old way. NEVER AGAIN WORLD WAR.

PS The USA is not doing much better in this regard (see their ENORMOUS financial problems) and the way they resolve them. Talk about last minute and almost internal war.

stefano de santis

Greece can't pay his enormous debt,amounting to 60-70 %of GDP.Does someone remember the latinamerican states in the years 70-80,when their debt with the IMF amounted to 120 % of their GDP? They didn't pay,more they didn't pay the interests on the debt.Greece is on the same way,and in short time we shall have the greek problem again,but worsened.No country can afford such burden,in terms of debt/GDP.The european leaders know this,but are dragging their foot hoping in a miracle.The miracle won't come.

Robert North

@Morani: you can rest assured that not all commentators here wish to see th EU implode. Quite the opposite actually at least where I come from. Its not just the ramifications which will be felt by all, but unlike Europe in previous centuries we do not see cultures different to ours as 'inferior' or needing 'enlightenment'. In any case if you cannot save yourself, China's trade surpluses will, so nothing to worry about (and then Norway's petrofunds).

Morani ya Simba

@sydKo2B4Av, how tragic it would be if the least violent continent with the lowest crime rates in history without resorting to police state methods like Singapore, greatest foreign aid budget and leader in research and conflict resolution were to collapse. Of course, you are free to count on our failure. Just don't expect us to be friends if you hope we fall. We may come through and you may be the next to hit the storm. Good luck then!

sydKo2B4Av

This is yet another firm step towards the inevitable collapse of western socialism and its over-indebted welfare economic structure and anti-democratic socio-political structure.

The Euro is condemned to be falling apart and the cost to the citizens will be horrendous.

Ricardo87

"And although European leaders insisted that their remedies for Greece were “exceptional and unique”, Ireland and Portugal may think otherwise."

These countries will also benefit from measures like interest rate around 3.5% and the maturity of the loans doubled to 15 years.

About Schumpeter

In this blog, our Schumpeter columnist and his colleagues provide commentary and analysis on the topics of business, finance and management. The blog takes its name from Joseph Schumpeter, an Austrian-American economist who likened capitalism to a "perennial gale of creative destruction"

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