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Ilargi: After having maintained for the past few years that Greece neither could nor would be allowed to default, EU leaders have finally given in. Of course, the word now is that this can be a default that doesn't trigger a credit event, in which payments on credit default swaps come due. Good luck with that. The credibility of Europe in the financial markets is shot. Gone. Trillions more in taxpayer funds will be thrown at the issues, but it doesn't matter anymore.
Not coincidentally, the change in attitude on Greece comes at a time when Italy has come under intense pressure. It's time to cut losses. Getting Greece done will open up space and time to "save" Italy. Or so undoubtedly goes the reasoning. It's not going to work.
Italy is not the EU periphery; Italy is very much in the heart of Europe. The country's nominal GDP is over $2 trillion. And its debts are staggeringly high. As Ambrose Evans-Pritchard writes for the Telegraph:
Italy and Spain must pray for a miracleOnce again Europe's debt crisis has metastasized, and once again the financial authorities face systemic contagion unless they take immediate and dramatic action. If the ECB's Jean-Claude Trichet is right in claiming that Europe was on the brink of a 1930s financial cataclysm a year ago - and I think he is - it is hard see how the threat is any less serious right now.
Fall-out from Greece flattened Portugal and Ireland last week. It is engulfing Spain and Italy, countries with €6.3 trillion ($9 trillion) of public and private debt between them.
Ilargi: Holders of this debt are first, of course, Italian banks, as this graph shows. The two last banks in the row, Unicredit and SanPaolo, hold some 40% of Italian sovereign debt. In the past few days, trading in Milan was temporarily halted for both, albeit at different times.
Obviously, this graph shines a light on other things as well. For one, European banks' holdings of Italian debt is 7-8 times bigger than that of Greece. Where it's taken European leaders forever to accept, as they did today, that there will have to be haircuts for private investors. When time comes to address Italy's debt, "haircut" won't be an appropriate metaphor. It’ll be more like putting their heads through a lawnmower, and without anaesthetics.
If we broaden our scope to look beyond banks, and include other institutional investors in PIIGS debt, this is the picture we get:
Clearly, it's not just the banks that will get hammered (or lawnmowered) . Pension funds, insurance companies etc. are right up there with them. Total "cross-border" exposure then looks as follows:
That's a neat $3.23 trillion right there. In sovereign debt. The EU bail-out fund is presently about $700 billion, and Germany has stated that enlarging it is out of the question.
Another interesting graph is this one:
As you see, French banks have a completely outsized exposure to Italy. Which means that if the markets come after Rome, they’ll hit Société Générale, BNP Paribas and Crédit Agricole too. There's no way they won't. Here's the overall PIIGS exposure for banks per country:
Paris will -need to- step in to try and save its financial institutions. The first steps in that direction are already being taken. The International Accounting Standards Board (IASB) has advised Europe to implement their International Financial Reporting Standard 9 (IFRS 9), which is nothing but a sly and underhanded mark to fantasy trick posing as a "standard". Think the US' FASB 157. Basically, IFRS 9 allows investors to hold assets at cost as long as they don't try and sell them. That Greek haircut which is being discussed shaves off as much as 60% of debt value. But they may still appear on the books at 100%.
That's really great. Unless you would like to know what your shares are really worth, and those your pension fund holds. Who needs transparency, or reality, when you can just spend your days dreaming of riches? We're all crackheads now.
Another shrewd European plan that has France written all over it is this one, as reported by Reuters:
'EU taxpayers to rescue bank test failures'European countries will support banks that fail stress tests if those lenders cannot raise capital from investors within six months, according to a draft EU document seen by Reuters. The paper, being prepared for EU finance ministers to approve on Tuesday, is an about-face from promises by G20 policymakers in the wake of the financial crisis that taxpayers would never have to bail out banks again.
The European Banking Authority is due to announce next week the results of its latest stress tests of the region's top lenders - 91 in all - in another attempt to reassure investors that European banks have been rebuilt against future shocks.
Ilargi: A third of the 91 stress-tested banks is believed to fail. Greek and Italian banks will be among them, some German, but looking at the graphs above is should be clear that it's the main French powerhouses that deserve our scrutiny.
There is no way the EU/ECB/IMF troika can save Italy if and when it comes under too much pressure. Pretending that it can is useless, but a valiant effort to do just that will be made. By then, however, Greece will have been fed to the dogs. And judging from the amounts of exposure to Ireland, Dublin looks like a lost case too. Moreover, there is no reason the markets won't come after Spain at the same time as Italy.
And then they can focus on France. This may sound far-fetched today, but that's just a temporary notion. Remember, total public and private debt for Italy and Spain is €6.3 trillion, or $9 trillion. For just these two countries. And a lot of that is hiding in the vaults of the French banks.
The best thing to do would be to come clean, to mark all assets to market, to restructure what must be restructured, and to bankrupt those institutions that are in fact bankrupt. This will not be done. Instead, extend and pretend will be the official policy -though it will be called something else-, until it no longer can be. That's what happened with Greece today: the official line went from "no defaults" to "sure, defaults, but..." in five seconds flat.
And that is the future for Italy too. And Ireland, Spain, Portugal. And after that France may have its turn. By then, though, the EU may have stopped functioning as a unit. Berlin, Paris and Amsterdam will reach a point where they'll throw anyone at the wolves who threatens their positions. Not that that will do a single thing to save them; it will merely prolong the agony. Alternatively, there will probably be attempts at creating a true fiscal union across Europe, or even a political one.
But that will never come to be. It's game over. The European leadership, having lost every inch of its credibility in the marketplace, is like the check player who refuses to admit defeat and insists on playing on and on even when the odds of winning are zero. Investors love it: they will get fed trillions of euros more in public funds, until that same public says "no mas".
Greece set to default on massive debt burden, European leaders concede
by Ian Traynor - Guardian
European leaders bowed to the inevitable and conceded that Greece is likely to default on its massive debt burden, which would be a first among the 17 countries using the euro. They also abruptly shifted tack in the eurozone debt crisis by raising the possibility of using the eurozone's bailout fund to buy back Greek debt on the markets, meaning sizeable losses for Greece's private investors and reduced debt levels for Athens.
Following 12 hours of fraught negotiations in Brussels haunted by the risks of contagion in the eurozone spreading to Italy, now being targeted by the financial markets for the first time in the 18-month crisis, the 17 governments of the eurozone pointedly failed to rule out a sovereign debt default by Greece.
A statement that at the meeting the European Central Bank "confirmed its position that a credit event or selective default should be avoided". There was no declaration of governments' support for the ECB position. Both Jean-Claude Juncker of Luxembourg, president of the Eurogroup, and Olli Rehn, EU commissioner for monetary affairs, declined to offer one. "That does not mean that the Eurogroup as such would do everything to provoke a credit event," quipped Juncker.
As recently as last week, eurozone ministers stressed the need to avoid default in Greece, indicating the rapid shifts under way in an escalating crisis. Deep-seated divisions remained between the wealthy northern creditor governments and southern Europe, with market pressures pushing up Italian and Spanish borrowing costs and appearing to vindicate ECB warnings of the risks of contagion from Greece.
Italian borrowing costs hit 5.7%, their highest levels in more than a decade, while the yields, or borrowing rates, on Spanish government bonds reached 6% – the highest level since the creation of the euro. Dealers reported a race to "safe havens" and gold priced in euros and sterling reached record levels of €1,110.48 and £979.89 an ounce in early trading before falling back, while the euro hit a record low against the Swiss franc – a safe-haven currency. Wall Street was also caught up in the anxiety, with US stocks falling 1% in early trading, while the FTSE 100 was also 1% lower.
Analysts said there was little hope of calm returning to the markets while eurozone governments remained gridlocked over how to respond despite weeks of negotiations aimed at encouraging Greece's private creditors to take part in a new bailout. France has proposed rolling over Greece's privately held debt, mostly for 30 years, while Germany revived calls for a Greek debt swap, entailing "haircuts" for investors. The meeting remained split on the scale and modality of private creditor involvement in the new Greek bailout, the second in more than a year, EU officials said.
European diplomats said the meeting needed to be "cathartic", paving the way for a breakthrough to stave off a wider catastrophe in the months ahead. The major new developments were that eurozone governments accepted for the first time that a Greek default may be inevitable and that the eurozone's €440bn euro bailout fund should be reconfigured to buy back Greek debt. "We stress our intention to make Greek debt more sustainable," said Jean-Claude Juncker, the Luxembourg prime minister who chairs the 17-country Eurogroup.
The interest Greece is paying on the bailout loans would be lowered, their maturities lengthened, and the "flexibility and scope" of the eurozone bailout fund would be "enhanced". Sources said the proposal was to use the fund to reduce Greece's debt burden by buying back Greek debt from bond-holders at a discount. This is likely to be contested by Germany, the central player among the creditor countries, and could run into problems in Germany's parliament. The rules for the bailout fund would need to be rewritten, meaning the deal would need to go before MPs in Berlin, EU officials said.
But the scheme would also require the participation of Greece's private creditors who would suffer losses, long a German demand. There was no final agreement this morning amid murmurings of an emergency EU or eurozone summit being called before the end of the month.
The outlines of the new rescue emerging this morning pitted Germany against the European Central Bank, with elements of the deal designed to accommodate both camps. Bailout fund buybacks are supported by the ECB, while private creditor losses are a German condition.
Accepting that a Greek default was now impossible to avoid, EU governments are hoping it will be brief and "selective", not triggering a "credit event" on the financial markets that could wreak havoc on the credit default swap markets, also in the US, and unleash contagion.
Last week two of the three big ratings agencies predicted a Greek-style scenario for Portugal, downgrading its debt to junk, while predicting any private-sector involvement in the second Greek bailout being negotiated would be viewed as a default.
Those verdicts provoked rage from the EU. Viviane Reding, the EU justice commissioner, said: "Europe can't allow three private US enterprises to destroy the euro." Either their "cartel" was smashed or "independent" European and Asian ratings agencies would be set up. "We can't have a situation where a cartel of three US enterprises decides the fates of entire national economies and their citizens," she said.
EU stance shifts on Greece default
by Peter Spiegel in Brussels and Patrick Jenkins - Financial Times
European leaders are for the first time prepared to accept that Athens should default on some of its bonds as part of a new bail-out plan for Greece that would put the country’s overall debt levels on a sustainable footing.
The new strategy, to be discussed at a Brussels meeting of eurozone finance ministers on Monday, could also include new concessions by Greece’s European lenders to reduce Athens’ debt, such as further lowering interest rates on bail-out loans and a broad-based bond buyback programme.
It also marks the possible abandonment of a French-backed plan for banks to roll-over their Greek debt. "The basic goal is to reduce the debt burden of Greece both through actions of the private sector and the public sector," said one senior European official involved in negotiations.
Officials cautioned the new tack was still in the early stages, and final details were not expected until late summer. But if the strategy were agreed, it would mark a significant shift in the 18-month struggle to contain the eurozone debt crisis.
