The EU summit hammered out yet another temporary fix today, albeit
a complicated one.
The proposal involves the
creation of a "European
Monetary Fund" and it will require
changes to the Maastricht Treaty. Paul Krugman does not like the austerity measures and ECB president
Jean-Claude Trichet had to eat
his words regarding defaults and acceptance
of defaulted bonds as collateral.
German taxpayers may potentially be screwed big
time on this bailout.
Can this agreement hold together? Before deciding let's look at some details.
"European Monetary
Fund" Created
In what French President
Nicolas Sarkozy likens to a "European Monetary Fund", EU Leaders Offer
$229 Billion in New Greek Aid
After eight hours of talks in Brussels,
leaders announced 159 billion euro ($229 billion)
in new aid for Greece late yesterday and cajoled bondholders into footing part of the bill. They
also empowered their 440-billion euro rescue fund to buy debt
across stressed euro
nations after a market rout last week sparked concern the crisis was spreading.
The fund can also aid troubled
banks and offer credit-lines to repel speculators.
The euro strengthened as officials
drew concessions from
Germany, the European Central Bank and investors for a twin- track strategy to support Greece and ensure its woes don’t
spread. The summit is the latest in a running-battle to resolve the crisis amid calls this week for tougher action from U.S. President Barack Obama and the International Monetary Fund.
The Greek financing
package will consist of
109 billion euros from the euro region
and the IMF. Financial institutions will contribute 50 billion euros after
agreeing to a series of
bond exchanges and buybacks that will also cut
Greece’s debt load, the leaders’ communiqué said.
French President Nicolas Sarkozy compared the transformation of the bailout
fund to the creation of a
“European Monetary Fund.”
The pact still doesn’t “make a significant dent” in Greece’s
debt and may disappoint investors by failing to boost the size of
the rescue fund, said Jonathan Loynes, chief European economist at Capital Economics Ltd. in London. “We
doubt that this package alone will bring an end to recent contagion effects and prevent the broader debt crisis from
continuing to deepen over
the coming months.”
For now, Merkel and her allies have succeeded in their drive to make investors co-finance bailouts after voters balked at the cost of saving spendthrift nations.
Banks will reduce Greece’s debt by 13.5
billion euros by exchanging bonds and “potentially much more” through a buyback program still
to be outlined by governments, said the Institute
of International Finance, a Washington-based group representing banks.
Trichet signaled governments
will guarantee any defaulted Greek debt offered
as collateral during
money market operations.
That may enable Greek banks to keep tapping the ECB for
emergency funds. Officials
said the aim would be limit
any credit event to a few days.
The facility will be able to buy debt directly from investors so long as creditors agree and the ECB declares
“exceptional financial
market circumstances.”
EU President Herman Van Rompuy
said the purchases could be used
to stabilize markets as
the ECB was doing or to
help countries retire debt at
a discount.
The fund may also start passing money to
countries to support banks a week
after stress tests on 90 financial
institutions put as many as 24 under
pressure to show they can
raise capital. Precautionary
credit lines would allow it
to lend to nations before
markets freeze, mimicking a system introduced
by the IMF for states that start
losing investor faith even though
they have relatively sound economies.
Governments will have to ratify the facility’s new
powers, posing a potential obstacle given domestic critics in Germany, Finland and the Netherlands.
One Step Closer to Nanny State
If Germany, Finland, and the Netherlands
foolishly approve this, it will
be one step closer to the European Nanny State that Germany has feared so long.
German Taxpayers
on the Hook
ZeroHedge comments 82 Million Soon
To Be Very Angry Germans, Or How Euro Bailout #2
Could Cost Up To 56% Of German GDP
This is
not a restructuring of existing
debt from the perspective
of the host country! Simply said
Greek debt will continue growing as a percentage of its GDP, meaning it, and Ireland, and
Portugal, and soon thereafter
Italy and Spain will be forced to borrow exclusively from the EFSF.
In a just released report
by Bernstein, which has actually
done the math on the required
contributions to the EFSF by the core countries,
the bottom line is that for an enlarged EFSF (which is what
its blank check expansion
today provided) to be effective, it will need to cover Italy and Belgium.
