Tifton, Georgia. "Family working in the Tifton Cotton Mill. Mrs. A.J. Young works in mill and at home. Nell (oldest girl) alternates in mill with mother. Mammy (next girl) runs 2 sides. Mary (next) runs 1,5 sides. Elic (oldest boy) works regularly. Eddie (next girl) helps in mill, sticks on bobbins. Four smallest children not working yet. Mother said she earns $4.50 a week and all the children earn $4.50 a week. Husband died and left her with 11 children. Two of them went off and got married. The family left the farm two years ago to work in the mill."
Ilargi: Earlier this week, there was a heart-renditioning comment on Reddit by someone involved -boots on the ground- in the process of evicting people from their homes. Very much recommended reading, see here for the original comment and here for the follow-up. The commenter named his follow-up: Why my job is to watch dreams die. And that got me thinking.
For that is what it often feels like what we do here at The Automatic Earth: we watch dreams die. Only, we see them die -mostly- before the people do whose dreams we watch. That may sound convoluted, but it really isn't. While it may be hard to predict and see what stone may fall next, it is very obvious that the large majority of them will indeed topple over.
There are big dreams, like that of a unified Europe, a dream that is age old, and has been shattered as often as it's been dreamt. This time will be no different. And neither will the consequences be any more bearable.
The German Federal Constitutional Court passed a judgment this week that seems to let Angela Merkel and her people off the hook: all EU bailouts to date passed the threshold of legality. For Merkel though, this is as Pyrrhic as it comes, and the same goes for the financial markets. The court, even as it condoned past actions, put very strict limits on future ones. Future bailouts will be very hard to pass, there will no longer be any last minute grand gestures, and a fiscal union for Europe was swept off the table in one fell swoop.
In case anyone still feels even this can be overcome, Slovakia of all places threatens the Euro project with imminent demise. The chairman of the parliament in Bratislava has said there will be no vote on the lift of EFSF funds until probably December. So even if there's a yes vote, no funds will be available until February 2012. Which is more than Europe can bear at this point in time. There are so many leaks in the system, it's already running out of fingers.
Dutch Finance Minister De Jager sent a letter to his parliament yesterday saying the next chunk of Greek Phase 1 bailout funds will be delayed from mid September to end September at the earliest. Greece is not living up to the conditions put on the bailouts. Not enough austerity. Firing 20% of civil servants is apparently what it will take. Not enough austerity in Italy either, or so we hear.
We could go on for a long time pointing out signs that paint the inevitable picture, but it should be clear by now that Europe is a dream we see die before our very eyes. Swiss bank UBS has an idea what that will likely lead to: "We note that almost no modern fiat currency monetary unions have broken up without some form of authoritarian or military government, or civil war."
The cause of the downfall of the Eurozone? Too much debt. It's no different from that of the people the Reddit commenter evicts from their homes. Too much debt. It's everywhere, and it will devour our societies.
There are other big dreams. Never ending economic growth comes to mind. Or technical progress that lasts forever and can solve all problems caused by .. technical progress. That reminds us of the yeast in the wine vat that die off at the height of their proliferation, not because they run out of wine, but because no organism can survive in a medium of its own waste.
We watch the big dreams die here. But they‘re not what we are most interested in. We care about the dreams of everyday people that are going to be shattered, if they’re not already. In that regard, I often say that what I think is our role can be defined as "minimizing the suffering of the herd". We have no solutions that can carry anyone safely away from the falling debris of our civilizations. The best we can do is to try and point to small ways that might make it all more bearable.
But having your dreams broken to bits will never be easy. And broken they will be if they have anything to do with our financial system, for it is itself broken beyond repair. Too much debt.
Whether you've paid into a pension plan for years only to find out there's nothing of it left, or you want to start a family but don't have a job or a home to live in, whether you want to provide your children with a good, let alone a better, future, your dreams too will be maimed beyond recognition. We are on the verge of entering the most severe credit crunch in history, and there are no easy ways out of it. We wouldn't do too well even if we made all the right choices, and at the same time there's no way we are going to make them.
The MO of our societies, the way we respond to the impending collapse of our systems, is defined by those who owe their very positions to those systems: bankers, captains of industry, media moguls and politicians. Instead of using the remaining resources to minimize suffering, they spend them all in a doomed effort to prop up the existing structures that made them what they are. Most of them don't know any better, and those that do proceed anyway because they think they themselves will be better off that way.
Deutsche Bank CEO Josef Ackermann said earlier this week: "Numerous European banks would not survive having to revalue sovereign debt held on the banking book at market levels." Indeed, neither would numerous American banks. Or pension funds, for that matter. Still, if one would wish to restore confidence in the financial system, marking assets to market is the only way to go.
Mark to market or the market will do it for you. Restructure debt, let those institutions go bankrupt that hold too much debt, and move on. But in no case use any more money that belongs to the people. Use that money to help out the people, minimize their future suffering.
Unfortunately, our societies simply don't have the political structures to make the right choices, or at least those that would serve the people best. Our political structures serve those who hold the power, and they will choose to hold on to that power. The structures allow them to use the people's wealth against the people's best interests. It's perverse, it's insidious, and it's our reality. Voting someone else into power doesn't change these structures one bit.
The people at UBS seem to realize this when they talk of impending civil war in Europe as a consequence of the break-up of the Eurozone. What they don't mention, for whatever reason, is, as Tyler Durden points out, that this will be the end of UBS, too. That seems sort of symbolic for the way many people view the future: they see a lot of negative developments, but a relatively benign position for themselves.
The best we can do is to continue to tell people to get closer to their family and friends, to establish closer communities. But also to stop making plans for decades into the future, because the future has too many embedded uncertainties. And don't expect too much, if anything, from our existing pension, health care and education systems. There will be no funding to keep them going.
So your children will once again be your pension plan, just like they were throughout the ages, and they still are throughout most of the world. They will have to learn their skills from their parents and communities. And yes, that is, provided they live long enough, that they don't succumb to afflictions that today are perfectly treatable but for which no provisions will be available.
We are watching dreams die. Other dreams will take their place. But, given the way the human mind works, it is going to be an epic struggle that many of us won't live to tell.
Donate to our Summer Fund Drive
The Bigger Picture: Primer Guide Update
German court curbs future bail-outs, bans EU fiscal union
by Ambrose Evans-Pritchard - Telegraph
Germany's constitutional court has at last delivered its Solomonic judgment on Europe's rescue machinery.
It chose to avert Götterdämmerung. The nexus of bail-outs already agreed for Greece, Portugal and Ireland are allowable under Germany's Basic Law - or Grundgesetz - because there is no "automatic" transfer of money beyond the Bundestag's control. Germany may participate in Europe's €440bn (£388bn) bail-out fund (EFSF).
To prohibit the existing rescues would have brought down the temple of monetary union within days, and with it Europe's financial system. The judges did not want a global depression on their conscience. Fears that the court might queer the pitch in some complicated way have been eating at markets for weeks, so Wednesday's relief rally was predictably fast and furious. Germany's DAX index surged 3.7pc and Milan's MIB was up 4.2pc as Italian banks came back from death.
Yet euphoria is surely misplaced. The court's president, Andreas Vosskuhle, cautioned Chancellor Angela Merkel and Brussels to watch their step. "This was a very tight decision. But it should not be mistakenly interpreted as a constitutional blank cheque authorising further rescue measures," he said.
The opinion is a partial victory for the professors who brought the case and fear that Euroland's crisis is dragging Germany across the Rubicon into an EMU debt union without treaty authority or democratic control. Karl Albrecht Schachtschneider, their lead jurist, called the verdict "a bad day for Germany and Europe and a slap in the face of the country". Yet in reality the professors extracted language that kills off any prospect of a debt union, or an EU treasury and fiscal federalism, for the foreseeable future.
"The Bundestag's budget responsibilities may not be transferred through open-ended appropriations to other actors. In particular, no financial mechanisms can lead to meaningful fiscal burdens without prior approval," said the opinion. "No permanent treaty mechanisms shall be established that leads to liability for the decisions of other states, especially if they entail incalculable consequences," it said. The ruling is "a clear rejection of eurobonds", said Otto Fricke, finance spokesman for the Free Democrats (FDP) in the governing coalition.
Above all, the court ruled that the Bundestag's fiscal sovereignty is the foundation of German democracy and that Article 38 of the Basic Law prohibits transfer of these prerogatives to "supra-national bodies". By stating that there can be no further bail-outs for the eurozone without the prior approval of the Bundestag's budget committee, the court has thrown a spanner in the works and rendered the EFSF almost unworkable.
It restricts the ability of Chancellor Angela Merkel to strike rescue deals at EU summits, leaving it unclear how she or any future Chancellor could respond to the sort of crisis that blew up in late July of this year when Italian and Spanish bond yields reached danger levels above 6pc. Moreover, Finland, the Netherlands and Slovakia are all eyeing variants of this legislative veto.