Until now, European leaders have been reluctant to back any plan categorised as a default for fear it could lead to a flight by investors from all bonds issued by peripheral eurozone countries – including Italy and Spain, the eurozone’s third and fourth largest economies.
Yields on Italian bonds, which move inversely to prices, rose sharply last week due to the Greek uncertainty. Senior European leaders – including Jean-Claude Trichet, European Central Bank chief, and Jean-Claude Junker, head of the euro group – are to meet top European Union officials ahead of Monday’s finance ministers’ gathering amidst growing fears of contagion.
A German-led group of creditor countries has for weeks been attempting to get "voluntary" help from private bondholders to delay repayment of Greek bonds, a move they hoped would lower Greece’s overall debt while avoiding a default.
But in recent days, debt rating agencies warned any attempt to get bondholders to participate would represent a selective default. Rather than abandon bondholder buy-ins, however, several European leaders have decided to return to a German-backed plan to push current Greek debt holders to swap their holdings for new, longer-maturing bonds.
The move essentially scraps a French proposal unveiled last month, which many analysts believed would only add to Greek debt levels by offering expensive incentives for banks that hold Greek debt to roll over their maturing bonds.
Officials said the Institute of International Finance, the group representing large banks holding Greek debt, has gradually moved away from the French plan and begun to embrace elements of the German plan. "There’s some convergence in the banking community towards a more realistic plan than the French plan, which was out of this world," said the senior European official. The plan criticised as being self-serving for the banks.
According to executives involved in the IIF talks, banks have pushed for a Greek bond buyback plan in return for agreeing to a restructuring programme, arguing that only if Greece’s overall debt were reduced could a sustainable recovery occur.
European officials said there was support for the proposal in government circles. The plan, originally pushed by German investors, including Deutsche Bank, could see as much as 10 per cent of outstanding Greek debt repurchased on the open market. Since Greek bonds are currently trading below face value, such purchases would essentially be a voluntary "haircut", since bondholders would accept payment for far less than the bonds are worth.
It remains unclear how a buyback would be financed, however. The European Commission has long pushed for the eurozone’s €440bn bail-out fund to be used for buybacks, but Berlin blocked the proposal.
German 'Nein' leaves Italy and Spain in turmoil
by Ambrose Evans-Pritchard - Telegraph
Italian and Spanish bond yields soared to post-EMU highs in a fresh day of credit turmoil after Germany blocked any meaningful measures to defuse the crisis.
Chancellor Angela Merkel called for more "frugality" in Italy, sticking to her script that Rome can solve its woes with an austerity budget. Her finance minister Wolfgang Schäuble said any boost to the EU's €500bn (£440bn) bail-out machinery was "out of the question". Mr Schäuble denied reports that Berlin was ready to empower the fund to purchase Spanish and Italian bonds pre-emptively on the open market, a move seen by experts as vital to halt dangerous contagion to the larger economies.
The market's verdict on EU foot-dragging was instant and brutal. Yields on 10-year Spanish bonds smashed through the 6pc barrier for the first time since 1997, made worse by warnings from the Castilla-La Mancha region that its deficit had become "extremely serious".
Italian yields jumped 44 points 5.7pc, a level that starts to threaten the sustainability of the country's finances. Markit's iTraxx SovX Western Europe, Europe's sovereign stress gauge, saw the biggest one-day rise ever. "Contagion was the word on everybody's lips," said Gavan Nolan, Markit's credit chief.
EU leaders seem unable to keep pace with the fast-moving events. Eurogroup finance ministers focused yesterday on details of "burden-sharing" for banks that lent to Greece, no longer the most urgent matter. A summit of top EU officials ended with no hint of how the crisis could be contained.
"We've painted ourselves into a corner. At this point, either someone – Germany, the European Central Bank – has to fundamentally shift position, or everything blows up," an EU official told Reuters.
Berlin has resisted any move to buy or guarantee the bonds of distressed debtors, viewing it as a slippery slope towards a fiscal union and a breach of Germany's Basic Law. The ECB in turn has refused to buy Spanish and Italian bonds, saying it is the task of EU governments.
The euro tumbled over two cents to under $1.40 against the US dollar. Gold rose to $1,556 an ounce on safe-haven flows. Italy's stock market led the rout of global bourses, dropping 4pc despite moves by the regulator Consob to curtail short-selling. Italian bank shares were pummelled again. Unicredit fell 6pc, and Intesa SanPaulo fell 7pc. London's FTSE 100 fell 1pc, while the Dow was off 1.3pc in early trading.
Escalating woes in Italy and Spain raise the stakes dramatically. The pair have €6.3 trillion of total debts between them. Jean-Claude Trichet, the ECB president, said Europe is now at "the epicentre of a global problem".
Yet EU attention remains focused on curbing the rating agencies, a campaign that is turning shrill. Viviane Reding, the EU Justice Commissioner, said the authorities must "smash the cartel of the three US rating agencies". Fitch is, in fact, French-owned.
Barclays Capital said EU leaders must recognise that Greece is insolvent and prepare for an orderly debt restructuring, perhaps one that shares the pain between private creditors and the EU taxpayer and gives Greece a way out of its trap by easing the debt burden by 60pc. Such a move requires back-stop defences to prevent contagion, perhaps by using the EFSF bail-out fund to shore up Club Med bond markets. The solution is elegant: what lacks is political will.
Gary Jenkins at Evolution Securities said the EU cannot keep stalling. Italy's borrowing costs are ratcheting towards the fatal line of 7pc. "It is worth remembering how quickly bond yields can get out of control by looking at what happened to Greek, Irish and Portuguese 10-year yields. What would keep me awake at night if I was a European finance minister is that we are only about 2pc from potential disaster," he said
US hedge funds bet against Italian bonds
by Dan McCrum - Financial Times
US hedge funds are placing large bets against the value of Italian government debt, directly shorting the bonds of the eurozone’s third largest economy. The funds have increased the size of short positions in the last month, speculating that investor concerns over the country’s ability to fund itself may spread from Europe’s periphery to Italy, according to investors in the funds briefed on the strategy.
On Friday, yields on Italian government debt – the largest bond market in Europe – hit their highest levels since October 2002. Italy is now borrowing at its biggest premium over German bunds, the benchmark for the region. The move followed the surfacing last week of tensions between Silvio Berlusconi, prime minister, and Giulio Tremonti, Italy’s finance minister, over the country’s proposed austerity programme.
As Italy’s funding costs rise, the value of its existing debt falls, creating a profit for those who have shorted it by borrowing the debt to sell and buy back at a later date. The funds are using the strategy in preference to buying credit default swaps, as attempts by the European authorities to avoid a technical default that would trigger CDS pay-outs for Greece have raised questions about the effectiveness of such derivative instruments, according to the investors.
Directly shorting government debt was typically considered riskier than buying default insurance, as a short seller must locate specific securities to complete the trade. The Italian bond market is highly liquid, however, and before the financial crisis shorting Italian bonds was a common strategy. The trade is based in part on expectations for the pattern of demand from Italian institutions – owners of the majority of Italy’s sovereign debt – which diminishes as the financial year progresses.
Meanwhile, the Italian government still has more than half its 2011 total debt issuance to go, a greater amount at this stage of the year than normal. Italy has a budget deficit below zero, but the country must refinance €900bn ($1,280bn) of maturing debt over the next five years. "There is a combination of fundamental and technical reasons which mean that Italy has probably got yields going up to some degree," says Gary Jenkins, head of fixed income research at Evolution Securities.
However, he cautioned: "Ironically, the trigger point for the trade to go wrong could be when it is at its most profitable. If the Italian situation gets too bad then European governments would have to step in and do something." If Italy’s economy were to suffer a debt crisis, he argues, then the final policy option available to the authorities will be common eurozone debt issuance funded collectively by the member countries.
Italy Orders Short Sellers to Reveal Positions After Market Dip
by Lorenzo Totaro - Bloomberg
Italy’s financial-market regulator moved to curb short selling after the country’s benchmark stock index fell the most in almost five months and bonds tumbled on investor concern Italy would be the next victim of the region’s debt crisis.
The regulator known as Consob ordered last night that short sellers must reveal their positions when they reach 0.2 percent or more of a company’s capital and then make additional filings for each additional 0.1 percent. The measure takes effect today and lasts until Sept. 9.
The decision came hours before Europe’s finance ministers gather for a regular meeting in Brussels today to seek ways to shore up Greece and defend the region’s other heavily indebted nations. The Italian ruling follows similar action taken in other European countries, including Germany, Rome-based Consob said in a statement posted on its website.
Consob’s commissioners held the emergency meeting yesterday after the country’s benchmark FTSE MIB index plunged 3.5 percent on July 8, led by a decline in UniCredit SpA and other bank shares that are the among the largest holders of the country’s debt. The yield on Italy’s 10-year bond rose to a nine-year high of 5.27 percent, driving the premium investors demand to hold the country’s debt over German bunds to a euro-era high of 244 basis points.
UniCredit, the country’s largest bank, plunged 7.9 percent and Banca Intesa SpA, the second-biggest lender, dropped 4.6 percent. Both hit lows not seen since the period when markets were emerging from the crisis spawned by the collapse of Lehman Brothers Holdings Inc.
Italian politicians including Paolo Bonaiuti, an undersecretary for Prime Minister Silvio Berlusconi and one of the premier’s main spokespeople, blamed the slide on "speculators" and pledged action to rein in investors perceived to be attacking Italy. Bonaiuti said Italy would be united "in blocking the effort of speculators."
On July 5, European lawmakers voted in favor of a ban on short selling of government bonds in the EU unless traders have at least "located and reserved" in advance the securities they intend to sell. The European Union Parliament in Strasbourg, France, also called for restrictions on traders’ use of credit- default swaps to profit from defaults on sovereign debt they don’t own.
Short selling involves the sale of securities borrowed from the owner, and generates profit when the trader repurchases them at a lower price and returns them to the owner. The amount of shorting is limited by the willingness of owners to lend.
The European Securities and Markets Authority, which co- ordinates the work of national regulators in the 27-nation EU, should be given emergency powers to temporarily ban short selling or trades in CDS on sovereign debt in the EU, the Parliament said. Politicians including German Chancellor Angela Merkel and French President Nicolas Sarkozy have claimed that naked short- selling and credit-default swaps worsened the euro area’s sovereign-debt crisis, and have called for EU curbs.
Michel Barnier, the EU’s financial-services chief, said last year such trades may lead to "disorderly markets and systemic risks." Finance ministers from the 27-nation region agreed in May that traders should be allowed to short sell government bonds and stocks if they have a "reasonable expectation" that they can obtain the underlying securities. They also rejected calls from Germany for a ban on sovereign CDS.
Race to safe havens as debt crisis deepens
by Ian Traynor - Guardian
Europe's big creditor governments are pushing for private investors to bear part of the cost of a new bailout of Greece amid mounting anxiety in the financial markets that the continued indecision would exacerbate the eurozone crisis.
With Italy, the eurozone's third biggest economy, being targeted by the financial markets for the first time in Europe's 18-month debt crisis, ECB warnings of contagion if Greece is allowed to default gained in credibility. Italian borrowing costs hit their highest levels in more than a decade of 5.7% while the yields, or borrowing rates, on Spanish government bonds reached 6% – the highest levels reached since the creation of the euro.
