The heads of government largely accomplished the three things on the agenda: renew their approach to the Greek problem; direct the eurozone’s rescue fund to prevent market panic engulfing other countries, notably Italy; and shore up Europe’s banking system. How they will do this is what matters.
By far the most decisive action was over Greece . . . On the other two goals, the eurozone has yet to prove its mettle. It is good to see support for making European financial stability facility resources go further – most of all in Berlin. But the complicated structures adopted to do so, and an evident distaste for putting up any more cash, will continue to weigh on investors’ confidence.
For all the rhetoric, therefore, this was no persuasive summit; it was not the moment when crisis management was finally given the political leadership it needs. More likely than not, the burden of bold action will again fall on technocrats: Mario Draghi, the incoming European Central Bank president, or Klaus Regling, the EFSF’s head.
Two hard and related questions now arise. First, where is the new capital going to come from? Banks as various as BNP Paribas, Banco Espirito Santo and Commerzbank are making it clear, in so many words, that the primary answer is: by shrinking. Reduced lending, retained earnings and asset sales, will enable them to reach the new European minimum core tier one capital ratio of 9 per cent. Bankers appear to be saying “we accept the target, now accept the consequences”. In a way, that is understandable. Tapping private investors would mean selling shares at ridiculously low multiples, as bankers see it. And agreeing to state investment would crimp their operational freedom.
So the second question becomes how policymakers can offset the threat to economic growth posed by reduced lending. Another credit crunch in Europe, this time home grown, is a serious threat to all of the continent’s economies, and most serious for the most vulnerable. The summit communiqué requires domestic authorities and the European Banking Authority to guard against excessive deleveraging. But what does that mean? And how will it be policed?
The core conundrum is that the amount of extra capital required to restore confidence in Europe’s banks depends on the extent to which the default risk by troubled sovereigns is stabilised. The recapitalisation plan fails to resolve that vicious circle.
The euro’s troubles have been a proxy for a deeper crisis of integration. Franco-German reconciliation and the fall of communism deprived the Union of its founding purpose. Perhaps the latest effort of eurozone leaders will stabilise the euro. But they have not addressed the deeper malaise.
Behind grandiloquent talk of European solidarity once lay a more serious recognition that national interests were best pursued by co-operation. More Europe meant more France ... and more Germany, and more Italy and so on. The euro crisis has seen the process recast as a zero sum game. What Greece, Portugal, Spain or Italy stand to gain, Germany, the Netherlands and others must lose. This way lies the return to Westphalian Europe.
The rising states have not missed the lesson. If states so politically, economically and culturally close as those in the eurozone can be so hesitant about rescuing the single currency, why should anyone else put their faith in “global governance”? Angela Merkel cannot abide Nicolas Sarkozy, but Hu Jintao is supposed to get along just fine with Barack Obama?
Italian banks, fresh from a round of capital raising this spring, have given a cool response to demands from the European authority that they require an additional €15bn of capital buffers.
The Bank of Italy, voicing the concerns of banker leaders, warned on Thursday the develeraging needed to be taken with great care not to impact the real economy. There are also concerns about considering fairly the vast holding of Italian sovereign debt held by Italian institutions which, while being one of the safety nets of the Italian state, have become a weight on the balance sheets of the lenders.
French growth will shrink to only one per cent of gross domestic product next year, requiring a new round of austerity measures to hit the centre-right government’s targets for bringing down rising debt levels.
Mr Sarkozy said the reduction in the 2012 growth forecast from a previously lowered estimate of 1.75 per cent – bringing France in line with latest forecasts for neighbouring Germany – would require €6bn-€8bn in extra austerity measures. This would be on top of €12bn ($17bn) already added to the budget, mainly through tax increases, in August as the economic outlook deteriorated in the face of the debt crisis.
The fresh move would enable the government to stay on target to reduce the budget deficit to 3 per cent of GDP in 2013 and thus begin to reduce public debt, due to peak at more than 87 per cent of GDP next year.
The impact of reduced growth on France’s public finances is particularly sensitive because its high debt level has called into question its triple A sovereign debt rating, which allows it to borrow at relatively low rates, and underpins France’s contribution to the eurozone rescue fund.
China is very likely to contribute to the eurozone’s bail-out fund but the scope of its involvement will depend on European leaders satisfying some key conditions, two senior advisers to the Chinese government have told the Financial Times.
Any Chinese support would depend on contributions from other countries and Beijing must be given strong guarantees on the safety of its investment, according to Li Daokui, an academic member of China’s central bank monetary policy committee, and Yu Yongding, a former member of that committee.
Professor Li said:
It is in China’s long-term and intrinsic interest to help Europe because they are our biggest trading partner but the chief concern of the Chinese government is how to explain this decision to our own people. The last thing China wants is to throw away the country’s wealth and be seen as just a source of dumb money.
He added that Beijing might also ask European leaders to refrain from criticising China’s currency policy, a frequent source of tension with trade partners. The US argues that an intentionally undervalued renminbi unfairly supports Chinese exports.
With $3,200bn in foreign exchange reserves, roughly a quarter of which are believed to be held in euros, China could be willing to contribute between $50bn and $100bn to the EFSF or a new fund set up under its auspices in collaboration with the IMF, according to one person familiar with the thinking of the Chinese leadership.
President Nicolas Sarkozy of France welcomed the prospect of a Chinese contribution to the eurozone rescue package:
Our independence would not be put into question by this. Why would we not accept that the Chinese had confidence in the eurozone and place a part of their surpluses in our funds or our banks. Would you rather they placed it with the US?