Mrs Merkel is already facing a simmering mutiny in the Bundestag. Up to 25 deputies from her coalition - mostly from the FDP and Bavaria's Social Christians (CSU), but also top Christian Democrats - intend to vote against the revamped EFSF later this month or abstain.
What this reflects is the deeper revolt by German society over escalating rescue costs and the threat to German nationhood. The budget committee is already fractious and is likely to prove tougher with each fresh demand. The question is how will it respond to the disintegration of Greece's rescue programme or if and when Brussels again pushes for a massive boost in the firepower of the EFSF to cope with Spain and Italy.
The path remains strewn with hurdles. Slovakia said it will not debate the EFSF bill until December, delaying activation until February, leaving a very reluctant ECB to hold the fort by purchasing Club Med bonds. Richard Sulik, the president of the Slovak parliament, has vowed to do everything he can to block the EFSF.
Harvinder Sian from RBS said both Athens and the EU-IMF team are likely to keep Greece's programme alive for another quarter, with the risk of a "hard default" in December. He said the sorts of "19th Century colonial demands" now being made on Greece have provoked armed revolutions in the past and might tempt Athens to act first, especially since 90pc of Greek debt is subject to Greek contract law.
The contagion risk remains acute. Portugal is "fundamentally uncompetitive" and carries a debt stock (360pc of GDP) too large for plausible deflation. "Spain is only at the start of a multi-year post bubble adjustment, while Italy has proven ungovernable in the gold-standard world of EMU," said Mr Sian, warning that private investors will not touch the region as long as there is any fear of EMU dissolution.
UBS has even put precise figures on the costs of break-up, deeming the current structure unworkable. "We note that almost no modern fiat currency monetary unions have broken up without some form of authoritarian or military government, or civil war," it said. As long as major banks are uttering such thoughts, this crisis can only rumble on.
German court upholds eurozone rescue
by Quentin Peel - FT
Germany’s powerful constitutional court has rejected a series of challenges to the eurozone financial rescue packages agreed last year for Greece and other debt-strapped members of the European currency union.
In an eagerly-awaited judgment issued on Wednesday, the judges in Karlsruhe decided that the measures did not infringe the budgetary authority of the Bundestag, the German parliament in Berlin. But they also ruled that in future the budget committee of the Bundestag must give its prior approval before any further German financial guarantees for loans to its 16 partners in the eurozone.
Andreas Vosskuhle, president of the second chamber of the constitutional court in Karlsruhe, said it was “a very close decision”. “It should not be mistakenly interpreted as a constitutional blank cheque authorising further rescue measures,” he said.
The judgment amounts to an important victory for the German government, although it could complicate negotiations over future crisis measures by reinforcing the parliamentary control of the Bundestag. It lifts a cloud over the €110bn rescue package agreed last year for Greece, and the €440bn European Financial Stability Facility (EFSF) used to provide further financial assistance for both Ireland and Portugal. It should also clear the way for German parliamentary approval for further crisis measures to extend the powers of the EFSF.
Ms Merkel faces a gruelling three weeks to win the backing of her own supporters for new crisis measures, agreed by eurozone leaders last month, which go a lot further than the original plan for Greece.
The package would allow the European Financial Stability Facility – the eurozone rescue fund – to use its funds to buy sovereign bonds in secondary markets, issue precautionary liquidity loans to eurozone members, as well as recapitalise banks in difficulty. It would increase the size of Germany’s financial guarantees for the EFSF from €123bn to €211bn ($297bn).
Carsten Brzeski, senior economist at ING Belgium, said the decision did not amount to a green light for any future rescue package. “Today’s ruling should bring some relief to financial markets as a total chaos scenario has been avoided but it should not lead to euphoria,” he said. “
A bigger say for German parliament in future bailouts could easily find copycats in other eurozone countries, undermining the clout of the beefed-up EFSF,” as well as the permanent European Stability Mechanism to be established from 2014, he added. He said that the ruling should clear the way for the Bundestag to approve the new reforms to the EFSF at the end of September.
A backbench rebellion within Ms Merkel’s centre-right coalition on Monday night saw 19 members of her own Christian Democrat group, and six members of the Free Democratic party – junior partners in the coalition – defy the chancellor’s appeal for parliamentary support.
Top party officials insisted on Tuesday that they still expected to win a government majority on September 29, when the Bundestag must vote on the eurozone package. But if 25 government supporters abstain or vote against, it would deny Ms Merkel a “chancellor’s majority” in the parliament, and lead to opposition calls for an early election.
In a key concession last week, the German government agreed to allow the Bundestag to define its own powers to police eurozone rescue measures in the light of the court’s judgment. Previous judgments by Karlsruhe have sought to reassert the power of the German parliament over European Union legislation, on the grounds that democratic control can only be exercised at national level.
The German government has argued that the Greek rescue package and the establishment of the EFSF were emergency measures necessary to ensure the stability of the euro, implemented as a last resort, and therefore compatible with both EU treaties and the German constitution.
Ms Merkel has faced growing criticism from within her own Christian Democratic Union, after a string of poor results in state elections culminated in a further loss of support in her home state of Mecklenburg-Vorpommern at the weekend. Sunday’s vote saw a clear victory for the opposition Social Democratic party, with 35.7 per cent of the vote, against just 23.1 per cent for Ms Merkel’s Christian Democratic Union. The liberal Free Democrats lost all their seats in the state parliament when their vote slumped from 9 per cent to less than 3 per cent.
The Bundestag will be voting only on the EFSF reforms on September 29, leaving even more controversial decisions on a new Greek rescue package, and a permanent eurozone rescue facility, until later.
Officials say that a vote on the Greek package cannot be held before October, once final details including private sector participation have been agreed with creditors.
Ratification of the European Stability Mechanism – the permanent replacement for the EFSF after 2014 – is not expected before December. Opponents of the bail-out proposals argue that the ESM vote will be the most critical of all, because the EFSF is only a temporary measure.
Chris Whalen: Bank Of America Should Declare Bankruptcy
by Linette Lopez - Business Insider
Bank of America has over $100 billion in mortgage liabilities, says Chris Whalen Co-founder of Institutional Risk Analytics.
On a web broadcast published on KingWorldNews, he advocates "the classical American way of dealing with this problem"-- complete and total restructuring through Chapter 11. Before its too late.
He says, "The only sane way of fixing this and I mean fix it so that Bank of America comes out of the process restructured, ready to support growth, support leverage, is a classic chapter 11..."
His point: Countrywide's bond trusts are worthless, were never properly constructed, and don't protect investors at all. Bank of America is on the hook for all of that, and while its subsidiaries are well capitalized, the parent company is bust. The only thing to do to fix this problem is to unmake $100s of billions worth of bond contracts.
Bank of America can't take that strain as is because it can't touch any subsidiary money to settle its legal claims, so equity holders are going to get wiped out, and bond holders are going to have to take serious haircut.
At least, says Whalen, if the bank files for bankruptcy, it can be saved."...we're not going to take the bank down. Bank of America is not going to close. I have all my money in Bank of America, my company, my personal accounts are all at Bank of America, and I have no concern because I know the folks at the FDIC will take care of it if they have to. But I don't think we have to go there."
Because of Countrywide, the biggest mortgage lender in the U.S. and thus the originator of most of the bad loans, Bank of America has the worst fate of the U.S. banks. But other major banks face some degree of pain depending on what comes out of FHFA's lawsuits.
Aside from the "moribund larger banks", Whalen specifically mentioned Allied Bank and Wells Fargo as companies in the danger zone. The rest of the banking sector is free of these massive legacy issues, though, and can continue as is.
So how do we fix the problems at big banks?
1. Repeal the Bank Holding Company Act so that the Federal Reserve isn't on the hook for their debt.
Then we should..."...allow commercial companies to control depositories. They would be separated (depositories and companies) but I think having new capital, better management, more innovative management, would help the U.S. tremendously. You know, banks aren't special. They aren't supposed to be special...I want to let the private sector take on risk and not put these artificial limits up so that the Fed protects big banks."
You see, to Whalen, the entire point of quantitative easing was to buy time so that banks could restructure. But the big boys haven't been doing it. Instead they, and Washington, have been "treading water" until they're forced to do something (or, in Washington's case, until after election season).
It's a game called "extend and pretend." But increasingly, its looking like the game is now over.
Banks face 'day of reckoning', says McKinsey
by Harry Wilson - Telegraph
Bank reforms coming into effect over the next decade will destroy the profit-drivers of the world’s largest banks and more than halve industry returns, according to McKinsey.
In a report titled ‘Day of reckoning’, McKinsey paints a bleak picture for banks, estimating that their average pre-regulation return on equity of 20pc will be cut to just seven percent by new capital requirements that will force them to maintain larger buffers against potential losses. Highly-profitable but risky businesses such as proprietary trading, which involves banks trading using their own money, could see their returns fall by more than 80pc.
Even traditional operations such as stock broking where banks acts as the intermediaries between the buyers and sellers of shares are expected to see their returns post the new regulation fall by 40pc, according to McKinsey.