Antonio Vigni, Banca Monte dei Paschi's managing director, said: "There has been a speculative attack on Italy in the past few days which is not justified by the fundamentals of either the country or the banks."
Dealers reported a race to "safe havens" and gold priced in euros and sterling reached record levels of €1,110.48 and £979.89 an ounce in early trading before falling back, while the euro hit a record low against the Swiss franc – a safe-haven currency. Wall Street was also caught up in the anxiety, with US stocks falling 1% in early trading, while the FTSE 100 was also 1% lower.
Analysts say there is little hope of calm returning to the markets while eurozone governments are gridlocked over how to respond despite weeks of negotiations with Greece's private creditors and various contradictory schemes being mooted and then rejected. Berlin's preference for a Greek debt swap, entailing "haircuts" for investors, was back on the table.
Eurozone finance ministers met in Brussels deeply divided in a fresh attempt to thrash out a deal. Earlier in the day, amid a mood of worsening pessimism that the governments would be able to forge a consensus, Herman van Rompuy, the European Council president, convened a special session with the ECB chief, Jean-Claude Trichet, José Manuel Barroso and Olli Rehn from the European commission, and Jean-Claude Juncker of Luxembourg, the president of the Eurogroup of 17 countries.
All the signs were that the hardline northern creditor countries bankrolling Greece – Germany, the Netherlands, Austria and Finland – had run out of patience and options and would now countenance a "selective default" for Athens. "Substantial private-sector involvement is for the Netherlands and Germany a precondition," said the Dutch finance minister, Jan Kees de Jager, emphasising that investor participation, whether voluntary or not and whether triggering a Greek default or not, was paramount.
"We still pursue a voluntary basis, but some ratings agencies will see any substantial participation maybe as not completely voluntary. We do pursue a voluntary basis but it has to be substantial private-sector involvement. That's our commitment and also our parliament demands it." Signalling that default was now conceivable, he added it should be "for a very short period".
The emerging consensus within the German-led camp is that private investors have to take losses on Greece, which is then temporarily and briefly declared to be in default in the hope that this still does not trigger a "credit event" and turmoil on the credit default swap markets. The Greek finance minister, Evangelos Venizelos, said: "I'm ready to participate in a substantial and constructive discussion on private-sector involvement."
Last week two of the three big ratings agencies predicted a Greek-style scenario for Portugal, downgrading its debt to junk, while predicting that any private-sector involvement in the second Greek bailout being negotiated would be viewed as a default. Those verdicts provoked rage from the EU. Viviane Reding, the EU justice commissioner, said: "Europe can't allow three private US enterprises to destroy the euro."
Either their "cartel" was smashed or "independent" European and Asian ratings agencies would be set up. "We can't have a situation where a cartel of three US enterprises decides the fates of entire national economies and their citizens," she said.
Last week's announcements from Moody's and Standard & Poor's have also shifted the terms of the dispute. The eurozone had been discussing a complicated French proposal to roll over privately held Greek debt, mostly for 30 years, in the hope of avoiding a default declaration. If that scheme is likely to be to be declared a default anyway, the German-led core decided, they might as well revert to a previous German proposal to swap maturing debt for new seven-year pledges, also resulting in default.
'EU taxpayers to rescue bank test failures'
European countries will support banks that fail stress tests if those lenders cannot raise capital from investors within six months, according to a draft EU document seen by Reuters. The paper, being prepared for EU finance ministers to approve on Tuesday, is an about-face from promises by G20 policymakers in the wake of the financial crisis that taxpayers would never have to bail out banks again.
The European Banking Authority is due to announce next week the results of its latest stress tests of the region's top lenders - 91 in all - in another attempt to reassure investors that European banks have been rebuilt against future shocks. This latest round of tests has been touted as being more rigorous than previous attempts in which few banks failed, and finance ministers' officials are drawing up plans for how to deal with the fallout.
Lenders that nearly fail the tests will be put on a critical watch list in case they deteriorate further, the document says. Those banks will be given until the end of September to repair their finances and will then have a further three months to implement it. News that EU governments appear serious about supporting banks that fail to maintain core capital of 5 percent in the face of several theoretical markets shocks lifted Bund futures and UK gilts.
"In essence that puts even more pressure on the periphery (euro zone countries) to come up with measures, not only to shore up their budgets, but to support their banking sectors, which they can ill-afford to do," said Marc Ostwald, strategist at Monument Securities. "It's basically a charge to safety on the back of this. This is a market which is living in mortal fear of anything to do with the euro zone and anything that puts the banking sector under more stress," Ostwald said.
The Italian/German 10-year yield spread hit fresh euro era highs amid fears that already fiscally stretched countries like Italy may have to dig into their pockets to bail out banks that fail the test as well.
Private Sector First
According to the document, capital-raising plans should first be based on "private-sector measures, including ... retained earnings ... raising additional common equity or high quality hybrid instruments from private investors, assets sales, mergers." But if the search for private capital leads nowhere, then governments should be ready to step in.
Officials do, however, make provision for "the extreme case" if efforts to rehabilitate a bank fail and it threatens wider stability, recommending "a process of orderly restructuring and resolution." The number of banks declared by the EBA to have failed will either encourage investors that Europe is now coming clean with its banking problems, or if the tests are deemed too lax again, they will hurt the EU's already battered credibility.
Previous stress tests are widely dismissed as too lax - all Irish banks passed last year's test just months before the EU and International Monetary Fund had to bail them and the country out.
In the document, dated July 7, officials write that banks that miss the 5 percent capital pass mark will be given until the end of September at the latest to submit recapitalisation plans, with a further three months to implement "private-sector measures." "If the relevant banks are unable to implement a credible capital plan by the specified deadlines the [government] stands ready to take necessary measures to maintain financial stability," officials write in the document seen by Reuters.
The new checks will measure how well the core capital that banks rely on to absorb losses such as unpaid loans holds up when exposed to an economic dip or fall in property prices. They also gauge the impact on banks should government bonds they own, issued by states such as Greece, lose value.
Those banks that come uncomfortably close to the 5 percent threshold will also be singled out for special attention. "Banks where the (core tier 1) ratio is above but close to the 5 percent benchmark under the stress scenario will be subject to reinforced prudential scrutiny so as to ensure that there is no unexpected deterioration in their capital position." - Reuters
Fears Italian banks may fail stress tests
by Jill Treanor - Guardian
Italian banks on Friday bore the brunt of concerns about the financial health of Europe's banking sector before official results of stress tests due on 15 July. Britain's big banks – including bailed-out Royal Bank of Scotland and Lloyds Banking Group – are among 91 in Europe to have been subjected to the crisis scenarios drawn up by the European Banking Authority. While Britain's banks are expected to pass the health check, Italian bank shares slumped amid concern they might need new capital and that the country may be dragged into the eurozone crisis.
Ratings agency Moody's has already predicted that almost a third of the banks being tested might need some form of external support to bolster their capital. The focus turned to Italy on Friday when shares in the country's biggest bank, UniCredit, were temporarily suspended amid anxiety it might need to raise fresh capital. It is the only major Italian bank that has yet to do so.
Italian officials insisted the stress tests would not be an issue for the country's banks. Even so, Italy became caught up in the anxiety about the health of the banking system and the eurozone. The premium that investors demand to hold Italian rather than benchmark German bonds reached its widest level since the launch of the euro more than 10 years ago.
M&G's Mike Riddell noted that Italy was now in the sights of speculators and described the situation as a "bloodbath". "Italian 10-year bond yield spreads have widened by 25 basis points versus Germany to a euro-era record. Long-dated Italian government bonds fell as much as 2 points earlier today," he said, noting that it costs Italy 4.6% if it wants to borrow for five years, and 5.3% if it wants to borrow for 10 years.
Among the concerns is that governments might have to prop up banks again if they fail the stress tests. According to Reuters, a document circulating in Brussels gives banks until the end of September to show how they might find the extra capital and then another three months to raise it, before governments step in. According to the reports, banks would be asked to first find "private-sector measures, including ... retained earnings ... [and] raising additional common equity or high-quality hybrid instruments from private investors, asset sales [or] mergers" before the authorities intervened.
The tests are conducted by national regulators across Europe but compiled by the European Banking Authority, which requires banks' crucial core tier one capital to remain above 5% after at least one of the worst-case scenarios, which include a drop in GDP over two years of 4%, compared with 3% for last year's tests.
There has been some concern that the authorities are determined that some banks fail the tests after the farce of last year, when Ireland's banks were given a clean bill of health four months before they were bailed out. Analysts at Nomura said that the largest capitalised banks in Europe were stronger than their global peers and they believed the tests were credible. "We expect a few failures," the analysts said.
Merkel Urges Italy to Stick to Austerity Measures
German Chancellor Angela Merkel on Monday responded to mounting investor concern over Italy by urging the country to pass its planned budget cuts to help restore confidence. Merkel said "Germany and all euro partners are steadfastly determined to defend the stability of the euro."
German Chancellor Angela Merkel urged Italy on Monday to pass an austerity budget to demonstrate that it is undertaking the reforms needed to restore confidence in the euro zone, as the currency slid against the dollar on concerns that Italy could be the next nation to fall victim to the debt crisis.
"Italy must itself send an important signal by agreeing on a budget that meets the need for frugality and consolidation," she told a joint news conference with Icelandic Prime Minister Johana Sigurdardottir in Berlin. "I have full confidence that the Italian government will pass exactly this kind of budget, I discussed this yesterday with the Italian premier," said Merkel.
The chancellor signalled she was skeptikal about demands for a sharp increase in the euro rescue fund to help cope with the crisis. Over the weekend, the German newspaper Die Welt quoted an unnamed European Central Bank source as saying the European Financial Stability Facility, the euro zone's sovereign bailout fund, which has a nominal size of €440 billion ($616 billion) euros, was not large enough to protect Italy.
Merkel was speaking as top euro-zone finance officials met in Brussels to discuss a second bailout for Greece and the worsening situation in Italy. Investors have been unsettled by fears that Italy's planned budget cuts totalling €47 billion might be watered down in parliament.
Political Pressure on Italian Finance Minister
The cabinet approved the cuts at the end of June. They have yet to be approved by parliament. Finance Minister Giulio Tremonti, until now regarded as the guarantor of a strict austerity program, is under mounting political pressure. On Friday, Prime Minister Silvio Berlusconi said changes would be made to the austerity package. In a newspaper interview, he said politics was about votes. Tremonti, by contrast, wants to balance the budget by 2014 -- otherwise, he had warned last week, there would be a "catastrophe."
The political impasse has prompted financial markets to focus on Italy, whose debt-to-GDP ratio, at 120 percent, is second only to that of Greece in Europe. However, the Italian budget deficit is under control and the economy, the euro zone's third-largest, is far stronger than that of the high-debt nations Greece, Ireland and Portugal that have sought EU bailouts.