The head of Europe’s most powerful national industry body has warned eurozone leaders about the dangers of approaching China or other nations to help resolve the region’s debt crisis, as this would put the fate of the battered euro in the hands of foreign governments.
“Asking a non-eurozone nation to help the euro would give the other nation the power to decide the fate of the single currency,” Hans-Peter Keitel, president of Germany’s BDI industry association, told the FT. “All help from them would come at some political cost.”
Eurozone business leaders are concerned that Europe could for example declare China a free-market economy, a move that could send EU import tariffs tumbling.
On almost every major issue, particularly the second €130bn Greek bail-out and increasing the firepower of the eurozone’s €440bn rescue fund, it could be days or weeks before the details that underpin the entire package are finally ironed out.
Potentially the most uncertain element is the deal struck with Greek bondholders for them to take a 50 per cent cut in the face value of their bonds.
Not only is the reduction in Greece’s debt dependent on almost all current bondholders participating in the plan, but the actual bond-swap which will produce the savings has not even begun to be negotiated.
“Here’s where you may be a little bit surprised, but this is where we decided to end last night,” said Charles Dallara, chief negotiator for the private bondholders.
Because the Greek deal has not been completed, the size of the newly beefed-up rescue fund cannot be exactly calculated. The €1,000bn that has been touted for the fund’s size is, as a result, a guesstimate based on the still-untested ability to multiply a still-unknown asset base by four to five times.
“Here’s where you may be a little bit surprised, but this is where we decided to end last night: the specific elements of the deal, that is to say the structure of the new claim on Greece, remains to be negotiated,” said Charles Dallara, managing director of the Institute of International Finance, the consortium of banks that negotiated on behalf of Greek bondholders.
By cutting in half the face value of the estimated €200bn in Greek bonds in private hands, officials have taken a far more aggressive stance in reducing Greece’s overall debt levels than they did three months ago, a move long called for by outside analysts. But such swingeing cuts are also dependent on almost all Greek bondholders agreeing to participate in the plan. Unlike the July deal, which set a target at 90 per cent participation, Thursday’s plan includes no such target.
In addition, by taking such big up-front haircuts, European officials threaten the very solvency of the largest single holders of Greek debt – Greek banks, which hold about €50bn in sovereign Greek bonds. A senior EU official said €30bn of the new €130bn rescue package must go to bailing out Greek banks – a €10bn increase from July.
Wall Street Journal
Contrary to headlines, European policy makers did not leave Brussels yesterday morning with the "final, even groundbreaking" plan to end the euro-zone's debt crises . . . What the summit does highlight, however, is that Europe's piecemeal approach is not going to cohere into a real or lasting solution if policy makers continue to ignore the underlying economic anemia that has afflicted the economies of Europe for decades.
The biggest accomplishment is the agreement to impose a voluntary 50% write-down on private holdings of Greek debt . . . But that's small consolation now that the European Central Bank, the International Monetary Fund and euro-zone governments hold about 40% of all Greek debt, a figure that will only grow as privately held bonds mature. As long as these institutions refuse to take haircuts on their own Greek holdings, a private-sector haircut can only go so far toward reducing total debt.
. . . the bailout fund [EFSF] is now authorized to act as a bond insurer, guaranteeing first-losses up to an as-yet undecided amount on new issuance of euro-zone sovereign debt.
The legal basis for this is dubious under the Rome Treaty, which explicitly forbids member states from guaranteeing each others' debt. And insurance doesn't come cheap when the sovereigns being insured are the same ones that might be bankrupted by having to pay more into an insurance fund. A first-loss guarantee may reduce the probability of default, but it raises the costs of default if it does happen.
In short, everyone is bailing out everyone. The larger problem betrayed by yesterday's agreement is that European leaders continue to act as if they are mainly dealing with a crisis of confidence, which can be restored with evermore far-reaching bailout schemes. Absent from this week's communiqués are any new ideas for promoting the structural economic reforms—both at the periphery and at the center of the euro zone—that might create real confidence in the euro zone's long-term economic prospects
- "Next Act--The Plan Is Put to Test" (no link)
. . . the markets most critical to the euro zone's financial health reacted coolly. Interest rates on sovereign bonds for Italy and Spain—the two big economies most at risk from being sucked deeper into the crisis—fell modestly but were still higher than is comfortable for cash-strapped governments: Yields on 10-year Italian bonds were around 5.7% and those on Spanish bonds about 5.3%.
. . . some noted that Institute of International Finance, negotiating on behalf of the private sector, had committed only to "work...to develop a concrete voluntary agreement" on Greek debt. "An invitation to agree to a haircut is not the same as a haircut," said Sony Kapoor, managing director of economic and financial think tank Re-Define.
- "EU's Greece Deal Has Dose of Irony" (no link)
After spending the aftermath of the financial crisis hogging the moral high ground and criticizing "Anglo-Saxon capitalism" for its penchant for financial engineering and excessive leverage, European Union leaders employed some of the same devices for Greece.
The plan was passed, but not without getting around some of the principles outlined after the 2008 debacle.
Take the idea—central to a solution of Greece's woes—that the country will undergo a "controlled default" in which banks and other debt holders would "voluntarily" agree to shoulder a 50% reduction in the value of their securities.
That is financial engineering at its most Machiavellian. The deal is designed to avoid triggering the payment of credit-default swaps on Greek debt, the much-maligned securities meant to insure against precisely this kind of scenario.
The structure is not much different from the accounting contortions used by banks during the 2008 crisis to avoid bearing the brunt of mortgage-related losses.