The Basel III rules, which come into full force in 2019, will require banks to maintain a Tier 1 capital ratio of at least 6pc as well as a 2.5pc counter-cyclical capital buffer, more than doubling the amount of capital financial institutions will be required to hold. McKinsey forecasts that about 65pc of the fall in returns will simply be because of the impact of the much higher Tier 1 capital ratio they will have to maintain and expects banks to take radical action to mitigate the cost of the reform.
"Exiting a business completely, through a sale or a wind-down of all assets, is the most severe measure but may be reasonable if regulatory costs cannot be adequately mitigated or shared with customers," said McKinsey.
UK policymakers have begun to sound concerns over the consequences of the new requirements. In a speech this month, Andrew Haldane, executive director of financial stability at the Bank of England, said banks had over-reacted to the crisis and could cut the amount of loss-bearing capital they hold from about 10pc to 7.5pc, closer to the minimum required by Basel III.
Deutsche Bank CEO Ackermann Warns of Renewed Financial Crisis
Josef Ackermann, the CEO of Deutsche Bank, has said that the current market volatility reminds him of the days immediately preceding the collapse of Lehman Brothers. He also blasted the IMF, saying that calls for the mandatory recapitalization of European banks are "not helpful."
It has been a mere three years since the collapse of the investment bank Lehman Brothers plunged the world into a deep financial crisis. But now, with economic indicators offering little room for optimism, a new crisis may be on the horizon.
That, at least, was the message offered by Deutsche Bank CEO Josef Ackermann on Monday in comments delivered at a conference in Frankfurt. "We should resign ourselves to the fact that the 'new normality' is characterized by volatility and uncertainty," Ackermann said. "All this reminds one of the autumn of 2008."
The volatility was on full display on Monday as the leading German market index, the DAX, plunged to a two-year low and stocks of European banks , including Ackermann's Deutsche Bank, lost value. The price of gold once again spiked upwards as investors sought security.
In addition, the European Central Bank reported that European banks on Friday parked €151 billion ($213.3 billion) overnight with the ECB, the highest total in more than a year. The increase reflects growing distrust on the financial markets, with banks shunning the higher interest rates they would earn by depositing money with each other.
'An Open Secret'
Despite his grim message, Ackermann also said that European banks were much better capitalized and less dependent on short-term liquidity than they were on the eve of the financial meltdown three years ago. He added that banks had also managed to reduce the amount of toxic assets on their books and had improved their risk management. But, he added, "it is an open secret that numerous European banks" would run into trouble were they forced to write down their sovereign bond holdings to reflect current market value.
Ackermann also once again blasted International Monetary Fund President Christine Lagarde for her suggestion that European banks submit to forced recapitalization. He said such calls were "not helpful" and suggested that they threatened to undermine European efforts to assist crisis-stricken euro-zone members. He said that a forced recapitalization would send the message that the European Union had little faith in its own strategy for saving the common currency. In comments last week, Ackermann said that he "thinks nothing at all" of Lagarde's demand for recapitalization.
'A Dangerous Illusion'
The Deutsche Bank CEO said that his own bank was well positioned for difficult times, though he said that he would consider reducing costs should the situation continue to deteriorate. He also urged further European integration and warned against the collapse of the euro zone.
"The costs of supporting weak member states, particularly from the German perspective, are less than the costs of disintegration," he said. "It is a dangerous illusion to believe that a country could do better should it reclaim the sovereignty it has delegated to the EU." Ackermann's speech on Monday was delivered at a conference entitled "Banks in Transition," organized by the German business daily Handelsblatt. The CEOs of Germany's Commerzbank, France's Societe Generale and Italy's UniCredit were also scheduled to speak on Monday and Tuesday.
Bring Out Your Dead - UBS Quantifies Costs Of Euro Break Up, Warns Of Collapse Of Banking System And Civil War
by Tyler Durden - Zero Hedge
Any time a major bank releases a report saying a given course of action is too costly, too prohibitive, too blonde, or simply too impossible, it is nearly guaranteed that that is precisely the course of action about to be undertaken. Which is why all non-euro skeptics are advised to shield their eyes and look away from the just released report by UBS (of surging 3 Month USD Libor rate fame) titled "Euro Break Up - The Consequences."
UBS conveniently sets up the straw man as follows: "Under the current structure and with the current membership, the Euro does not work. Either the current structure will have to change, or the current membership will have to change." So far so good. Yet where it gets scary is when UBS quantifies the actual opportunity cost to one or more countries leaving the Euro. Notably Germany.
"Were a stronger country such as Germany to leave the Euro, the consequences would include corporate default, recapitalisation of the banking system and collapse of international trade. If Germany were to leave, we believe the cost to be around EUR6,000 to EUR8,000 for every German adult and child in the first year, and a range of EUR3,500 to EUR4,500 per person per year thereafter. That is the equivalent of 20% to 25% of GDP in the first year. " It also would mean the end of UBS, but we digress.
Where it gets even more scary is when UBS, like many other banks to come, succumbs to the Mutual Assured Destruction trope made so popular by ole' Hank Paulson : "The economic cost is, in many ways, the least of the concerns investors should have about a break-up. Fragmentation of the Euro would incur political costs. Europe’s "soft power" influence internationally would cease (as the concept of "Europe" as an integrated polity becomes meaningless).
It is also worth observing that almost no modern fiat currency monetary unions have broken up without some form of authoritarian or military government, or civil war." So you see: save the euro for the children, so we can avoid all out war (and UBS can continue to exist). The scariest thing, however, by far, is that for this report to have been issued, it means that Germany is now actively considering dumping the euro.
Fiscal confederation, not break-up
Our base case with an overwhelming probability is that the Euro moves slowly (and painfully) towards some kind of fiscal integration. The risk case, of break-up, is considerably more costly and close to zero probability. Countries can not be expelled, but sovereign states could choose to secede. However, popular discussion of the break-up option considerably underestimates the consequences of such a move.
The economic cost (part 1)
The cost of a weak country leaving the Euro is significant. Consequences include sovereign default, corporate default, collapse of the banking system and collapse of international trade. There is little prospect of devaluation offering much assistance. We estimate that a weak Euro country leaving the Euro would incur a cost of around EUR9,500 to EUR11,500 per person in the exiting country during the first year. That cost would then probably amount to EUR3,000 to EUR4,000 per person per year over subsequent years. That equates to a range of 40% to 50% of GDP in the first year.
The economic cost (part 2)
Were a stronger country such as Germany to leave the Euro, the consequences would include corporate default, recapitalisation of the banking system and collapse of international trade. If Germany were to leave, we believe the cost to be around EUR6,000 to EUR8,000 for every German adult and child in the first year, and a range of EUR3,500 to EUR4,500 per person per year thereafter. That is the equivalent of 20% to 25% of GDP in the first year. In comparison, the cost of bailing out Greece, Ireland and Portugal entirely in the wake of the default of those countries would be a little over EUR1,000 per person, in a single hit.
The political cost
The economic cost is, in many ways, the least of the concerns investors should have about a break-up. Fragmentation of the Euro would incur political costs. Europe’s "soft power" influence internationally would cease (as the concept of "Europe" as an integrated polity becomes meaningless). It is also worth observing that almost no modern fiat currency monetary unions have broken up without some form of authoritarian or military government, or civil war.
A little more on that particularly troubling last point:
Do monetary unions break up without civil wars?
The break-up of a monetary union is a very rare event. Moreover the break-up of a monetary union with a fiat currency system (ie, paper currency) is extremely unusual. Fixed exchange rate schemes break up all the time. Monetary unions that relied on specie payments did fragment – the Latin Monetary Union of the 19th century fragmented several times – but should be thought of as more of a fixed exchange rate adjustment. Countries went on and off the gold or silver or bimetal standards, and in doing so made or broke ties with other countries’ currencies.
If we consider fiat currency monetary union fragmentation, it is fair to say that the economic circumstances that create a climate for a break-up and the economic consequences that follow from a break-up are very severe indeed. It takes enormous stress for a government to get to the point where it considers abandoning the lex monetae of a country. The disruption that would follow such a move is also going to be extreme. The costs are high – whether it is a strong or a weak country leaving – in purely monetary terms. When the unemployment consequences are factored in, it is virtually impossible to consider a break-up scenario without some serious social consequences.
With this degree of social dislocation, the historical parallels are unappealing. Past instances of monetary union break-ups have tended to produce one of two results. Either there was a more authoritarian government response to contain or repress the social disorder (a scenario that tended to require a change from democratic to authoritarian or military government), or alternatively, the social disorder worked with existing fault lines in society to divide the country, spilling over into civil war. These are not inevitable conclusions, but indicate that monetary union break-up is not something that can be treated as a casual issue of exchange rate policy.
Even with a paucity of case studies, what evidence we have does lend credence to the political cost argument. Clearly, not all parts of a fracturing monetary union necessarily collapse into chaos. The point is not that everyone suffers, but that some part of the former monetary union is highly likely to suffer.