Merkel also said that Germany agreed with other leaders of the euro zone that Greece needed fast approval of a second bailout package and that Germany would do everything needed to defend the euro currency.
"Germany and all euro partners are steadfastly determined to defend the stability of the euro," she said. "Regarding Greece, I would like to say it must get a new program very quickly, within a very short time frame." The euro slid Monday on concern about Italy, trading down 1.5 percent at $1.4050 at the start of US trading. European stock markets have also been falling.
The West is in for a rude awakening after years of abusing 'risk-free' debt
by Liam Halligan - Telegraph
The global economy faces a unique double threat. The eurozone, of course, remains on the brink of a major, perhaps terminal, crisis. Then there's the small matter of the US Congress possibly "closing down" the government of the largest economy on Earth.
Although separate, these dangers are intimately related. Both have their roots in grotesque and utterly unsustainable levels of government debt. For it's the massive sovereign liabilities not just of the eurozone "periphery", but some of the "core" nations too, that could yet cause the single currency to break up – an end-game "cranks" like me have been predicting for almost 20 years, but which now even the most slavish Europhiles must accept is possible. A "euroquake", were it to happen, would send financial shockwaves across the world.
Similarly, it is the possible refusal of American lawmakers to raise their country's sovereign debt ceiling that could yet cause a "run" on US Treasuries. This outcome too, were it to take place, would seriously undermine global markets given the habit, nay culturally conditioned reflex in some cases, of so many big institutional investors to use Uncle Sam's IOUs as a "safe haven" to park their funds.
Commentary on these twin tribulations has focused on whether, by this time next year, either will have sparked another "Lehman moment", or whether both the eurozone and the US will have "gotten away with it" and "muddled through". I certainly hope it's the latter. But I can't help thinking that, even if the fudge is liberally applied, arms being twisted and political deals done to stave off an immediate crisis, the current predicaments of both the US and eurozone will still have an enormously detrimental impact on the Western world, the implications staying with us for decades to come.
For even if we get through this, something has "snapped", if not yet in terms of how the West perceives itself, then in terms of how we are viewed by the rest of the world.
On Friday, the eurozone's debt crisis intensified, amidst the first serious signs that "fiscal contagion" is spreading to Italy. Domestic political tensions – with Silvio Berlusconi, Italy's ludicrous prime minister, attacking the finance minister, Giulio Tremonti – caused Italian bond yields to leap to a nine-year high. Without Tremonti to rein him in, Berlusconi would surely show the same irresponsibility towards Italy's finances as he has in so many other aspects of his so-called leadership. That's why, as Berlusconi threatened to sack Tremonti, investors felt Italian default risks were more acute and demanded higher returns to hold Italy's sovereign debt.
Italy has a debt-to-GDP ratio of 119pc, among the largest in the eurozone. That's one reason Berlusconi's outburst sent Italian 10-year bond yields soaring to 5.27pc, up nearly half a percentage point. The premium Italy pays to borrow over and above Germany is now wider than at a euro-era high. With almost €1,000bn (£890bn) of sovereign liabilities maturing over the next five years, steeper yields will escalate Italy's refinance costs, acting as a millstone around the neck of the economy.
Debt markets were reacting not only to Berlusconi, but also to ongoing speculation that eurozone policymakers may impose losses on private sector holders of Greek bonds. Their reluctance to do so is in part due to the disgracefully entwined relationship between Europe's political and financial elites. An additional problem, though, is that, while Greece is an economic minnow, Italy is the third biggest economy in the single currency area and the seventh biggest economy on Earth. It is just too big to bail out. While the eurozone could perhaps survive a Greek default, an Italian debt failure would mean all bets are off.
Worries over Italy caused the euro to fall against the dollar. The greenback gained against the single currency despite an incredibly bleak US jobs report, which was alarming in itself but also likely to complicate the already tortuous negotiations over America's debt-ceiling. Obama's current fiscal plan forecasts that the tax share of US GDP will rise by 2.2 percentage points in 2012, with spending falling by 1.7 percentage points – as earlier tax cuts are phased out and America's 2009 fiscal stimulus comes to a close. Meanwhile, a deadline of August 2 looms on raising the federal government's debt ceiling from $14.3 trillion to $16.7 trillion (£10.4 trillion).
Under intense pressure from the Tea Party, Republicans are pushing for deep, multi-year spending cuts as a pre-condition for allowing more debt. If the Democrats don't deliver, the US may be unable to raise the finance it needs to honour its obligations, which could see the government having to choose between refusing interest payments to the Chinese or stopping US welfare cheques.
Obama is negotiating with Congressional leaders in the White House. But while there are deep divisions to be overcome, a solution can surely be found. The fact that the US economy generated only 18,000 jobs in June, down from 25,000 in May and having plunged from 70,000 new jobs monthly between February and April, shows the fragility of the US recovery.
One senses that the Republicans, having made their point, and having made sure everyone understands it's been made, will then conclude that the implications of a US default are simply too cataclysmic to contemplate. Similarly, one assumes that the eurozone bigwigs will ultimately bang their respective heads together and come up with a burden-sharing plan that spreads the pain between taxpayers and governments, marking down Greek debts, and extending payment schedules, but not so much that the eurozone's bloated banks are plunged into a crisis anew.
This may be informed optimism. Or it may just be wishful thinking. Whatever the outcome, one thing is clear: Westerners who think our massive sovereign debts are someone else's problem are in for a rude awakening. Yes – the so-called emerging markets, led by China and the big oil exporters, are the biggest holders of our sovereign debt. I often hear "savvy" observers argue that such countries wouldn't dare stop lending to us because that would undermine the value of the Western debt they already hold.
This is a staggeringly complacent view. While the big emerging markets are fiscally sound, running relatively small annual deficits and with rather low debt stocks, the Western world – not only the US and the eurozone's "usual suspects", but the UK, too – is in great fiscal danger. The only reason we are still able to roll over our sovereign liabilities is because, for the most part, the true extent of the fiscal risks we face hasn't yet been priced in to yields on global markets. What's happening on the eurozone's periphery, even if the current crisis is averted, is just the beginning.
In my view, a sudden and massive re-pricing of Western sovereign risk will happen much sooner than is widely expected. For now, global investors are in denial, assessing that default risks in many of the big emerging markets are much greater than in the West.
This is nonsense – particularly when you consider that the governments of the "advanced" countries are tacitly reliant on debasing and depreciating their currencies in order to lower their liabilities, so imposing on their creditors a form of "soft default".
At some point soon, and it brings me no pleasure to write this, private sector Western investors, together with our emerging market creditors, will drastically cut their exposure to Western sovereign debt. This will come as a rude awakening to the US and the big European sovereigns, who for years now have abused their "risk-free" status.
Don’t blame Moody’s for a messy euro crisis
by Wolfgang Münchau - Financial Times
You can always gauge the temperature of the eurozone crisis by the blame game. Last week, the cacophony briefly subsided when everybody who mattered accused the rating agencies of engaging in an anti-European conspiracy. This was the day after Moody’s downgraded Portugal to junk. The fury of the reaction tells me that the process is in real trouble, once again.
The most interesting aspect of Moody’s rating was not the downgrade itself, but the reasoning. Moody’s expects that Portugal, like Greece, will need another loan. Moody’s also expects that the politics will be just as messy. Will not the Germans again seek private-sector participation as a condition? Of course they will. Moody’s concluded, rightly in my view, that the messy European Union politics constitutes a reason for concern. Having observed this crisis from the start, I agree. This is as much a crisis of policy co-ordination as it is a debt crisis.
Shortly before Moody’s downgrade, Standard & Poor’s pronounced that the French proposal for a debt rollover would, if implemented, constitute a selective default.
If you add together S&P and Moody’s comments, you get a sense of the disturbing dynamic that lies ahead. Say, the eurozone governments decided to force Greece to default on part of its debt, and the rating agencies were to attach a selective default rating to Greek government bonds. If you expect, as Moody’s does, that Portugal will end up in the same position as Greece – having to request a follow-up loan – then the same private-sector participation rules would also apply to Portugal.
Portugal would also receive a selective default rating at some point. Ireland will probably also need a second programme. I am not surprised at all that bond markets have been revaluing Spanish and Italian bonds. Neither country is in danger of defaulting, but their ratings will be dragged down to junk level if the periphery defaults.
Everybody hates the rating agencies and no one hates them more than the Europeans. The rating agencies were, without a doubt, an important contributing factor to the credit bubble. But last week, they did us a favour. They showed that populism will not work. The European Central Bank is absolutely right on this. A Greek default will unleash a dynamic process that will threaten the eurozone’s financial stability, even its very survival.
The impasse leaves us with a single solution in the short run – and a single solution in the long run. The two are, in fact, the same. In the short run, the only way to bring the private sector into a voluntary scheme is a debt swap, to be organised by the European financial stability facility. That is currently not possible because the EFSF is not allowed to purchase bonds in secondary markets. Germany, in particular would have to change its position on this issue. But the Germans are among those who are pushing the hardest for private-sector participation. I would not be surprised if they changed their mind again – as they have been doing time and again in the past 18 months.
If the rules on the EFSF were relaxed, it could offer to buy up Greek debt at a discount, say 20 per cent, in exchange for its own AAA-rated bonds. The sellers would have to register a loss, but at least they end up with good securities. There would be no reason for the rating agencies to act.
In the long run, the only solution is a eurozone bond, which you can think of as an extended secondary-market purchase programme by the EFSF. This is why the short-term and long-term solutions are identical. Of course, it will not be called a eurozone bond. The Germans had a wonderful euphemism to describe the debt they raised to pay for unification: Sondervermögen, or "special wealth". The EU will come up with a similarly misleading name. let us not kid ourselves however: a eurozone bond it will be.
Last week, a group of former European prime ministers proposed in the Financial Times the use of the European Investment Bank to issue eurozone bonds. This is an intriguing idea. It would have the major advantage that it would not require any changes to the European Treaties, at least not for now. The most important technical point is that the eurozone bond, or whatever it is called, would be issued on a "joint and several" basis. This means that everybody is responsible for the whole amount – similar to an overdraft in a joint bank account.
Do not think of it as something utopian, something that electorates have to approve in a referendum. On the contrary. The eurozone bond is – literally – the default option in this crisis. It is what will happen when nothing happens. If governments face the choice between the eurozone bond or an intrastate fiscal transfer, they will choose the former. Germany will not only accept it. Germany will propose it.
We have to thank the rating agencies for giving the eurozone’s policymakers a clearer vision of which strategies are feasible, and which are not. It is now time to get serious.
EU calls emergency meeting as crisis stalks Italy
by Luke Baker - Reuters
European Council President Herman Van Rompuy has called an emergency meeting of top officials dealing with the euro zone debt crisis for Monday morning, reflecting concern that the crisis could spread to Italy, the region's third largest economy.
European Central Bank President Jean-Claude Trichet will attend the meeting along with Jean-Claude Juncker, chairman of the region's finance ministers, European Commission President Jose Manuel Barroso and Olli Rehn, the economic and monetary affairs commissioner, three official sources told Reuters.
