AMERICAN FUTURE

Financial Times

• Alan Greenspan, “Europe’s crisis is all about the north-south split“

The ranking of credit risk spreads by size across the eurozone in 2010 was almost identical to the ranking of the level of unit labour costs (relative to that of Germany), suggesting that the higher labour costs and prices have rendered “euro-south” less competitive and so more subject to credit risk. The more competitively priced net exports of the northern eurozone participants, in effect, more than covered the rising level of net imports of the south. In short, between 1999 and the first quarter of 2011, there has been a continuous net transfer of goods and services shipped from the north to the south. Northern Europe in effect has been subsidising southern European consumption from the onset of the euro on January 1 1999. It is not a recent phenomenon.

• Howard Davies, “It’s time for plain-speaking to Europe’s electorates“

No one knows today which euro-denominated contracts, which are found all over the world, should be redenominated into one or more new currencies. Would it be on the basis of nationality, or residence, or intended place of settlement of the contract, or law of jurisdiction over the contract? Who would decide? Which courts could enforce whatever was decided? In every case of redenomination there would be a winner and a loser, so every attempt to enforce a change would be disputed. Then arrangements for the new currency(ies) would be needed. Intricate preparations were made over many years to introduce the euro – we were involved.

• Gillian Tett, “America’s six key lessons for a ‘euro Tarp‘”

Firstly, size matters. When Hank Paulson, then Treasury secretary, unveiled Tarp back in 2008, he told colleagues he was looking for a “bazooka” to stun the markets and turn sentiment around. At the time, $700bn seemed big enough to work, since this number – crucially – outpaced market expectations. And while those expectations subsequently got inflated – and analysts started calling for, say, $1,000bn – these doubts did not set in until later; and, crucially, after sentiment had turned.

Secondly, co-ordination is crucial. One reason why Mr Paulson’s bazooka “stunned” the markets was that it was wielded by a single team – policy was being set by a close-knit group of Treasury and Fed officials. This mattered because in late 2008, investors had no stomach for delay or conflicting policy signals.

Thirdly, excessive democracy does not always help. In the first stage of Tarp, politicians were involved; Congress, after all, initially vetoed Mr Paulson’s plan before approving it after a market crash. But later a tight team of bureaucrats took control and were able to fire the Tarp bazooka with speed, in a straight(ish) line. Remember how Mr Paulson yanked the bank chief executives into the Treasury on a Sunday afternoon and ordered them to accept capital injections – and sign? That could never have occurred if Congress had been involved.

Fourth, plans need to be flexible. When Mr Paulson initially created Tarp, his team thought that the $700bn would be used to buy bad assets from banks. However, they later decided to recapitalise the banks instead. Future financial historians will argue endlessly about whether this was the “right” decision but if nothing else, this showed that the Treasury had great freedom to act.

Fifth, stress tests only work if they address the visible points of stress that the public and markets care about. The US stress tests of early 2009 were far from perfect; some experts thought, for example, that reserves for commercial real estate were too small, and there were no reserves for impairment of sovereign debt. But while that worried geeks, the stress tests did address the issue that was really bothering markets: namely whether there were enough reserves for residential mortgages. And that, coupled with their comprehensive nature, made them seem “credible” enough to turn sentiment.

. . . there is a sixth key point to remember. Back in 2008, it was widely assumed – at least among the US public – that most of the $700bn used in Tarp was permanently “spent”. But these days, Treasury officials reckon that less than $50bn has really been lost. For once Tarp was deployed, and sentiment stabilised, then asset values rose, along with bank earnings, enabling much of that money to be repaid.

• Philip Stephens, “Save the euro — let Greece default“

The pressing decision is about the timing and terms of Greek default. It is possible that the politicians still have a choice between orderly restructuring and a chaotic collapse that quickly engulfs everyone else. Possible, but not certain. The more governments argue about how to build firewalls around the other peripheral economies and about how to insulate the banking system, the more likely the flames will spread uncontrolled across the continent.

• Lex, “European stress tests: a grim backdrop“

Which part of “stress test” do the eurozone’s policymakers not understand? That so many European banks passed the annual exams in July yet still had their shares trashed by investors says it all: the pass mark was too low and the questions were too narrow. That banks have since struggled with funding and come under the microscope of US regulators rightly concerned at the risk to US banks shows the consequences of eurozone policymakers’ state of denial. Their failure to allow for eurozone defaults doomed the tests of the European Banking Authority. Its retests must take account of the grim backdrop.

• John Kay, “What Europe can learn from Kissinger-style ambiguity“

Ambiguity has been central to the European project. The European Union is built on what Cass Sunstein, the US legal scholar, describes as incompletely theorised agreements: it is often possible to reach consensus on a course of action even if there are different reasons for and objectives behind such action. The evolution of monetary union in Europe was an incompletely theorised agreement. For Germany, it was a means of extending the economic discipline of the Bundesbank to more profligate trading partners. For France, it was a way of putting European monetary policy under greater political, and particularly French, control.

• Patrick Jenkins, “UK government fears new RBS bail-out“

Nervousness is growing in Whitehall that the government might have to inject further capital into Royal Bank of Scotland as part of an effort to recapitalise Europe’s banks.

Moody’s added to that unease on Friday by downgrading RBS amid a re-rating of the UK banking sector after a review of the systemic support offered by the British government.

• Peter Spiegel, “Barroso enters fray over bank support“

José Manuel Barroso, president of the European Commission, will soon present his own plan for Europe-wide bank recapitalisations, the clearest sign yet that the region’s leaders could come up with a strategy to shore up its financial sector as soon as a summit later this month.