The fracturing of the Czech and Slovak monetary union in 1993 led to an immediate sealing of the border, capital controls and limits on bank withdrawals. This was not so much secession as destruction and substitution (the Czechoslovak currency ceased to exist entirely). Although the Czech Republic that emerged from the crisis was considered to be a free country (using the Freedom House definition), with political rights improving relative to Czechoslovakia (also considered to be a free country), Slovakia saw a deterioration in the assessment of its political rights and civil liberties, and was designated "partially free" (again, using Freedom House criteria).
Similarly the break-up of the Soviet Union saw authoritarian regimes in the resulting states. Of course, this was not a change from the previous status quo, but that is not the point. The question is not how a liberal democracy develops, but whether a liberal democracy could withstand the social turmoil that surrounds a monetary union fracturing. We lack evidence to support the idea that it could.
Even the US monetary union break-up in 1932-33 was accompanied by something close to authoritarianism. Roosevelt’s inauguration was described by a contemporary journalist as being conducted in "a beleaguered capital in wartime", with machine guns covering the Mall. State militia were called out to deal with the reactions of local populations, unhappy at what had happened to the monetary union (and specifically their access to their banks).
Older examples are less helpful, as they tend to be more akin to fixed exchange rate regimes under a gold standard or some other international monetary arrangement. Nevertheless, the Irish separation from the UK, or the convulsions of the Latin Monetary Union in Europe (particularly around the Franco-Prussian war in 1870 and its aftermath) saw monetary unions fragment with varying degrees of violence in some parts of the union.
Writing in 1997, the Harvard economist Martin Feldstein offered a view that seems to be somewhat chillingly precognitive. He said "Uniform monetary policy and inflexible exchange rates will create conflicts whenever cyclical conditions differ among the member countries... Although a sovereign country... could in principle withdraw from the EMU, the potential trade sanctions and other pressures on such a country are likely to make membership in the EMU irreversible unless there is widespread economic dislocation in Europe or, more generally, a collapse of the peaceful coexistence within Europe."
As for what happens if UBS, and the Euro Unionists lose the fight for the euro:
Our base case for the Euro is that the monetary union will hold together, with some kind of fiscal confederation (providing automatic stabilisers to economies, not transfers to governments). This is how the US monetary union was resurrected in the 1930s. It is how the UK monetary union, and indeed the German monetary union, have held together.
But what if the disaster scenario happens? How can investors invest if they believe in a break-up, however low the probability? The simple answer is that they cannot. Investing for a break-up scenario has not guaranteed winners within the Euro area. The growth consequences are awful in any break-up scenario. The risk of civil disorder questions the rule of law, and as such basic issues such as property rights. Even those countries that avoid internal strife and divisions will likely have to use administrative controls to avoid extreme positions in their markets.
The only way to hedge against a Euro break-up scenario is to own no Euro assets at all.
Alas, this will be the final outcome. Unfortunately trillions more in taxpayer capital will be lost before we get there. In the meantime, enjoy as UBS just unwittingly announced the final countdown for the EUR.
Quitting euro 'would cost Greece and Portugal half their GDP'
by Phillip Inman - Guardian
Analysis by UBS delivers stark warning to eurozone members of the cost of a breakup of the single currency area
Greece or Portugal would lose up to 50% of their national income if they quit the euro, according to research by analysts at Swiss investment bank UBS. A eurozone country with a more robust economy, such as France or the Netherlands, would see 20% to 25% of national income disappear if they went back to operating their own currency.
For Greece the loss would be $165bn (£100bn) from its $330bn annual gross domestic product, while France would suffer a loss of $660bn from its $2.65 trillion annual GDP. The stark warning to eurozone members that a breakup of the euro currency club will cost them dear follows several speeches by policymakers and economists that the status quo is untenable.
German chancellor Angela Merkel has dismissed talk of a breakup, but has struggled to articulate a coherent alternative currency union that would include Greece and Portugal, the two ailing countries most likely to face eviction. In Brussels, commission staff are busy working on plans for a closer fiscal and monetary union built around eurozone members, with stricter limits on borrowing and tighter banking regulations.
However, the slow pace of reforms in Greece and determined resistance in Italy to further austerity, has undermined moves for a closer union. UBS said: "Under the current structure and with the current membership, the euro does not work. Either the current structure will have to change, or the current membership will have to change.
"If Germany were to leave, we believe the cost to be around €6,000 (£5,250) to €8,000 for every German adult and child in the first year, and a range of €3,500 to €4,500 per person per year thereafter. That is the equivalent of 20% to 25% of GDP in the first year. In comparison, the cost of bailing out Greece, Ireland and Portugal entirely in the wake of the default of those countries would be a little over €1,000 per person, in a single hit.
UBS analysts Paul Donovan and Stephen Deo also fear wider political ramifications. "There are also political costs to consider. Europe's 'soft power' influence internationally would cease. We note that almost no modern fiat currency monetary unions have broken up without some form of authoritarian or military government, or civil war."
The economist Nouriel Roubini has long argued the costs of forcing ailing countries to maintain their membership of the euro could have even higher costs. Greece, Portugal and Italy could face a decade-long depression and political upheaval inside the euro, while the costs of a swift exit could be wiped out by strong growth with an independent currency.
U.S. fortunes increasingly determined in Brussels, Frankfurt
by Neil Irwin - Washington Post
A steep new decline in U.S. stock markets Tuesday underscores a rising risk for the nation’s economy: that Europe’s fiscal troubles will spread across the Atlantic and weaken growth on these shores. The Standard & Poor’s 500 was down 2 percent at noon Tuesday, even as the only news about the U.S. economy since Friday was a surprisingly positive report about the nation’s service sector.
The markets were instead responding to the growing financial instability in Europe, where stocks plummeted more than 5 percent in an alarming sell-off on Monday, the Labor Day holiday in the United States. Investors are increasingly fearful that the economies of Europe’s largest countries, particularly Germany, are slowing, and that the governments on the continent will not be able to agree on measures to avert a deeper crisis.
In effect, the value of the U.S. corporate sector--and by extension, Americans’ wealth and business confidence--is being determined by events in Brussels, Frankfurt, Rome and Berlin.
Indeed, this is not the first time there have been signs that Europe’s troubles are having an outsized impact on the United States’ own financial stakes. It was in the spring of 2010 that the U.S. economy seemed to be finally taking off--only to falter at exactly the time the European crisis became more severe. Similarly, as the European situation has become more dire in the early months of this year, growth in the United States slowed once again.
The $240 billion worth of goods and services that the United States exported to Europe last year amounts to only 1.6 percent of U.S. economic activity. But the events of the last year show how the links, particularly through financial markets, are far greater than that number would suggest.
Global investors increasingly view risk in binary terms: When things are looking calmer on the global economic front, stock markets rise across the world; when things look scarier, they fall. Instead of differentiating among the economies in the United States, Europe and Japan, market measures are moving closely in tandem.
Moreover, because major U.S. companies have operations around the globe, executives are more likely to try to offset weakness in their overseas operations by pulling back on hiring and capital investment domestically, even if the U.S. economy is proceeding apace. More than ever, in other words, Europe’s problems are our problems.
Euro-Zone Rescue Faces Stumbling Block in Slovakia
by Gordon Fairclough - Wall Street Journal
Slovak lawmakers will reconvene here Tuesday after their summer break, but a critical piece of legislation will be conspicuously absent from the agenda: A bill to widen the role of a euro-zone rescue fund. Parliament Speaker Richard Sulik said he will do everything he can to delay a vote on the measure—passage of which is necessary for the common currency bloc to move ahead with plans to strengthen the financial safety net for the euro's weakest members.
As speaker, Mr. Sulik has significant power in setting Parliament's legislative agenda. "It's not possible to solve a debt crisis by creating new debts," Mr. Sulik said in an interview Friday, in which he made clear his opposition to any expansion of the European Financial Stability Facility. He pledged to postpone a final vote on the measure until at least the end of the year.
The delay is one of a growing list of potential disruptions that is vexing European policy makers and unsettling markets, which are anxious about precarious state finances in Greece and Italy and are questioning the political resolve of euro-zone governments. On Monday, Slovakia's finance ministry issued a statement calling on Parliament to speed up a vote, which many observers expect would result in passage of the bill, saying that waiting would be "counterproductive in the current circumstances."
Jean-Claude Trichet, president of the European Central Bank, also said Monday that there is an "immediate need" for action to implement the bailout plans agreed to by euro-zone national leaders in July. But growing opposition in legislatures across Europe appears to make that unlikely. Finnish lawmakers, for example, are insisting that their country get collateral for any additional loans to Greece, sparking calls for equal treatment by other nations. A solution to that dispute may not come until a meeting of euro-zone finance ministers on Sept. 16.
Driving resistance to the latest round of crisis measures is growing anger among politicians—and their constituents—in stronger euro-zone nations who feel they are being asked to subsidize the citizens of states that have been borrowing and spending beyond their means.