Van Rompuy's spokesman Dirk De Backer said: "It's a coordination, not a crisis meeting." He added that Italy would not be on the agenda and declined to say what would be discussed. However, two official sources told Reuters that the situation in Italy would be discussed. The talks were organized after a sharp sell-off in Italian assets on Friday, which has increased fears that Italy, with the highest sovereign debt ratio relative to its economy in the euro zone after Greece, could be next to suffer in the crisis. A second international bailout of Greece will also be discussed, the sources said.
The spread of the Italian 10-year government bond yield over benchmark German Bunds hit euro lifetime highs around 2.45 percentage points on Friday, raising the Italian yield to 5.28 percent, close to the 5.5-5.7 percent area which some bankers think could start putting heavy pressure on Italy's finances. Shares in Italy's biggest bank, Unicredit Spa, fell 7.9 percent on Friday, partly because of worries about the results of stress tests of the health of European banks that will be released on July 15. The leading Italian stock index sank 3.5 percent.
The market pressure is due partly to Italy's high sovereign debt and sluggish economy, but also to concern that Prime Minister Silvio Berlusconi may be trying to undermine and even push out Finance Minister Giulio Tremonti, who has promoted deep spending cuts to control the budget deficit. "We can't go on for many more days like Friday," a senior ECB official said. "We're very worried about Italy."
Monday's emergency meeting will precede a previously scheduled gathering of the euro zone's 17 finance ministers to discuss how to secure a contribution of private sector investors to the second bailout of Greece, as well as the results of the stress tests of 91 European banks.
Greece is already receiving 110 billion euros ($157 billion) of international loans under a rescue scheme launched in May last year but this has failed to change market expectations that it will eventually default on its debt.
Senior euro zone officials worry that progress toward a second Greek bailout, which would also total around 110 billion euros and aim to fund the country into late 2014, is not being made quickly enough and that the delay is poisoning investors' confidence in weak economies around the region.
"We need to move on this in the next couple of weeks. It's not a case of waiting until late August or early September as Germany is saying. That's too late and markets will make us pay for it," a top euro zone official told Reuters on Saturday.
German officials insist they too want to put together the second Greek bailout as quickly as possible, but the private sector's contribution is proving to be a major sticking point. Germany, the Netherlands, Austria and Finland are determined that banks, insurers and other private holders of Greek government bonds should bear some of the costs of helping Athens. But more than two weeks of negotiations with bankers represented by the Institute of International Finance (IIF), a lobby group, have made next to no progress on agreeing a formula acceptable to all sides.
Initially talks focused on a complex French plan for private creditors to roll over up to 30 billion euros of Greek debt, buying new bonds as their existing ones matured. Around half of proceeds from Greek bonds maturing before the end of 2014 would be rolled over into very long-term debt while 20 percent would be put into a "guarantee fund" of AAA-rated securities.
But as that plan has floundered, Berlin has revived a proposal to swap Greek bonds for longer-dated debt that would extend maturities by seven years. Proposals to buy back Greek bonds and retire them have also been floated.
In a buy-back, the euro zone's bailout fund, the European Financial Stability Facility, might buy Greek bonds from the market, or the EFSF might lend Greece money to buy bonds. However, these schemes would require further changes to the EFSF's rules and would therefore have to go through national parliaments, an official source said.
A senior euro zone official told Reuters on Friday that rather than progress being made in the talks with the IIF, as IIF managing director Charles Dallara has said, all sides were close to being "back to square one." Dallara will attend the meeting of euro zone finance ministers in Brussels on Monday.
Since the euro zone's debt crisis erupted last year, the region's rich governments have aimed to limit it to Greece, Ireland and Portugal, which have so far signed up to bailouts totaling 273 billion euros -- a sum that is small compared to the financial resources of the zone as a whole.
Spain, traditionally seen as the next potential domino in the crisis, has managed to retain its access to market funding through fiscal reforms. But because of the large sizes of the Spanish and Italian economies, pressure on the euro zone would increase dramatically if those countries eventually needed financial assistance.
Private analysts have estimated a three-year bailout of Spain, based on its projected gross issuance of medium- and long-term debt in 2011, might cost some 300 billion euros -- excluding any additional money for cleaning up Spain's banks. A three-year rescue of Italy could cost twice that.
German newspaper Die Welt quoted an unnamed ECB source as saying on Sunday that the EFSF, which has a nominal size of 440 billion euros, was not large enough to protect Italy because it had not been designed to do that.
In Italy on Sunday, politicians and government officials scrambled to present a united front and defend Tremonti. Umberto Bossi, the powerful leader of Berlusconi's Northern League coalition allies, praised Tremonti for "listening to the markets."
"From tomorrow, we have the job of showing we are united and blocking the effort of speculators," said Paolo Bonaiuti, a government undersecretary and senior aide to Berlusconi. "In the coming months we have 120-130 billion euros of bond issues to deal with, so we need cohesion and united intent; it'll take effort to show that the markets are overdoing it."
However, Berlusconi himself was silent over the weekend and canceled two appointments to speak, and it was not clear how long the appearance of consensus in the government over austerity plans would last.
One factor behind bond markets' growing instability is a sense that the euro zone's basic strategy for dealing with debt problems -- keeping countries afloat with emergency loans in the hope they can grow their way out of their debts within a few years -- is flawed. More radical action to cut the countries' debts or boost economic growth may be needed.
In Germany on Sunday, President Christian Wulff said Greece would need a lot longer to resolve its debt problems than many people in Europe were now acknowledging. Wulff, a former leader in Chancellor Angela Merkel's conservative Christian Democrats and now Germany's ceremonial head of state, told ZDF television there was a need for "an overall concept" for resolving Europe's debt crisis. "It can't be something that will suffice for a three-month period but rather has to offer solutions to the problem that will cover the next 10 to 15 years," Wulff said.
Italy and Spain must pray for a miracle
by Ambrose Evans-Pritchard - Telegraph
Once again Europe's debt crisis has metastasized, and once again the financial authorities face systemic contagion unless they take immediate and dramatic action.
If the ECB's Jean-Claude Trichet is right in claiming that Europe was on the brink of a 1930s financial cataclysm a year ago - and I think he is - it is hard see how the threat is any less serious right now.
Fall-out from Greece flattened Portugal and Ireland last week. It is engulfing Spain and Italy, countries with €6.3 trillion of public and private debt between them. Yields on Italian 10-year bonds hit a post-EMU high of 5.3pc on Friday. This is not just a theoretical price: the Italian treasury has to roll over €69bn (£61bn) in August and September; it must tap the markets for €500bn before the end of 2013. The interest burden on Italy's €1.84 trillion stock of public debt is about to rise very fast.
Spanish yields punched even higher, through the danger line of 5.7pc. The bond markets of both countries are replicating the pattern seen in Greece, Portugal, and Ireland before each spiraled into insolvency. And the virus is moving up the European map. French banks alone have $472bn (£394bn) of exposure to Italy and $175bn to Spain, according to the Bank for International Settlements.
"We believe the European sovereign crisis might be entering a new phase with contagion reaching the larger economies," said Jacques Cailloux, chief Europe economist at RBS. "It is unclear to us how this latest negative shock to confidence is going to be undone in the absence of a 'shock and awe' policy response."
Italy's premier Silvio Berlusconi has chosen this moment of acute danger to undermine his own finance minister, Giulio Tremonti, the one figure in his cabinet respected by global bond vigilantes. "He's not a team player, and thinks he's genius and that everybody else is a cretin," said Mr Berlusconi.
Meanwhile, Mr Tremonti is living free in the Rome house of a political ally just arrested on corruption charges. Resignation rumours circulate hourly. You can hear the knifes sharpening. "The government ceased to exist months ago," wrote Massimo Giannini in La Repubblica. "What other country would allow itself the suicidal luxury of offering cynical markets such a spectacle of political disintegration and institutional decay at a time when Europe is destabilized by Greece's sovereign debt and haunted by contagion? We have a band of poltroons dancing under the volcano, and the volcano is about to erupt."
What can the eurozone now do to trump its last "shock and awe"? More loan packages solve nothing. Pretending that this is just a liquidity crisis will no longer wash. What it will take is a belated recognition by Germany that this crisis is not a morality tale contrasting virtuous, thrifty Teutons, with feckless Greco-Latins and Guinness-befuddled Celts, but rather a North-South structural crisis caused by the inherent workings of monetary union.
The implications of this are profound. Germany must now be willing either to buy or guarantee Spanish and Italian debt, and in doing so to cross the Rubicon to fiscal and political union, or accept that EMU must break up with calamitous consequences for German foreign policy. Large matters, beyond the intellectual vision of Germany's current leaders.
It will also take a total purge of the ECB's leadership, which clings to its madcap doctrine that monetary policy can be separated from other emergency operations, and which chose last week of all moments to raise interest rates again and kick Spain in the teeth. It did so knowing that the one-year Euribor rate used to price more than 90pc of Spanish mortgages must rise in lock-step. As one Spanish commentator put it, the Eurotower in Frankfurt should be torn down, and salt sown in the ground.
If the governor of the Banco de Espana really endorsed this rate rise (supposedly "unanimous") he should be hauled before the elected Cortes and ordered to explain such locura: if the EU authorities object, they should be told in crisp terms that Spain is a great and ancient sovereign nation facing a national emergency and will do as it sees fit.
Where is the inflation threat? The eurozone's M1 money supply has contracted on a month-to-month basis over the past two months, with sharper declines in the periphery. Annualized M1 growth is falling, not rising: it was 2.9pc in March, 1.6pc in April, and 1.2pc in May. Broader M3 grew at a rate of 2.2pc over the past three months.
The PMI data for Italy and Spain have dropped below the recession line. The Goldman Sachs global PMI indicator shows that 80pc of the world is tipping into a slowdown, including India and China. Taiwan's bell-weather exports to China sank 12pc in June from the month before.
The calamitous US jobs data released last Friday leave no doubt that the US remains trapped in depression. Broad U6 unemployment rose from 15.8 to 16.2pc in June; the numbers in work fell by a quarter million to 153.4m; the average time without a job reached a fresh record of 39.8 weeks; hourly pay fell; hours worked fell; the employment/population ratio crashed to new lows of 58.2pc.
This is not a time for the ECB to raise rates. It has repeated the error made in mid-2008 when it tightened into the final phase of an oil shock, when half the eurozone was already in recession. Once is careless, twice is unforgivable.
Italy has eschewed the maelstrom until now, despite losing 30pc in unit labour competitiveness against Germany under EMU. It has lower private debt than G7 peers. Its banks dodged the US and Club Med housing bubbles. However, they lent instead to the Italian state, the third biggest debtor in the world with liabilities of 120pc of GDP, and that is now turning into the problem. For though Italy's fiscal deficit looks small at 4.7pc of GDP, it is not small when adjusted for a moribund economy, rising rates, and the scale of the debt stock.