Although the Commission does not have the power to impose capital injections by national governments, Mr Barroso’s comments on Thursday echoed those by Angela Merkel, the German chancellor, who this week said her government was prepared to prop up German banks and urged a co-ordinated European effort.

• Hugh Carnegy, “France fights pressure to recapitalise banks“

Nicolas Sarkozy, who will be in Berlin on Sunday for euro crisis talks, must have winced when he heard Angela Merkel, the German chancellor, say on Wednesday that her government was prepared, if necessary, to recapitalise the country’s banks.

The French president, his ministers and officials have stuck rigidly to the exact opposite line through the past few torrid months of crisis – that France’s banks do not need recapitalisation, despite being under constant attack in the financial markets for their heavy exposure to risky eurozone sovereign debt.

The centre-right government insists the banks are stable, based on plans set out by the big three – BNP Paribas, Société Générale and Crédit Agricole – to meet minimum capital requirements under Basel III regulations by 2013, six years ahead of deadline.

And the banks themselves are keen to avoid state equity injections, which would likely be dilutive to shareholders.

Wall Street Journal (no links)

• Brian Blackstone, “Central Banks Step Up Battle to Contain Crisis“

The Bank of England made a surprise decision to buy government bonds to try to bring down interest rates and spark growth, while the European Central Bank revived measures from last year to try to keep capital flowing to Europe’s ailing banks.

“This is the most serious financial crisis at least since the 1930s, if not ever,” U.K. bank chief Mervyn King said, explaining the decision to add money into the strained financial system. “We’re creating money because there’s not enough money in the economy.”

A flurry of meetings by global policy makers in recent weeks has done little to inspire confidence that a permanent fix is in store for Europe’s beleaguered periphery, and economic indicators in recent days have offered fresh signs that Europe risks sliding into another recession. France’s statistics agency Thursday predicted recession for Spain and Italy by year’s end, saying that would help drag France’s growth to zero.

• William Horobin, “France Lowers Outlook, Sees Italy, Spain, Slump“

France’s growth outlook has deteriorated sharply over the summer and the country is headed for a second quarter of stagnation as the shock of the euro-zone debt crisis manifests itself in the real economy, national statistics agency Insee said Thursday.

Insee slashed its gross domestic product growth forecasts for the remainder of the year to 0.3% in the third quarter and zero growth in the fourth quarter, bringing 2011 GDP growth to 1.7%.

The statistics agency had previously forecast 0.5% quarter-on-quarter growth in the final two quarters of this year and 2.1% for the full year. However, “events over the summer have wrecked this scenario,” Insee said in its outlook.

“The lesson of the summer is that while we had been saying for a year and a half that the Greek crisis was a risk, now we are seeing this risk has materialized in figures,” said the head of Insee’s forecast department, Sandrine Duchêne.

Insee expects Italy and Spain to go into recession in the second half of 2011, with contractions of 0.1% in the third and fourth quarters for Italy and a contraction of 0.2% in Spain. Economic surveys in the two countries have deteriorated significantly over the last few months, with industrial production in Spain particularly weak, Ms. Duchêne said.

The weakness of other European countries will contribute to a stagnation of world trade in the third quarter. In the fourth quarter trade is expected to decline, and as demand from businesses shrinks, consumption will be the sole supporter of growth in France to the end of the year, Ms. Duchêne said.

• Geoffrey T. Smith, “European Banking Body May Consider New Stress Tests“

The European Banking Authority said Thursday it can’t rule out launching a new round of stress tests on Europe’s banks, but denied having already done so.

Separately, European Commission President José Manuel Barroso said Europe’s banks may need recapitalization and work is already underway on some aspects of this.

An EBA spokeswoman said “the situation has evolved rapidly and dramatically” since the EBA published the results of its stress tests in July, adding that the body, “as a technical authority, will of course assess all the alternatives.”

• Brussels Beat, “Plan to Recapitalize Banks Remains Thin on Details“

Stock markets around Europe have rallied this week on the apparent expectation, fostered by such comments, that the failure of Franco-Belgian bank Dexia SA has galvanized the euro zone into recognition that it has a major problem and plans to do something about it. To convince the markets, it would have to be quite a plan: The International Monetary Fund has estimated that the currency bloc needs €200 billion to €300 billion ($267 billion to $400 billion) to cope with the crisis and its knock-on effects.

There’s no detail, though, of any proposal, except one that Germany has been pushing. Under it, governments would pledge to launch or relaunch backstop funds like the one Germany created after the 2008 financial crisis. If the private market won’t provide the money, then national governments will act. If they are financially stretched, then the expanded European Financial Stability Facility, soon to get authority to supply banks with capital, will step in. Berlin appears to be hoping EU leaders will back the idea at a summit on Oct. 17-18.

Critics say that wouldn’t be so much a plan as an announcement, and are skeptical that anything more significant is in the works.

New York Times

• Editorial, “The Trouble with Greece“

Europe has been right to demand that, in exchange for bailout financing, Greece carry out painful structural reforms to make its economy more competitive and able to generate more revenue to pay down the country’s huge debts. Without that pressure, Athens would likely never be able to overcome fierce resistance from public-sector unions, professionals, the wealthy and all of the special interests determined to keep doing business as usual.

But Europe has been dead wrong to simultaneously demand that Greece impose steep new taxes and deep social spending cuts guaranteed to prolong and worsen an already severe recession. That will make it impossible for the country to earn its way out of debt.