[Bernstein]
An extension of the EFSF to
cover Italy and Spain would require a €790bn
(32% of GDP) guarantee from
Germany
This strategy is not only unlikely to succeed but would also run into
some serious structural difficulties. To cover 100% of
the roll-over for Greece, Portugal, Ireland, Spain,
Italy and Belgium as well as an allowance for bank support at 7% of the banks' balance sheets until the end of 2013, the support mechanism(s),
would need to be able to deploy a total of
€2.4trn in available funds.
1937 Replay
Paul Krugman is unhappy with the deal and is screaming 1937! 1937! 1937!
The Telegraph has a leaked draft of the eurozone rescue plan for Greece. The financial
engineering is Rube Goldbergish and unconvincing.
But here’s what leaped out at me:
9. All euro area Member States will adhere strictly
to the agreed fiscal targets,
improve competitiveness
and address macro-economic
imbalances. Deficits in
all countries except those
under a programme will be brought below
3% by 2013 at the latest.
OK, so we’re going to demand harsh austerity in the debt-crisis countries; and meanwhile,
we’re also going to have austerity in the
non-debt-crisis
countries.
Plus, the ECB is raising
rates.
The Serious People are determined
to destroy all the advanced economies
in the name of prudence.
Greece Defaults
Felix Salmon has a nice comprehensive wrapup of the new
agreement in his post Greece Defaults.
The latest Greek bailout is done and it
involves Greece going into “selective default,” which
is, yes, a kind of default.
This is a bail-in as well
as a bail-out: while Greece
is getting the €109
billion it needs to cover its fiscal deficit, both the official sector and the private sector are going to take losses on their loans to the country.
As such, it sets at least two hugely important precedents. Firstly, eurozone countries will be allowed
to default on their debt.
Secondly, a whole new financing
architecture is being built for Greece; French president Nicolas Sarkozy called
it “the beginnings
of a European Monetary Fund.”
The nature of massive precedent-setting
international financing deals is
that they never happen only once. One thing is for sure: these tools will be
used again, in future. They will be
used again in Greece, since this deal is not enough on its own to bring Greece into solvency;
and they will be used in other
countries on Europe’s periphery
too, with Portugal and/or
Ireland probably coming next.
The Maastricht treaty will
get resuscitated, with all eurozone countries except Greece, Ireland and
Portugal committing to bring
their deficit down to less than 3% of GDP by 2013.
Paul Krugman is screaming about this, but this was a central part of the eurozone project from the get-go, and clearly the eurozone needs some kind
of fiscal straitjacket for its
constituent members to prevent
the rest of them from running up enormous deficits and then getting bailed out by Germany.
Finally, the EU will provide “credit enhancement” for Greece’s
private-sector bonds. This is
a central part of the default plan, and it looks a lot like the Brady
plan of the late 1980s. The official statement from the IIF, which is representing
private-sector creditors
in this matter, is a little vague, but essentially if you’re a holder of Greek bonds right now, you have three [four] choices.
1.
You
can do nothing, and hope that Greece
pays you in full and on time.
2.
You
can extend your maturities out to 30 years, and accept a modest coupon of 4.5%; in return, your
principal will be guaranteed with an embedded zero-coupon bond from an impeccable triple-A-rated
EU institution, probably the EFSF.
3.
You
can extend your maturities out to 30 years, take a 20% haircut, and get a higher coupon of 6.42%; again,
the principal is guaranteed
with zero-coupon collateral.
4.
You
can extend your maturities out to 15 years, take a
20% haircut, get a coupon
of 5.9%, and have only a partial principal guarantee through funds held in an escrow account.
There is much more in
Salmon' s article regarding what
exactly is happening and what the options are. It's worth a closer look. Inquiring minds may also wish
to consider the Official Statement
by the EU.
Three Critical
Points
1.
The
critical point from
Salmon is "The nature of massive precedent-setting international financing
deals is that they never happen only once."
2.
The
critical point from
Bernstein is the amount German taxpayers will be on the hook once Salmon is proven correct.
3.
The
critical point from Krugman involves short-term pain. Even if one disagrees with Krugman in the long haul (as I
do), the short-term pain for Spain, Portugal,
Ireland, Greece, and Italy
is likely to be unbearable.
In light of the above, let's
return to the question I asked earlier:
Can this agreement hold
together?
I don't see how it can.
Mish
GlobalEconomicAnalysis.blogspot.com
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