Italian GDP has not grown for a decade. The official forecast is 1.1pc this year, 1.3pc in 2012, and 1.5pc in 2013, but outside analysts are gloomier. David Owen from Jefferies Fixed Income says the "elephant in the room" is that Italy's debt interest payments will explode within three or four years if the average borrowing cost ratchets up 200 or 300 basis points. The apparently stable debt trajectory will take an entirely different shape. That is the fear now stalking markets.
It is almost pointless trying to establish exactly why this latest bout of contagion has erupted. You can blame Moody's for its downgrade of Portugal, or blame Germany's Krieg against private investors for forcing Moody's to act the way it did. The deeper cause lies in the entire machinery of wreckage created by the Maastricht process since the mid-1990s.
A full-throttle global recovery would mitigate this; a half-decade of super-easy money by the ECB to weaken the overvalued euro and stave off debt deflation would help, too. Without either, Italy and Spain can only pray for a miracle.
Worries Grow Over US Jobs
by Justin Lahart and Joe Light - Wall Street Journal
The U.S. economy added painfully few jobs for the second month in a row, undermining hopes that the sluggish recovery was getting back on track, depressing financial markets and putting new pressure on policy makers to come to the rescue.
The government's broadest snapshot of employment showed the nation added just 18,000 jobs in June. Private-sector hiring slipped to its slowest pace in over a year, and government continued shedding workers. May's equally disappointing job-creation number was cut in half. The unemployment rate ticked up to 9.2%, from 9.1% in May. The report also showed that even more workers dropped out of the job market.
The economy has been fitful for two years since the recession formally ended. In the past, spending and hiring rapidly recovered after deep downturns. But the damage the housing bust and subsequent credit crisis did to household and business balance sheets appears to have hobbled that rebound.
Most economists remain hopeful that hiring will increase in the months to come as supply-chain disruptions ease and as lower gasoline prices boost spending power. But the weak jobs report raises the chances that consumers will hold off on purchases and that, in turn, will make companies reluctant to hire. "We really do need to see some signs that economic growth is picking up in the near future," said Goldman Sachs economist Andrew Tilton. "The pressure is on."
June's dismal numbers contradict a string of relatively upbeat recent reports on the economy, which had convinced many investors and economists that it was gaining steam. Stocks fell, with the Dow Jones Industrial Average shedding 62.29 points to 12657.20. Treasurys rose, pushing their yields lower.
The weakness in Friday's jobs report was broad-based. Alongside scant hiring, wages edged lower, and the amount of time private-sector workers clocked on the job each week slipped. The numbers also hinted at trouble to come: Temporary-help jobs, which often signal the job market's direction, fell by 12,000, the third straight monthly decline. Average hourly earnings for all workers on private payrolls edged down 1 cent to $22.99 in June. The average work week slipped to 34.3 hours from 34.4 in May.
Hiring was tepid across most industries. Manufacturing employment, which many economists expected to climb as supply disruptions stemming from Japan's earthquake eased, rose by just 6,000. Retailing jobs increased by only 5,000, despite reports from many stores of solid June sales. Construction payrolls fell by 9,000 and the financial-services sector cut 15,000 jobs.
"Every major component of the report was weak," said Bank of America-Merrill Lynch economist Ethan Harris. "That doesn't happen very often—usually there's some little ray of hope. The only silver lining is it might motivate Washington to get its act together."
President Barack Obama, who is to meet with congressional leaders Sunday as part of talks to reduce the budget deficit, tied uncertainty over the debt ceiling and the lack of a concrete deficit-reduction plan to the weak job market. "The American people need us to do everything we can to help strengthen this economy and make sure that we are producing more jobs," Mr. Obama said in the Rose Garden.
But congressional Democrats and Republicans remain at odds over the budget. Democrats say that given the weak job market, they want no austerity cuts for at least another year and Republicans say they won't accept any tax increases for the same reason. "Tax hikes on families and job creators would only make things worse," House Speaker John A. Boehner said Friday.
The grim jobs update puts pressure on the Federal Reserve to explore new ways to support an economy that appears to be stumbling. At the very least, the report makes clear that the Fed is unlikely to raise interest rates in the foreseeable future.
With inflation picking up this year, the Fed is unlikely to take new steps to bolster growth soon. But if inflation drops, or if the second-half economic rebound Fed officials expect doesn't materialize, the central bank could take new actions. One option would be to restart the Treasury-buying program it ended last month. Others include making new commitments not to raise interest rates or sell its securities holdings.
The private sector added just 57,000 jobs in June, down from 73,000 a month earlier and the fewest since May of last year. Private payrolls, which account for about 70% of the work force, are 2.1 million higher than they were at their low in 2009, but are still 6.7 million below where they were in late 2007 when the recession began.
Carl Camden, chief executive of Troy, Mich.-based staffing company Kelly Services Inc., said that so far his company hasn't seen customers shedding temporary workers—usually an early warning that the economy is in deep trouble—and that some companies have been converting temporary workers to permanent status. "This still feels to me like a soft patch rather than a harbinger of doom," he said.
Employer Rose Marie Nichols McGee, the co-owner of Nichols Garden Nursery in Albany, Ore., isn't optimistic. With sales flat this year, she says she is unlikely to expand her work force of 10 employees. "The economy here is just not bouncing up," she says. "We're just not experiencing the growth we keep hearing about."
Amid the struggle to close budget gaps, government employment at the federal, state and local levels fell by a total of 39,000 jobs in June, the eighth consecutive month of declines. Johnna Palm of Carlisle, Pa., lost her job as a community-development specialist with the Cumberland County Redevelopment Authority in mid-June. Ms. Palm, 45 years old, estimates that her severance package, along with her savings and unemployment, are enough to last her six months.
Right now, she plans to apply for a range of positions, possibly in grant writing or administration. But once her savings dwindle, she says she'll start looking at lower-paying work. "If I get to that point, I can work retail. I can stock shelves. I can be a hotel desk clerk," she says. "I'm trying to be realistic."
US Economy Faces a Jolt as Benefit Checks Run Out
by Motoko Rich - New York Times
An extraordinary amount of personal income is coming directly from the government.
Close to $2 of every $10 that went into Americans’ wallets last year were payments like jobless benefits, food stamps, Social Security and disability, according to an analysis by Moody’s Analytics. In states hit hard by the downturn, like Arizona, Florida, Michigan and Ohio, residents derived even more of their income from the government.
By the end of this year, however, many of those dollars are going to disappear, with the expiration of extended benefits intended to help people cope with the lingering effects of the recession. Moody’s Analytics estimates $37 billion will be drained from the nation’s pocketbooks this year. In terms of economic impact, that is slightly less than the spending cuts Congress enacted to keep the government financed through September, averting a shutdown.
Unless hiring picks up sharply to compensate, economists fear that the lost income will further crimp consumer spending and act as a drag on a recovery that is still quite fragile. Among the other supports that are slipping away are federal aid to the states, the Federal Reserve’s program to pump money into the economy and the payroll tax cut, scheduled to expire at the end of the year.
"If we don’t get more job growth and gains in wages and salaries, then consumers just aren’t going to have the firepower to spend, and the economy is going to weaken," said Mark Zandi, chief economist of Moody’s Analytics, a macroeconomic consulting firm.
Job growth has remained elusive. There are 4.6 unemployed workers for every opening, according to the Labor Department, and Friday’s unemployment report showed that employers added an anemic 18,000 jobs in June. In Arizona, where there are 10 job seekers for every opening, 45,000 people could lose benefits by the end of the year, according to estimates from the state Department of Economic Security. Yet employers in the state have added just 4,000 jobs over the last 12 months.
Some other states will also feel a disproportionate loss of income unless hiring revives. In Florida, where nearly 476,000 people are collecting unemployment benefits, employers have added only 11,200 jobs in the last year. In Michigan, employers have added about 40,000 jobs since May 2010, but about 267,000 people are claiming jobless benefits.
Throughout the recession and its aftermath, government benefits have helped keep money in people’s wallets and, in turn, circulating among businesses. Total government payments rose to $2.3 trillion in 2010, from $1.7 trillion in 2007, an increase of about 35 percent.
While some of that growth was in Social Security and disability benefits as the population aged, the majority resulted from payments to people continuing to suffer from the recession, said Mr. Zandi. Unemployment benefits, including emergency and extended benefits, are more than three times their prerecession level, he said. The nearly 20 percent of personal income now provided by the government is close to a record high.
Approved by Congress last December, the final extension of jobless benefits — for a maximum of 99 weeks for each unemployed person — is scheduled to conclude at the end of this year. A handful of states, like Wisconsin and Arizona, have already cut off weeks 80 through 99 for their residents. Meanwhile, more of the long-term unemployed are bumping up against the 99-week limit.
Consumers account for an estimated 60 to 70 percent of the country’s economic activity, but two years into the official recovery, businesses are still complaining that people simply are not spending enough.
"Regardless of why people have less money to spend, it affects all retailers in all industries," said Michael Siemienas, spokesman for SuperValu, which operates grocery chains including Cub Foods, Shop ’n Save and Save-A-Lot. Mr. Siemienas said that the number of SuperValu’s customers using electronic benefit transfers to pay bills had grown over the last year.
Because benefit payments tend to be spent right away to cover basic needs like food and rent, they provide a direct boost to consumer spending. In a study for the Labor Department, Wayne Vroman, an economist at the Urban Institute, estimated that every $1 paid in jobless benefits generated as much as $2 in the economy.
For many of the nearly 7.5 million people collecting unemployment benefits, those payments are keeping them afloat. Laura Metz, 42, was laid off from a clerical job paying $15.30 an hour at a home health care provider near her home in Commerce, Mich., nearly 15 months ago. She has been collecting $362 a week in unemployment insurance and about $50 a month in food stamps.
That covers the basics. But Ms. Metz stopped making her mortgage payments last year on the modest home she shares with her 19-year-old son. A program that allowed her to make a lower monthly payment has expired, and she is waiting to see if the lender will modify her loan. She can no longer make her student loan payments for her bachelor’s degree or master’s in business administration, and she has downgraded her Internet and cable service and cut back on car trips and snacks.
Ms. Metz, who has been applying for administrative jobs, has been shocked at the dearth of opportunities. A decade ago, when she applied for clerical jobs, "as soon as I walked up, there was a sign saying ‘We’re hiring,’ but it’s not like that now," she said. "It’s really, really difficult."
Businesses that rely heavily on low-income shoppers worry that their customers will have little to spend. Najib Atisha, who co-owns two small grocery stores in Detroit, said people receiving government assistance made up about a third of his customers downtown and as much as 60 percent at his store on the west side of the city. "Of course, we’re hoping that things will turn around, but it’s always easier to lose jobs than it is to gain jobs," Mr. Atisha said. "I think it’s going to take twice as long to rebound as it took to get where we are now."
Some business groups argue that extending unemployment benefits has had deleterious effects on employers and potential workers. "It’s having a chilling effect on hiring," said Wendy Block, director of health policy and human resources at the Michigan Chamber of Commerce. "At one point, our unemployment taxes were just a blip on the balance sheet, but when you’re talking over $500 a head, this is significant." Last year, Michigan spent $6.2 billion on jobless benefits, according to the National Employment Law Center.