For many in Slovakia, the second-poorest member of the euro zone—Estonia is the poorest—the idea of bailing out nations that are considerably richer is especially galling. Slovaks shouldn't be asked to help rescue Greece, said Maria Cikhtova, who works at a small dry-cleaners in downtown Bratislava. "It's not fair. It's their debt. They should pay for it," said Ms. Cikhtova. "They are on strike all the time. They're not doing anything." Ms. Cikhtova, who is 52 years old, said she earns about €500 ($710) a month before tax. "Before we joined the euro, the government had to cut spending a lot," she said. "They should have to do that, too."
Mr. Sulik, the speaker of Parliament and head of one of the four parties in Slovakia's coalition government, said such popular opposition has stiffened his own resolve against the new bailout measures, which he said amount to "trying to put out a fire with a fan." The only real solution to the debt crisis, Mr. Sulik said, is rigorous enforcement of the currency bloc's regulations on budget deficits and public debt—not extending more loans. "The more we let countries violate the rules, the worse things will get," he said. "Greece has to go into bankruptcy."
The speaker's position has put him at odds with Slovak Prime Minister Iveta Radicova and her party, which supports adoption of the new measures. That represents a shift for a government that last year was slow to sign off on the establishment of the EFSF, and that refused to participate in a separate bailout loan for Greece.
Mr. Sulik's views, however, haven't changed. He said strict adherence to limits on everything from budget deficits to inflation rates was required of Slovakia before it was admitted to the euro area at the beginning of 2009. "Now when I see what is being allowed for Greece and Italy, it really makes me angry," Mr. Sulik said. "We have to pay because of this double standard. It's a real injustice."
Greek Euro Exit Likely Within Days
by Investica - Actionforex.com
The game is up for Greece as there is surely no way back for the country and a rapid Euro exit is increasingly likely. Without decisive action, the Euro is also likely to come under increasingly severe selling pressure as the financial crisis spreads.
In theory, the EU and IMF can continue to provide the funds agreed under the existing bailout programme, but this will only delay the inevitable as on the current trajectory Greek public debt is likely to be at least 180% of GDP next year. The collateral row also illustrates how difficult it will be to keep EU members on board and willing to contribute to the planned second bailout package. Indeed, there is a high risk that the second bailout will unravel within the next few days.
Greece will have to reflate its economy and default on its sovereign debt to help secure a medium-term recovery and this will not be possible within the Euro-zone. It is increasingly likely that Greece will be sacrificed politically and economically in an attempt to keep the rest of the Euro area intact and aim for a more orderly move towards greater fiscal union even though this may be politically impossible.
The market’s vote of no confidence in Greece and the bailout package could hardly be clearer as Greek bond yields rise exponentionally, at one point the 2-year yields rose to a staggering 55% on Monday. The only question now appears to be the timing and method of Euro exit. Greece can either make the decision itself or it will effectively be forced out by the other members.
The decision could be taken out of Greece’s hands by the German constitutional court which will rule on Wednesday whether the EU bailouts were legitimate under German Law. If the court rules unambiguously that the bailouts were unconstitutional then the Euro-zone in its current form would have no chance of survival as the peripheral countries would come under immediate and terminal attack. A more complex and less clearly defined ruling looks the more likely outcome which would demand additional guarantees for future aid.
Such an outcome would also create market uncertainty and confusion. It would also make life even more difficult for Greece, but would not be decisive enough to force am immediate exit. More importantly, it would intensify political tensions in Germany as Chancellor Merkel would find it even more difficult to gain parliamentary support for an expanded EFSF as domestic opposition would increase further.
Tensions are flaring throughout the Euro area as Italian bond yields rise even with the support of ECB buying. Last week, the ECB almost doubled its buying of peripheral bonds as they bought EUR13.3 compared with EUR6.7bn the previous week. Italian yields have still increased back to the 5.50% area and credit-default swaps also rose sharply on Monday. European banking stocks were also sold very heavily during Monday.
The ECB is clearly extremely frustrated with the situation and has warned Italy not to slide on austerity measures in expectation that the ECB will prevent any market fall-out. The Italian government will continue to debate austerity measures on Tuesday at the same time as a General Strike has been called and the domestic willpower looks shattered.
The political and economic developments appear to have a surreal quality with key political players calling for action to stem the crisis, but simply insisting that measures agreed previously need to be implemented in full and more quickly. The calls for austerity in the face of recessionary conditions and rising debts will simply not work as the outcome will be for a further increase in debt and even weaker growth while political support will crumble.
In this environment, it is far from clear that the European authorities will be able to prevent a more substantial break-up of the Euro area. If Greece leaves the Euro, Portugal and Ireland would have great difficulties staying in while Italy would also be extremely vulnerable.
The only logical policy is for Europe to chop away as much of the periphery as is required to stop the infection from destroying the core. If they act quickly and promise more fiscal co-operation, then the casualty list may be small. The longer a decision is delayed, the more likely it is that countries such as Italy will also be forced out of the Euro area with the emergence of a two-tier Euro area.
Strikes hit Rome, Madrid in midst of debt debate
by Howard Schneider - Washington Post
Workers marched in Italy and Spain on Tuesday to protest planned spending cuts as new data confirmed fears of an economic slowdown across Europe. Regional stock markets dropped for a third day, with some having lost about 10 percent of their value since Friday. After a sharp sell-off Monday to start the week, the Stoxx 50 index of euro-zone companies shed another 1.8 percent on Tuesday.
U.S. stocks also slid for the third straight day on Tuesday, though they rose above the day’s lows in a late-afternoon rally. The Dow Jones industrial average closed down nearly 1 percent; the Standard & Poor’s index was down 0.74 percent; and the Nasdaq index dropped 0.26 percent.
The White House said on Tuesday that it was confident that Europe would be able to manage its growing debt crisis. "The Europeans face a difficult challenge but we believe they have both the ability and the will to meet those obligations," White House spokesman Jay Carney said during his press briefing. He said President Obama and senior aides had been in regular consultations with their European counterparts on the matter.
The market declines reflect widening concerns around the euro-area economy, as governments battle a complicated and interconnected set of problems that have confounded them for nearly two years. The situation has caused leading analysts to compare the environment to the months leading up to the 2008 collapse of Lehman Bros., and warned that a fragile global economy could not stand another financial crisis of that magnitude.
But the sense of instability is clear, from the streets of European capitals clogged with striking workers to the offices of central banks. Officials at the Swiss National Bank surprised markets Tuesday by slapping a new fixed minimum exchange rate of 1.20 francs to the euro. The Swiss have been struggling to curb their soaring currency, which has become a haven amid jitters over the euro and which threatened the Swiss economy by driving up the price of the country’s exports.
Some analysts feared a disruption in currency markets if other nations take similar measures to keep their currencies from rising as the dollar and the euro slump. The Swiss bank warned that it was prepared to buy massive amounts of foreign currency to support the new minimum exchange rate. The Swiss franc fell nearly eight percent against the euro for the day.
In Washington, the trade group representing major financial companies said it had become increasingly worried that new regulations meant to strengthen the banking system were undercutting economic growth. The Institute of International Finance said in a major study that the new banking rules, set by a committee of world central bankers convened out of Basel, Switzerland, are forcing banks to boost their capital and cash levels at a time when the economy needs stronger credit growth.
Because of the mistrust that is building, particularly in the European banking system, that capital is becoming increasingly expensive to raise — another drag on bank profits, performance and lending.
Even as the Federal Reserve Bank loosens the U.S. money supply to try to boost the nation’s economy, the bank capital rules are pushing institutions to be more conservative, said IIF managing director Charles Dallara. n"It is essential to find the right balance in this process, especially at a time of pronounced economic weakness," Dallara said.
Updated statistics showed that growth in the 17-nation euro area dropped sharply from April through July, when the region’s economy expanded just 0.2 percent compared with 0.8 percent for the first three months of the year. German factory orders fell in July, also confirming a slowdown in the area’s largest economy.
Analysts said the measures that make up the gross domestic product show that more contraction on the way: Household spending is expected to continue falling as governments cut budgets, slash public sector payrolls and take other steps to trim deficits; exports, the one bright spot for countries such as Spain and Ireland, are also beginning to dip as the world economy slackens. The data cast "further doubt on the region’s ability to grow its way out of the debt crisis," Ben May, European economist for Capital Economics, wrote in an analysis of the latest figures.
The strikes in Italy and Spain were aimed at an array of government efforts to control public debt and maintain confidence that the two countries will be able to pay their bills without the international bailout of the sort that Greece, Portugal and Ireland required this year. Italy, in particular, would strain the available euro-area resources if it needed to be rescued.
The Italian Parliament is debating how to trim its budget by $60 billion, and union members said they wanted to protect the social programs and benefits built up for Italian workers. Talks also continued Tuesday in Berlin over an expanded rescue program for Greece. Accepted in principle at a July 21 meeting of euro-area leaders, the program is foundering on a demand by Finland that Greece post collateral for its share of an upcoming emergency loan.
