Only three sleeps to Halloween and it seems the Europeans have pulled off another ‘trick or treat” with its latest agreement to settle Greece’s debt problem and the question of bailing out banks.
It’s the third attempt since May of 2010 and once again financial markets have bought the dubious mixture of silver linings and hot air offered by European political leaders. The old cliché is beware of Greeks bearing gifts. For markets and analysts, it should be updated to beware of Europeans bearing deals about settling financial crises. The culpability for this debacle has long since spread beyond Athens.
There are quite a few points that come to mind from reading reports on the agreement (go online to the Financial Times for the best coverage; the UK Telegraph‘s live coverage is unsurprisingly sceptical and entertaining. And checkout Reuters blogger Felix Salmon’s priceless “official” diagram of the deal). Here are some of the more important:
This deal is deeply humiliating for Europe. Because Germany won’t let the European Central Bank play a direct role in the bailout (it is already supporting the entire eurozone banking system on a day to day basis, plus buying Italian and Spanish sovereign debt, as well as debt from Greece, Ireland and Portugal) by financing the stability fund directly, the actual method to pump up the European Financial Stability Facility is complex, highly artificial and sees Europe outsourcing its funding.
China has been approached to help finance the 1 trillion euro expansion of the EFSF by way of investing in Special Purpose Vehicles of the type used by Goldman Sachs, Merrill Lynch, Citigroup et al before the GFC. They’ll be used to finance the buying of Italian, Spanish and other eurozone sovereign debt that might need supporting over the next few years. The IMF may also be approached, and there was talk earlier in the week that the Saudis would be approached as well. Speculation that European officials would be approaching the local pawnbroker remains unconfirmed.
The outsourcing is because, basically, the Europeans are broke (well, outside Germany) and can’t finance their own bailout directly from their national balance sheets. If it was done that way, France would lose its AAA rating (which could happen anyway if there is a recession next year — Standard & Poor’s has warned that’s what it will do if there is a slump) and the stability fund idea would collapse. Germany is already putting in around 210 billion euros, and doesn’t want to contribute any more, and doesn’t want the ECB involved to provide high quality AAA rated money would would solve a lot of the problems.
So the eurozone will use a discredited type of financing, and leverage (and don’t you appreciate the irony, that as Europeans and others are forcing banks to deleverage their balance sheets and act more prudently, they themselves are racing off to the hairier edges of financing, with huge risks and not much understanding), and are asking a bunch of rich countries that are not democracies, such as China and the oil sheikdoms, for help. No doubt there will be calls to made to the one party state called Singapore, where Temasek Holdings and the GIC, the country’s two wealth funds, have proven to be dud investors in their deals to recapitalise some European and US banks in the past five years.
As the Americans have found, having China as your banker can lead to all sorts of conflicts of interest and conflicts generally. Europe is now China’s biggest market, so they will probably do something — overnight, Chinese sources were reported as saying EU bailout fund chief/head mendicant Klaus Regling would receive a positive reception in Beijing — but they are not mugs and will insist on strong guarantees and other controls to make the point they are not ‘chump money’.
The deal with Greece is unrealistic. This is the key part of the deal. The banks have to volunteer (the voluntarism is central to avoiding a much-feared “credit event”) to cut their holdings of Greek debt by 50% and they will need 106 billion euros of new capital (after revaluing their holdings of sovereign debt by 50%).
The upshot is that Greece sees its debt cut by around 100 billion euros and it is projected to be 120% of the economy by 2020, which is still too high for the country to survive. This cut in Greece’s debt-to-GDP ratio, (which has been forecast to peak north of 180% in 2013), simply won’t be enough to put its debt load on a sustainable footing. It’s a debt load similar to Italy’s, but Italy, unlike Greece, enjoys a primary budget surplus, meaning that it is servicing existing debt rather than creating new debt. Greece will have to go on creating new debt for years to come, simply to pay interest and keep the country running. This is consigning the country to two decades or more of slow growth, high unemployment and rising levels of poverty — and a lot more of the social strife of the last 12 months.
The reality of the cuts for banks on their Greek debt is the solvency of the largest single holders of Greek debt — Greek banks — is threatened. They hold around 50 billion of sovereign Greek bonds and 30 billion of the new 130 billion rescue package will go to bailing out these banks (including two owned by French banks Soc Gen and Credit Agricole). That’s 50% or 10 billion euros more than the July 21 bailout agreement, which tells us something about the true state of the Greek banking system and the economy generally.
By the way, there was an amusing spat in the aftermath of the deal overnight, when Nicolas Sarkozy stated the bleeding obvious, that Greece should never have been allowed into the Euro in the first place. The Greeks bit back, saying it was “wrong to scapegoat any individual country”. Still, as far as scapegoats goes, the Greeks will do till someone better comes along.
And that will be Italy.
Watch for Italy to be the next problem, or rather its teenage prostitute-using Prime Minister, Silvio Berlusconi. Berlusconi — now plainly regarded as a serious problem by Sarkozy and Angela Merkel — has promised a massive program of economic reform, but no one believes him. He can’t lie straight in bed by himself, let alone with anyone else. While he is in power, with the racist Northern league as his partner, Italy will be unstable and won’t keep to its side of the deal with the rest of Europe. Italy has an estimated 250 billion euros of debt falling due next year and the bailout fund will be on the hook for all of that.
So it had better find the extra 750 billion euros of “firepower’ very quickly. The best thing for Europe would be for Berlusconi to be dumped either through a no confidence vote in Parliament or a split in the government and early elections. While Berlusconi is around the need for a 4th and final bailout (of all of the eurozone) will be very much on the cards.
Finally, the exclusion of the European Central Bank from direct involvement in the big bailout fund doesn’t lessen its importance: it increases it because if this deal fails, the ECB is the last resort. The ECB can make a big symbolic move next Thursday night by unwinding the stupid 0.5% increase in interest rates that the retiring governor, Jean Claude Trichet imposed on the eurozone this year, in his stupid idea that the European economy ‘s biggest foe was inflation, not an impending slowdown. The slowdown is winning, hands down.