Some economic studies show that people who collect unemployment benefits are less likely to look for or accept work until their benefits are close to running out. "Unemployment insurance extends the typical amount of time that people will spend off the job and not looking for work," said Chris Edwards, an economist at the Cato Institute, a libertarian organization.
In Michigan, Ms. Metz said that if all else failed, she would have to move in with her parents, who live on a fixed income. But she is determined to find work before her benefits run out and plans to expand her search to include light industrial manufacturing. "It’s getting close to the end," she said. "And I got to do what I got to do."
The Housing Horror Show Is Worse Than You Think
by Roben Farzad - Businessweek
Despite some upbeat news, key housing market statistics point to years of stagnation
You might be tempted to believe that after four years of brutal declines in home prices, the worst of the crisis is over. The Standard & Poor’s/Case-Shiller 20-city index of prices has fallen back to where it was in 2003. Housing prices in Phoenix are at 2000 levels, and Las Vegas is revisiting 1999.
Lower prices have made homes more affordable than they’ve been in a generation, and sales have gone up in six of the past nine months. "It’s very unlikely that we will see a significant further decline" in prices, Housing and Urban Development Secretary Shaun Donovan said in a July 3 appearance on CNN. "The real question is, when will we start to see sustainable increases? Some think it will be as early as the end of this summer or this fall."
Doug Ramsey of Minneapolis investment firm Leuthold Group is a student of asset bubbles, from tech stocks in the late ’90s to commodities in the late ’70s and railroads in the 19th century. His outlook is very different from the HUD Secretary’s. Ramsey calculates that single-family housing starts would have to soar an unprecedented 60 percent to 70 percent from their current half-century low of a 419,000 annual rate just to hit the average low of the past six housing busts since 1960 (650,000 to 700,000).
Ramsey says every housing statistic he tracks, including new and existing home prices and the performance of homebuilding stocks, has so far matched the pattern of prices after the bursting of other bubbles, including the Dow Jones industrial average following the crash of 1929 and Japan’s Nikkei after its 1989 peak. It starts with a steep decline lasting three or four years, followed by a brief rally that ends in years of stagnation. The Dow took 35 years to return to pre-crash levels. The Nikkei trades at less than a third of where it peaked 22 years ago. "The housing decline," he says, "will be a long, multiyear process, and the multiplier effect across the economy will be enormous."
Others are equally gloomy. "It’s still a vicious cycle of foreclosures, prices falling, and buyers remaining on the sidelines," says Jonathan Smoke, head of research for Hanley Wood, a housing data company. With the homeownership rate possibly headed to its pre-bubble level of 64 percent from 69 percent at the peak, Smoke calculates that the nation needs 1.6 million fewer homes that it now has. "We’ve gone through a period when we should have been tearing down houses," he says. "The supply of total housing stock is beyond what is necessary."
Scott Simon, a portfolio manager who heads real estate analysis for bond giant Pimco, says because this housing bust is so much worse than previous ones, it’s hard to tell when it will end. "There are all these things going on that we have never seen before," he says. "No one knows how or what to model."
Simon has been traveling the country with a 28-page PowerPoint presentation for clients that illustrates the dire state of today’s housing market. Three of 10 homes, he notes, are now sold for a loss. American homeowners have equity (market value minus mortgage debt) equal to 38 percent of their homes’ worth, down a third since 2005 and half what it was in 1950. A lot of the decline is attributable to people who have negative equity—they owe more on their mortgages than their homes are worth.
Simon also points to the affordability index, which measures the ability of a family with the median national income to buy a median-price home at current mortgage rates. The index is near an all-time high and double its level in 2006 at the peak of the bubble—meaning buyers should find many more homes within their budgets. "I would never have believed this index could get so high," he says.
A rise in affordability should have spurred purchases, boosting prices and keeping a lid on the index. "What this instead means to me is that the credit is not available to most people," he says. "Houses aren’t cheap if you can’t get the loan." Simon worries that the problem will get worse in October, when Fannie Mae, Freddie Mac, and the Federal Housing Administration drop the maximum mortgage they will buy to $625,000 from $729,750 as a temporary increase expires.
The crux of Simon’s analysis is that the loose lending practices seen during the housing bubble allowed 5 million renters to become homeowners, and that the market is in the protracted process of evicting this group. He believes housing prices will decline 6 percent to 8 percent nationally, with 6 million to 7 million more foreclosures yet to come.
If these predictions are right, the economy will be missing a key driving force for years—and the nation will keep paying the price for what Ramsey calls the "illusory prosperity" of the housing boom. "Think about local tax revenues—what the housing bubble contributed to coffers across the country," he says. "The ripple effect for the economy was enormous: washers, dryers, carpeting, construction jobs." The housing wealth that has now evaporated gave Americans false expectations about economic growth and rising standards of living. Asks Ramsey: "What was real and what was never meant to be?"
Lawmakers Mulling Fate of Fannie and Freddie Split on U.S. Role
by Lorraine Woellert - Bloomberg
The U.S. housing industry is finding political traction in Congress as it objects to plans that would wind down Fannie Mae and Freddie Mac and eliminate any government role in mortgage finance.
Two members of the House Financial Services Committee, Gary Miller, a California Republican, and Carolyn McCarthy, a New York Democrat, today introduced legislation to create a government-run replacement for the two mortgage finance companies, which originally were chartered by Congress.
The measure directly challenges House Republican leaders, who have backed bills that would do away with the two companies and aim to minimize the risk that taxpayers will have to bail out future mortgage failures.
"This ideological approach has resulted in a stalemate for years," Miller said at a press conference. "It’s not getting us any closer to fixing the housing problem." He and McCarthy were joined at the event by leaders from two of the industry’s most active lobbying groups, the National Association of Realtors and the National Association of Homebuilders. The legislation reflects concerns by the industry, consumer activists and some policymakers that a complete withdrawal of government support for home lending could deepen the housing recession.
That message has gained momentum even as Fannie Mae and Freddie Mac continue to rely on taxpayers for survival. The two have cost the Treasury Department about $130 billion since they were seized by regulators in September 2008.
"There was the idea that people were so tired of taxpayer losses related to housing that the traditional housing lobby would not be able to retaliate effectively," said Jim Vogel, head of agency debt research at FTN Financial in Memphis, Tennessee. "It’s time to start waving the housing flag again." That would be a turnaround from February, when the U.S. Treasury Department recommended selling off the holdings of Fannie Mae and Freddie Mac within a decade and the fourth- ranking House Republican, Jeb Hensarling of Texas, said he wanted to do it in half that time.
Since then, homebuilders, real estate agents, investment banks, civil rights leaders and consumer advocates have lobbied to preserve a government role -- including the implicit federal guarantee behind Fannie Mae and Freddie Mac, which were created by Congress as private companies designed to expand home ownership.
Line of Credit
Washington-based Fannie Mae and Freddie Mac of McLean, Virginia, were put under government control when failing subprime loans took them to the brink of insolvency. The Treasury told investors the U.S. would make good on the companies’ debt and promised the firms an unlimited line of credit. The companies have accepted more than $160 billion in Treasury aid. As of the first quarter of 2011, they had paid $26 billion in dividends back to the Treasury.
The Miller-McCarthy bill would create a "secondary market facility" for residential mortgages, in essence a federal utility that would buy home loans, pool them into bonds, and insure their principal and interest payments. The utility would be governed by a presidentially appointed board. "We don’t want Congress meddling," Miller said. Income from the bond sales would finance the company’s operation and any profit would be returned to the Treasury.
The Miller-McCarthy proposal follows a plan introduced in May by Representatives John Campbell, a California Republican, and Michigan Democrat Gary Peters. That bill would replace the government’s guarantee behind housing bonds with a system of privately run associations that would bear most of the risk. The Campbell-Peters bill was modeled on proposals from the Housing Policy Council, a Washington trade group that represents big financial companies, private mortgage insurers, lenders and loan servicers, including JPMorgan Chase & Co., and the Mortgage Bankers Association, whose members include small lenders.
Smaller lenders oppose the approach, saying they fear that they could be squeezed by larger competitors who might end up being the ones selling the guarantees now sold by Fannie Mae and Freddie Mac. "Under the Miller bill, the big banks don’t get to play. Under the Campbell bill they might," said Rob Zimmer, a lobbyist for Community Mortgage Lenders of America, which works for small lenders.
At this stage in the legislative process, both proposals are little more than stakes in the ground. Neither will get a hearing before the Financial Services Committee, said Representative Scott Garrett of New Jersey, who is leading Republican efforts to eliminate Fannie Mae and Freddie Mac. "The central tenet of the Republican philosophy is no more bailouts," Garrett said. "We will only be considering legislation that abides by that principle."
He said "it comes as no surprise" that mortgage lenders, investors and others in the housing business want to preserve as much of the current system as they can. "They wanted to be bailed out before and they want a system again where they can be bailed out," Garrett said.
US public pensions face accounting overhaul
by Dan McCrum and Nicole Bullock- Financial Times
Proposals to improve the way US state and local governments report pension liabilities were published on Friday in response to mounting concerns about shortfalls.
Public pensions have become a topic of debate, pitting lawmakers against public worker unions in tough negotiations over how to close gaps that are forecast to top $2,000bn by observers using more conservative accounting standards than are now recommended. The Governmental Accounting Standards Board has proposed that pension funds should use much more conservative assumptions under certain circumstances.
The changes also would end the practice by which pension funds can treat as temporary what are typically regular increases in payments to beneficiaries. Critics say this allows the funds to understate liabilities. However, under the proposals, state and local government pension plans will retain considerable discretion in how they estimate the funding status of their plan. The funding status will determine whether they should adopt the more conservative accounting.
"It doesn’t really address the problem. It’s a compromise driven more by political considerations than economics", said Josh Rauh, associate professor of finance at the Kellogg School of Management at Northwestern University, a prominent critic of public pension accounting methods.
Public pension plans typically assume that their assets will grow 6-8 per cent per year, rates few achieved in the past decade. The rules are voluntary but analysts said that it would be difficult for states not to adopt them and, if implemented, it would mean reported public pensions gaps increase. Investment losses during the financial crisis exacerbated underfunding of public pensions and revealed what critics say were years of mismanagement by state and local governments and accounting rules that do not clearly reflect the liabilities associated with retirement benefits.
Fears have arisen that states and local government already cash-strapped from tax revenue declines since the recession will be further squeezed by having to make up for pension gaps. "It is going to make the under-funded states look worse and potentially dramatically worse," said Matt Fabian, managing director of Municipal Market Advisors.
Among states, Illinois and New Jersey face pension funding requirements that are straining their budgets, Moody’s said earlier this year. The pension funds of the commonwealth of Puerto Rico are in the worse shape with assets totaling just 13.5 per cent of estimated liabilities. Central Falls, a city of 19,000 people in Rhode Island, faces potential bankruptcy after failing to fund a pension fund, which Moody’s recently warned is on track to run out of cash by October.