Failure of the 17 euro-area parliaments to approve the new program for Greece could put the country again at risk of default, which would threaten the many European banks that have loaned money to the Greek government.
U.N. Study: Austerity Measures Pushing World Economy Toward Disaster
by Tom Miles - Reuters
The pursuit of austerity measures and deficit cuts is pushing the world economy toward disaster in a misguided attempt to please global financial markets, the annual report of the United Nations economic thinktank UNCTAD said on Tuesday.
The report, entitled "Post-crisis policy challenges in the world economy," savaged U.S. and European economic policies and called for wage increases, stricter regulation of financial markets, including a return to a system of managed exchange rates, and a conscious break with market-led thinking. "The message here is very pragmatic: we need to reverse our course quickly," said UNCTAD Secretary General Supachai Panitchpakdi.
Supachai, a former head of the World Trade Organization, said the policy response to the crisis, with an emphasis on fiscal tightening, was misconceived and inept. The report's lead author Heiner Flassbeck said the global economic situation was extremely dangerous and, without more stimulus, a decade of stagnation was the best-case scenario. The current policies were a disaster, said Flassbeck, head of the globalization and development strategies division at the U.N. Conference on Trade and Development, and a former deputy finance minister in Germany.
"If interests rates everywhere are zero, and if governments stick to the policy of not only keeping fiscal deficits where they are but retrenching, cutting public expenditure, then we will end up in permanent recession," he said. "Unemployment depends very much on demand. And if you have no demand then you need government to step in with a huge program for stimulating the economy. This was the U.S. scenario in the past. Now it's worse because wages are rising less than in the past so you're going to need a bigger stimulus program."
The recovery from the financial crisis was not only jobless, which was to be expected, but it was also "wageless," he said, with Americans, Japanese and Europeans -- 70 percent of the world economy -- expecting their incomes to stagnate. In its last report a year ago, UNCTAD said a premature removal of stimulus policies might cause a deflationary spiral with attendant slumps in growth and employment around the world.
"Let's not fool ourselves. This is a realistic scenario for the whole developed world, if we do not understand the lessons now, and really quickly, because we do not have other instruments any more," Flassbeck told a news conference to launch this year's report. "To revive the economy with a wageless recovery with diminished expectations by the private economy, by private households, what are the instruments at hand? There is nothing." He said that even if things go well, global economic growth would slow to about 1.5 percent in 2012, less than half the U.N. forecast of 3.1 percent growth for this year.
The report put much of the blame for the crisis on deregulation of financial markets, which it said invited destabilizing "herd behavior" by speculators, and allowed an over-concentration of banking activities. "What we've seen in the past and we never learn is that countries seem to have excessive belief in the financial markets. And we've seen time and again that financial markets are not very sound in their judgment," said Supachai.
"But still people keep thinking that they are doing these austerity measures because they want to please the markets so that the markets give them better ratings, including the rating agencies which do not always produce the best assessment."
Flassbeck said the herd mentality was evident whenever equity markets and commodity markets all lurch in tandem on the same day, an effect that could not conceivably be caused by real swings in demand. But the world was ignoring it, he said. "If the G20 negotiations were not confidential I would tell you that it's ignored even there," he said.
A November summit of the 20 biggest economies would reach "extremely weak" conclusions on tackling the crisis and would underestimate the influence of financial markets, he said. "We have three areas where the G20 wanted to be strong. The first is the coordination of economic policy: nothing. The second is commodities speculation: more or less nothing; and the third is international global monetary order: nothing. So that's the result of nine months deliberation by the G20."
The U.N. report said the world should introduce a system of rules-based floating exchange rates, which would kill off distorting "carry trades" in which investors borrow currencies with low interest rates to buy higher-yielding currencies. The system would be based on divergences between the consumer prices or interest rates applicable to different currencies, and unlike the defunct Bretton Woods system, it would cater for continual adjustments in exchange rates.
European banks face collapse under debts, warns Deutsche Bank chief Josef Ackermann
by Louise Armitstead - Telegraph
Josef Ackermann, the chief executive of Deutsche Bank, Germany's biggest bank, has warned that "numerous" European lenders would collapse if they were forced to book their losses on stricken sovereign bonds.
Mr Ackermann said that the value of billions of euros of loans has plunged to a level that could overwhelm smaller banks. He told a conference in Frankfurt: "Numerous European banks would not survive having to revalue sovereign debt held on the banking book at market levels." Mr Ackermann said market conditions were as febrile as the height of the banking crisis. "We should resign ourselves to the fact that the 'new normality' is characterised by volatility and uncertainty," he said. "All this reminds one of the autumn of 2008."
The volatility was demonstrated as Deutsche Bank shares tumbled 8.9pc as banks led a stock markets lower across Europe. Deutsche Bank's shares closed at €23.79, valuing the company at €21.6bn (£18.9bn) - its lowest level since it completed a €10.2bn rights issue last October. The Stoxx Europe 600 banking index fell to its lowest level for 29 months. The DAX fell to its lowest level in two years.
Traders said fears over the banks' exposure to European debt were exacerbated by the uncertainty of the US legal cases and regulatory reform. The debt crisis has also squeezed bank revenues as mergers and acquisitions – as well as stock market listings – have been shelved. Trading figures have also fallen. Mr Ackermann said that bank profits will take a long time to recover.
"Prospects for the financial sector overall... are rather limited," he said. "The outlook for the future growth of revenues is limited by both the current situation and structurally."
Deutsche Bank has already warned that it could miss its target of €6.4bn pre-tax profits this year without a quick and sustainable resolution of the European debt crisis. Even so, Mr Ackermann firmly rejected the proposal by Christine Lagarde, the new head of the International Monetary Fund, for another round of recapitalising European banks.
Mr Ackermann claims that the move would be "counterproductive" and argued that "a forced recapitalisation would give the signal that politicians do not themselves believe in the measures" they have implemented to bolster fragile eurozone countries.
Ms Lagarde has said banks need another capital injection to "avert contagion". She told reporters she believed it is "necessary to recapitalise European banks so that they are strong enough to withstand the risks linked to the debt crisis and weak growth".
European Bankers Urge Leaders to Move Quickly on Debt Crisis
by Liz Alderman and James Kanter - New York Times
As the stock and bond markets seem eerily similar to the dark days of 2008, Jean-Claude Trichet and Mario Draghi, the current and incoming chiefs of the European Central Bank, pointedly urged European leaders to move quickly to ensure that the euro zone’s debt crisis does not become seriously worse.
Europe needs to "make a quantum step up in economic and political integration," Mr. Draghi said as the bond yields of Greece, Italy and other countries with weak finances jumped Monday amid investor fears that such efforts might be failing. He and Mr. Trichet addressed a forum in Paris that focused on the world three years after the collapse of Lehman Brothers.
President Obama will deliver a jobs speech on Thursday, a day before the Group of 7 wealthiest nations meet in Marseille to discuss the European and American economies. Washington wants to make sure that headwinds from Europe’s crisis do not cross the Atlantic while the United States economy remains weak.
Mr. Draghi’s call goes to the heart of what politicians now acknowledge is a root cause of Europe’s crisis, but that few seem ready to change: the lack of a federal fiscal union that would make the euro zone look more like the United States. The idea is something that Germany and others are wary of because it could undermine their national authority.
The calls for what defenders of sovereignty have called the "F word" — federalism — are growing louder, however, as investors warn that volatile financial markets are starting to look similar to the days surrounding Lehman Brothers’ collapse.
Mr. Trichet, who turns over the central bank presidency to Mr. Draghi at the end of October, renewed calls for a federal European government, with a federal finance ministry. Those institutions would have the power to "impose decisions on countries" whose own policies threaten the rest of the euro union, Mr. Trichet said at the Paris conference, sponsored by the Institut Montaigne, a research group.
In Brussels, meanwhile, an unusual gathering of former European leaders, academics and industrialists urged politicians to recognize that part of the answer to Europe’s ills was to give up some sovereignty to keep the euro alive.
"It has become clear that a monetary union without some form of fiscal federalism and coordinated economic policy will not work," the group said in a statement. Its members include a former German chancellor, Gerhard Schröder; a former Finnish prime minister, Matti Vanhanen; and Nouriel Roubini, a New York University economist. "Either the Europeans move forward," Mr. Roubini said, or face "a situation of potential breakup or disintegration."
Benoit d’Anglelin, a former Lehman banker for 15 years who is now a manager at Ondra Partners, a financial advisory firm in Paris, said he was seeing "extreme risk aversion now" by pension funds and institutional investors, who have been dumping "everything risk-related," since March. "It’s becoming unsustainable," Mr. d’Anglelin said. "Imagine what will happen if the selling gets more serious."
Despite pledges by European leaders in July to pump billions of euros more into a European Union bailout fund for debt-stricken countries, known as the European Financial Stability Facility, it is not so clear that parliaments in the 17 countries in the euro zone will approve an expansion.