Defaulting rescued Argentina. It could work for Athens too
by Heather Stewart - Observer
Struggling under an impossible burden after its IMF bailouts, Buenos Aires knew its one hope was to stop paying its debts and become a pariah – and so it proved
Protesters on the streets of Athens this summer have been brandishing banners depicting a panicky helicopter airlift. Not Saigon at the height of the Vietnam war, but Buenos Aires in 2001, when Fernando de la Rúa fled from the roof of his presidential palace to escape riots in the streets.
Argentina, stuck in a painful recession since 1998, had done everything the International Monetary Fund had told it to do. After several bailouts, the government imposed wave after wave of eye-watering austerity measures, as prescribed by the "Washington consensus", and sought a voluntary restructuring with its private sector creditors, all of which will sound familiar to the Greeks.
Yet the economic crisis continued to worsen. In December 2001, as the government slapped a limit on cash withdrawals – the so-called corralito – to prevent a destabilising run on the banks, the IMF effectively pulled the plug, saying it could not complete the latest of many reviews of Argentina's economic policies – a condition of it receiving continued financial support. "Within a month of this announcement," as a subsequent internal IMF review put it, "economic, social and political dislocation occurred simultaneously".
The Argentinian people took to the streets in their hundreds of thousands, banging their pots and pans, and threw out the government. A caretaker president, appointed to take over from de la Rúa, was also deposed within weeks, giving way to Eduardo Duhalde.
In the depths of the political and social crisis, Argentina risked the wrath of the world's financial markets and the IMF and defaulted on its debts, suspending repayments on some of its bonds. In early 2002, it abandoned the cherished one-to-one peg to the US dollar.
"Argentina drew a line in the sand," says Mark Weisbrot of the Center for Economic and Policy Research (CEPR) in Washington. "They said, we're not doing any deal that puts us in the same situation three years from now."
The peso plummeted to $0.25 within months, Argentina became a pariah and the economy slumped. Yet by the second quarter of 2002, it had bounced back to growth. And aided by high commodity prices and a boom for many of its key trading partners, Argentina continued expanding at a healthy clip, 8% on average, until the credit crunch hit.
"Default and devaluation enabled Argentina to get its economy on track, and to get hold of its exchange rate and monetary policy again, and to be able to do this in a way that served the country's needs better than the needs of the financial markets," says Alan Cibils, chair of the political economy department at the Universidad Nacional de General Sarmiento in Buenos Aires.
"It was a successful default," agrees Weisbrot. "Their economy reached the post-crisis level of output within three years, which is going to take Greece 10 years if they're lucky. They took 11 to 12 million people out of poverty in that time."
Like Greece, Buenos Aires had swallowed the textbook analysis – backed by the IMF and the consensus of academic economists and domestic politicians – which said its problem was not an overvalued currency and unsustainable debts, but too much public spending.
As the economists Roberto Frenkel and Martin Rapetti put it in a study of the Argentine crisis for the CEPR, the theory was that "fiscal discipline would entail stronger confidence, and consequently the risk premium would fall and bring interest rates down. Therefore, domestic expenditure would recover and push the economy out of the recession. Lower interest rates and an increased GDP would, in turn, re-establish a balanced budget, and thus close a virtuous circle."
It didn't work. In fact, drastic public spending cuts made the downturn worse, while the dollar peg prevented the devaluation that eventually helped Argentina to get back its competitiveness.
Similarly, Athens – locked into the euro – is unable to devalue, or control its own interest rates, and the solution being pressed on Greece by its eurozone neighbours involves privatisation, liberalisation and drastic public spending cuts.
"The parallels are really striking," says Peter Chowla of the Bretton Woods Project, which monitors the IMF and the World Bank. "Argentina had an IMF loan, which required austerity, and it failed for more than a year, and then they decided to double down, give them another loan and demand more austerity." There was also a series of voluntary restructurings, similar to the scheme being proposed for Greece, which briefly bought the Argentinian government some time, before the markets lost their nerve and bond yields shot up again.
Cibils travelled to Greece in May to tell campaigners about Argentina's experiences. "It just blew my mind that these policies that have failed catastrophically, repeatedly, are now being pushed on European countries," he says. His message to activists was that "default is not only not the end of the world; default is the first step of your next stage. What's happening now is unsustainable. When the ECB and the French and German policymakers say a default would be a disaster, they're speaking on behalf of the financial industry."
Argentina's experience does show that default is not simple, or easy. The "social dislocation", as the IMF put it, was profound. Meanwhile, it took years to negotiate a deal with about three quarters of its bondholders, under which the value of its debts was written down by about 75%. It had to impose foreign exchange and capital controls to prevent money flooding out of the country – completely against the IMF rulebook – and bail out domestic banks and households whose debts were denominated in foreign currencies.
Even now, some of Argentina's creditors are still holding out, and it has been unable to return to financial markets. But most of its deficit resulted from interest payments on its debts, so it was able to get by without borrowing in the years succeeding the crisis.
Greece is running a deficit even without its interest payments; but Weisbrot says more sources of capital are available than a decade ago. Several countries rejected by western lenders, including Venezuela and Cuba, have been able to borrow from China in recent years; and Greece is a small economy, so would need modest sums, in global terms.
Talks on a fresh bailout for Greece from the IMF and the EU appeared to have run into the sand last week, with banks unable to agree the terms of a potential debt rollover, and credit ratings agencies warning that any such deal would constitute a "selective default" – anathema to the European Central Bank.
Meanwhile, the ECB pressed ahead with its plan to raise interest rates, ratcheting up the pressure on the struggling eurozone economies, including Greece, amid growing questions about whether the IMF would release the final tranche of last year's emergency bailout. Christine Lagarde, the IMF's managing director, has reiterated the need for Athens to press on with its spending cuts.
Even with a new rescue package, Argentina's experience suggests that the protesters on the streets are right to see nothing ahead but austerity, austerity, austerity, and to question whether it will work. For now, financial markets, led by the mighty ratings agencies, are dictating the pace of events. But unless politicians get a grip on the situation, Weisbrot warns, Greece will lurch from one crisis to another: "I don't see a happy ending."
UK chain retailers 'closing 20 stores a day'
by Zoe Wood - Guardian
The gravity of the high street downturn is spelled out in new research published on Friday which shows UK retail chains have been closing stores this year at a rate of about 20 a day. The alarming statistic comes as closing down sales at TJ Hughes's 57 department stores get under way. The Liverpool-based chain went into administration last week, putting more than 4,000 jobs at risk.
The administrators, Ernst & Young, said they were holding talks with more than 30 prospective buyers, but analysts suggested the chain, nearly a century old, would be broken up and shops auctioned. Tom Jack of Ernst & Young said they were encouraged by the level of interest in TJ Hughes, but needed to sell the mountain of unsold stock sitting in its storerooms in case a buyer failed to materialise.
TJ Hughes, which offered large discounts on brands such as Wrangler and LG, is just one the casualties in a bleak year for the sector as weak consumer spending has devastated the high street. The latest figures from accountancy firm PricewaterhouseCoopers show 375 retailers went bust in the second quarter of 2011, a 9% increase on the same period last year.
Its analysis, which used figures compiled by the Local Data Company, showed chain retailers were closing about 4,000 stores in the first five months of this year. Specialist clothing, shoes and jewellers were the most vulnerable types of shop. Some of that was cancelled out by the expansion of supermarkets, pawnbrokers and coffee shops, but the national vacancy rate is still 14.5%.
Home improvement firm Focus DIY, Habitat and fashion chain Jane Norman are among the high street chains to have failed in the last two months. On Wednesday the administrators of Homeform, the collapsed kitchen and bathroom showroom group, made 557 staff redundant after they failed to find a buyer for its Möben and Dolphin brands.
The sale of the Sharps Bedroom business saved 96 of its 160 showrooms from closure. Homeform's administrator has cautioned that unless a white knight buyer emerges, 453 customers who paid their deposits in cash rather than by debit or credit card – payments totalling £1.5m – would be unlikely to get a refund. PwC said analysis of recent high-profile retail failures suggested that half of a group's stores would close as a result.
A year ago, TJ Hughes was in the black. The chain made profits of £6.8m on sales of £267m in the year to 30 January 2010, according to the most recent set of accounts filed at Companies House. The documents show the retailer agreed a new £10m loan facility with Lloyds Banking Group that year, with a £3m repayment due in January this year. The state-backed bank's loan was acquired by Endless in March and it has emerged that it had been sold on to GA Europe, the American restructuring specialist, which is also running the closing-down sales.
Stephen Robertson, director general of the British Retail Consortium, said: "High streets are at the heart of local communities and economies, providing jobs and essential services, but some are in trouble. These figures are further evidence of the tough trading conditions being experienced by non-food retailers in particular. The government's review of the high street must result in urgent action."
"Practical steps are needed to protect and promote our high streets so they remain attractive locations where businesses of all kinds can thrive. This cannot be left to chance." A proactive approach to managing our town centres would benefit customers, communities, retailers and other businesses. Priorities should include keeping business rates down, deterring crime and having good, affordable parking and public transport.
"It's encouraging that not all regions are seeing a fall in retail premises; some have seen a net gain thanks to new stores opening. The priority must be protecting that growth and helping it spread to all parts of the country, boosting town centres and creating jobs."
Southern Cross wind-up bid sees shares' value wiped out
Some of the City's biggest institutions today saw the last part of what was a £1.1 billion investment disappear after struggling care homes group Southern Cross suspended its shares and set out plans to wind itself up.
Restructuring plans drawn up last month by Southern Cross and its 80 landlords aimed to see homes transferred to new operators by September. But today's shock announcement sees the firm closing its entire operations.
The shares were suspended at 6?p, down from their 606p peak in 2007, equivalent to more than £1 billion, but Southern Cross admitted investors would see the total value of their shares wiped out.
Its biggest backers include Credit Suisse, Henderson Investors, JO Hambro, Deutsche Bank, UBS, and taxpayer-backed Lloyds Banking Group. The ownership of Southern Cross's 752 homes, which look after 31,000 residents, will pass to their landlords, the biggest of whom are Four Seasons, NHP and London & Regional.
But although Southern Cross said it had organised for a third of its homes to be taken back under the wing of landlords who already run other homes, the future of 500 homes looking after thousands of elderly Britons remained in the air.
Yet Southern Cross has repeatedly refused to name the landlords of its individual homes to help worried residents and relatives and today declined to comment. In a statement, it said landlords were "finalising their plans and further announcements will be made in due course".
The GMB union, which represents some of Southern Cross's 44,000 staff, pointed out more than half of the group's homes, 336 care homes, are owned by companies based outside the UK, with 325 of them registered in tax havens. A total of 199 landlord groups are registered in the Cayman Islands, with another 130 in Guernsey, Gibraltar, Jersey, British Virgin Islands, and the Isle of Man. Critics worried the "double-digit" number of homes Southern Cross said last month would close could rise, as unprofitable homes will be difficult to pass on.
Chairman Christopher Fisher said: "We anticipate that the period of uncertainty which we have been experiencing will now draw to a close. We regret the loss of value which shareholders have experienced."
Southern Cross's collapse came after it was unable to afford its £200 million annual rent bill while being hit by government cuts and falling admissions.