It is also possible that a German constitutional court could throw the euro into chaos when it issues a ruling Wednesday on Germany’s participation in the rescue mechanism for fiscally troubled euro members. Analysts say the judges are likely to impose restrictions on the German government that could make decision making in the zone even more cumbersome than it already is.
It would be surprise if the panel of judges banned Germany from taking part altogether, a drastic step that would deprive the rescue fund of its biggest contributor and undermine the integrity of the euro. But the court could well require a vote by the German Parliament every time the bailout fund makes a big move.
Members of the advisory group that gathered Monday in Brussels, including Mr. Schröder, expressed strong support for euro bonds. Despite a fierce debate in Germany, Mr. Schröder said the German public could accept them — as long as there were strict controls placed on how and when they were issued.
Even if euro bonds win wider backing, there are other issues that threaten to upend plans for a tighter monetary union to support the euro. Finland has cast doubt on pledges of European unity by insisting that it receive collateral from Greece in return for aid, another issue that threatens to upset plans to expand the bailout fund. Finland’s prime minister, Jyrid Katainen, pledged Monday to resolve the issue quickly.
Europe’s leaders are acting like firefighters, Felipe González, a former Spanish prime minister, said at the briefing held in Brussels. "They try to deal with the current fire but not prevent the next."
Europeans Talk of Sharp Change in Fiscal Affairs
by Louise Story and Matthew Saltmarsh - New York Times
As leaders in Europe try to contain a deepening financial crisis, they are also increasingly talking about making fundamental changes to the way their 17-nation economic union works.
The idea is to create a central financial authority — with powers in areas like taxation, bond issuance and budget approval — that could eventually turn the euro zone into something resembling a United States of Europe.
Officials have been hesitant to publicly endorse such a drastic change. But privately they say the issue has gained urgency in recent months, as it has become clear that Europe’s current approach, which requires unanimity on any significant moves, is unwieldy and inefficient. The idea is being promoted by some global financial officials, who worry about the risks that continued uncertainty in Europe poses to the global economy.
Recently, for instance, when an official from a European central bank met with a financial official in Washington, his host brandished the Articles of Confederation, the 1781 precursor to the United States Constitution, to use as an example of why stronger unions become necessary.
The story of America’s failed early effort to operate as a loose confederation of 13 states is looking increasingly relevant for many European officials. The lack of strong central coordination of the euro zone’s debt and spending policies is a crucial reason Europe has been unable to resolve its financial crisis despite more than 18 months of effort.
The lack of progress has contributed to steep declines in European stocks recently, sending tremors through markets in the United States as well. On Monday alone, several major European markets fell more than 4 percent while markets were also down on Tuesday morning in Australia and Japan. And that is why, despite all the political obstacles, Europe appears to be inching closer to a more centralized approach, and some officials are going public on the issue.
"If today’s policy makers want to successfully stay the course, they will have to press ahead with structural changes and deeper economic integration," António Borges, director of the International Monetary Fund’s European unit, said in a recent speech. "To put the crisis behind us, we need more Europe, not less. And we need it now."
Nothing happens quickly in Europe, however. For the most part, such efforts are still being made behind the scenes. But several longtime financial and central bank officials and staff members said there had been a substantial step-up in planning for a closer European fiscal relationship to match the unified monetary union under which the euro zone has operated for more than a decade.
For now, officials are mainly talking in generalities. "The crisis has clearly revealed the need for strong economic governance in a zone with a single currency," Jean-Claude Trichet, the departing president of the European Central Bank, said in a speech Monday, repeating earlier calls for greater fiscal discipline.
Officials, who spoke anonymously because their discussions were politically charged, said a major overhaul of the way Europe conducts fiscal policy was likely to take a long time and require changes in the treaties governing the euro. But they pointed to the smaller changes that were already taking place as evidence that euro area financial ministries see that they have little choice but to move together if they want to avoid a catastrophic breakdown.
With the new bailout for Greece that was agreed upon by European leaders in July still awaiting approval from each country in the euro zone, the fractionalized way that Europe runs fiscal decision-making risks setting off yet another crisis at each step along the way. Every plan requires agreement among finance ministers and the Parliament of any member country can veto the deal.
Many economists say that the Continent’s debt crisis, which began in early 2010 with the threat that Greece might have to default on its loans, could have been resolved far more quickly if there were some sort of central financial body, akin to the Treasury Department in the United States.
"If they had the equivalent of the U.S. Treasury, then this treasury could have formulated proposals with the collective objective in mind, rather than 17 national objectives competing with each other," said Garry J. Schinasi, a former official with the International Monetary Fund who now privately advises European central banks and governments. "Instead, they fumbled around and took two baby steps forward and three backward."
The idea of a European Treasury that would enforce fiscal discipline on wayward countries, while also having the power to spread European Union wealth from healthier countries to ones struggling to pay their debts, is fiercely unpopular among voters in many countries. Those in prosperous nations like Germany do not want to see their taxes used to bail out countries that borrowed their way into trouble. And those in weaker nations are reluctant to allow outsiders to dictate how their governments spend their money and tax their citizens.
Europe’s currency union has its roots in the agreement signed in 1992 known as the Maastricht Treaty, which set in motion the rules for creating the euro and for joining the euro zone. A later agreement established the European Central Bank, which manages interest rates much like the United States Federal Reserve. But the Maastricht Treaty stopped short of telling countries how to handle spending or taxation, leaving them loose rules on budget deficits to follow — or break, as many did, including Germany and France in the early days of the euro.
In the United States, of course, agreements between Congress and the White House on budget measures can be extremely difficult to reach. But the European process is even more arduous. The problems were highlighted Friday when talks between the Europeans, the I.M.F. and Greece were put off because Athens was coming up short in its plans for meeting budget targets. Stock markets promptly fell on the news.
This week, more challenges await. The top court in Germany is scheduled to rule Wednesday on whether it is legal for that country’s leaders to make such an agreement. While it is expected to allow Germany to participate in the bailout, the constitutional court could surprise the experts. On Thursday, officials in Finland are supposed to make a statement outlining their conditions for approving the deal, which will probably set the pattern for other countries seeking guarantees from Greece that their loans will be paid back.
The heavy lifting involved in approving the new deal for Greece illustrates how difficult it would be to create a European Treasury. But that has not stopped some officials from calling for moves in that direction. Last month, Angela Merkel, the German chancellor, and Nicolas Sarkozy, the French president, proposed new financial transaction taxes for the euro zone, as well as standards for corporate tax laws, so no country could lure businesses at the expense of others with exceptionally low tax rates. They also proposed that each country enshrine in its constitution rules that would limit deficits, a process that is now under way in Spain, Portugal and elsewhere.
Last Thursday, Wolfgang Schäuble, the German finance minister, told the newspaper Bild that he would like to see the European Union’s treaty revised — an arduous process — to enable the union to make common fiscal policies.
An official in the German Finance Ministry, who was not authorized to speak on the matter publicly, said the ministry was trying to avoid terms like fiscal union because it would alienate voters. But he acknowledged that it saw such a union as both necessary and inevitable. "You could call it a fiscal union, but the minister won’t do that," the official said. "What we are talking about is pooling our fiscal policy and doing to fiscal policy what we’ve done with monetary policy."
The euro zone is also moving to increase oversight of countries’ budget plans earlier in the process and to give the European Commission greater power to propose financial penalties on countries that violate the rules, unless blocked by a large majority of members. If and when that happens, said Graham Bishop, an independent financial analyst who has advised the British and European Parliaments, it "would be the moment of collective control of an errant state — the final step toward a de facto political union."
Greek Woes Threaten German Coalition
by Marcus Walker and Bernd Radowitz - Wall Street Journal
Merkel Fights to Quell Rebellion as Mock Vote Shows 25 Lawmakers Oppose Legislation on Bigger Bailout Fund
German Chancellor Angela Merkel is fighting to quell a rebellion within her ruling coalition that could potentially destabilize her government, after 25 lawmakers from her center-right camp indicated they might not support legislation to strengthen Europe's bailout fund. Mock votes among lawmakers in Ms. Merkel's coalition late Monday showed she will have to fight to keep her governing majority together in a crucial ballot on Sept. 29, when Germany's parliament will vote on proposals to make the main euro-zone bailout fund bigger and more flexible.
The measures in question are a key plank of a deal struck July 21 by European leaders to restore investor confidence in euro-zone government debt. But a larger-than-expected number of backbenchers from Ms. Merkel's Christian Democrats, as well as from her junior coalition partners the Free Democrats, refused to support the measures in Monday's mock votes. The lack of support is a public signal of dissent within the ranks of the party.
Germany's parliament is widely expected to pass the measures despite the unrest in government ranks, because opposition parties have said they will back the legislation. But reliance on opposition votes would be a severe embarrassment for the chancellor, raising questions about the survival of her government. The unrest within the coalition reflects many lawmakers' belief that ever-expanding bailouts of poorer euro nations pose a growing risk to German taxpayers.
The chancellor is expected to lobby her backbenchers hard to support the legislation. Some of the lawmakers who abstained or objected in the mock votes may bend to pressure and support the government on Sept. 29, analysts say. Failure to pass the euro-zone measures with her own coalition's votes in parliament could trigger a political crisis in Germany, since it would show that Ms. Merkel doesn't have an effective ruling majority on the biggest issue currently facing the country and Europe.
The chancellor's ability to enact other euro-zone overhauls—such as the greater coordination of euro members' fiscal policies and debt management that most economists now say is needed to shore up Europe's common currency—would also be in doubt. Germany's ruling center-right coalition has 19 more votes than it needs to maintain a majority of 311 votes in parliament. In the mock votes, 14 lawmakers opposed the measures to beef up the euro-zone bailout fund, while 11 others abstained.
The legislation in question would increase the lending capacity of the main euro-zone bailout fund, the European Financial Stability Facility, to €440 billion ($620 billion) from €250 billion, while also allowing the fund to lend more flexibly to governments and to buy sovereign bonds in the secondary market.
The European Central Bank is pushing national governments to implement these changes as soon as possible. The ECB has reluctantly propped up the prices of Italian and Spanish government bonds through secondary-market purchases since early August, but wants the government-backed bailout fund to take over such activities in order to protect the central bank's independence.
Ms. Merkel's challenge in maintaining support for her euro-zone policies within her coalition is being hampered by events in Greece, where the government is struggling to achieve the reduction of its budget deficit that was supposed to be the quid pro quo for receiving emergency loans from Germany and the rest of the euro zone.
German Finance Minister Wolfgang Schäuble reminded Greece on Tuesday that each quarterly disbursement of international loans depends on Greece making progress on its deficit. In a speech to Germany's parliament, Mr. Schäuble reiterated that Athens can't get its next tranche of aid unless it satisfies the team of international inspectors from the European Union, ECB and International Monetary Fund that is monitoring Greece's progress.
Greece's government, responding to the rebukes from Germany and elsewhere in Europe, vowed Tuesday to increase the pace of its economic overhauls. Finance Minister Evangelos Venizelos told reporters the government would step up efforts to shrink the public sector, privatize state industries and liberalize the economy. His remarks followed a Greek cabinet meeting that was called to discuss the country's faltering reform drive.
The outcome of Ms. Merkel's struggle in parliament partly depends on a ruling, expected Wednesday, by Germany's constitutional court, which has been considering lawsuits against German participation in the European bailout programs for Greece, Ireland and Portugal. If the court rules that those bailout decisions were legally sound, it could help Ms. Merkel disarm some of the criticism within her coalition, analysts say.
If court demands a bigger say for Germany's parliament in future bailout decisions, as many analysts expect, that too could help Ms. Merkel reassure her lawmakers—though it could make it harder for Europe to make fast decisions if the debt crisis escalates.
Italy's government, like Greece's, is frustrating European authorities with its sputtering reform ambitions. Rome on Tuesday said it will again revamp its efforts to close its budget deficit, even as tens of thousands of Italians took to the streets to protest the austerity drive.
Fed Struggles With Twisted Logic
by David Reilly - Wall Street Journal
Even if the Fed "twists," the economy may not dance with it.
Friday's disappointing jobs figures heightened investor expectations the Federal Reserve will embrace more extraordinary easing at its late-September meeting. Monday's European stock plunge will only fuel such thinking. One likely course of action: The Fed will shift, or "twist," its $1.65 trillion portfolio of Treasury securities to hold more long-dated government debt.
Market reaction would depend on the type of "twist." In one scenario, yields on short-dated government debt could rise, for example, while those on the 10-year note could fall further as the Fed boosts purchases in this area.
Detail aside, what impact would such a move have on the economy? Probably not much. In some ways, the "twist" is similar to the Fed's so-called quantitative-easing programs in which it bought Treasurys, Michael Cloherty, head of U.S. rates strategy at RBC Capital Markets, noted in a report Friday. The advantage, he added, is "the QE brand name is fairly tarnished now, so there is some good done by having a different label on a similar policy."
Labels aside, central-bank easing policies typically encourage businesses to borrow and invest due to lower rates. But companies are already reluctant to expand despite already super-low rates. A twist isn't likely to change that.
Another benefit should be lower mortgage rates. Yet, again, they are already at historic lows, while home prices are down and housing supply plentiful. With buyers hesitant, even lower rates may well not reflate housing markets.
Finally, some might hope a twist would boost confidence by sparking a stock rally like that from the last $600 billion bond-buying program. Yet "twisting" wouldn't expand the Fed balance sheet. And it may give the impression the Fed is clutching at straws, especially given skepticism on the effectiveness of the last QE program in boosting the economy.
Meanwhile, there are potential downsides. The Fed would be extending its manipulation of markets explicitly to the long end of the yield curve. This means investors will lose even more clarity on the yield curve as a way of signaling or seeing views on long-term inflation and growth. The Fed would also stoke fears it is monetizing government debt longer-term. That could increase political pressure on the Fed, further weaken the dollar and send gold to new heights.
And those are apparent risks. "The Fed might think it knows what the results will be, but surprises have hidden in every extraordinary move the Fed has made the last three years," Jim Vogel of FTN Financial points out. Unfortunately, hidden surprises aren't likely to include plunging unemployment or surging economic growth. As the Fed itself has acknowledged, its ability to cure the economy is growing more and more limited.
Italy strikes as race to pass austerity starts
by James Mackenzie - Reuters
Workers across Italy began a strike on Tuesday as the center-right government of Prime Minister Silvio Berlusconi scrambled to secure parliamentary backing for a package of austerity measures.
The eight-hour strike called by the CGIL, Italy's largest union, is expected to disrupt public transport including air traffic, underlining a sense of emergency in the euro zone's third largest economy. The strike, called to protest the 45.5 billion euro ($64 billion) austerity measures, coincides with the opening of a debate in the Senate which the government hopes will see swift approval before the package moves to the lower house.
In an unusual statement that highlighted the gravity of the situation after a sell off of Italian bonds on Monday, President Giorgio Napolitano said urgent action was needed to restore trust in public finances. "It is a sign of the persistent difficulty in regaining trust as is urgently and indispensably required," he said, adding that he urged all parties not to block measures needed to restore credibility. He said there was time to insert measures "capable of reinforcing the efficiency and credibility" of the austerity package passed in parliament last month. It is currently undergoing revision.
Business daily Il Sole 24 Ore said an increase in VAT, a measure so far resisted by Economy Minister Giulio Tremonti, may be included in the package as well as a possible delay to retirement ages. Tuesday's debate in the Senate is due to start at 4.30 p.m. (10:30 a.m. ET) with upper house approval possible as early as Wednesday after the center-left opposition Democratic Party said late on Monday it was willing to allow a swift vote. The package would then move to the lower house before final approval, originally expected by September 20.
The European Central Bank has been shielding Rome from the full force of the market by purchasing Italian bonds to try to hold down yields and stop borrowing costs from reaching unsustainable levels. But its patience has been stretched by the chaotic manner in which the austerity package has been handled and by the absence of concrete steps to meet the government's pledge of balancing the budget by 2013.
On Monday, Mario Draghi, who takes over as head of the ECB in November, stepped up calls for Italy to act, delivering a pointed warning that the central bank's willingness to continue buying bonds "should not be taken for granted."
In a clear sign of rising market worries, yields on Italian 10-year bonds climbed to nearly 5.6 percent on Monday, approaching the levels of more than 6 percent seen before the ECB began buying bonds last month.
The premium investors demand to buy Italian bonds rather than benchmark German debt widened to 369 basis points, more than 30 points higher than the equivalent Spanish spread as Italy has moved firmly to the center of the euro zone crisis. "Italy is today the weak point of the euro. Its weakness risks irreparably the whole European construction, multiplying the damage for us as well," Turin daily La Stampa said in a front-page editorial.
Italy's European partners have been watching with alarm as government wrangling has overshadowed the package. German Chancellor Angela Merkel told members of her party on Monday that the situation in Italy was "extremely fragile." Italy has wrestled with sluggish growth and one of the world's highest levels of public debt for years but a modest deficit, high private savings and a conservative banking system had kept it largely on the margins of the crisis until July.
Berlusconi's government, which until recently boasted repeatedly of keeping Italy out of the crisis, has struggled to build a defense against the market pressure, hampered by deep divisions in its own ranks over tax and pension issues. Measures ranging from a tax on high earners, retirement delays for some university graduates, cuts to local government funding or the abolition of small town councils have been proposed and then dropped with bewildering speed.
In their place, Tremonti is putting his faith in stepped up measures to combat tax evasion despite a long history of failure by successive Italian governments. Berlusconi and Tremonti have appeared increasingly at odds over the package, heightening speculation of a possible political crisis which could bring down the government.
Further complicating the picture, Berlusconi has also been hit by a new legal case, following the arrest of a businessman last week on charges of attempted extortion of the premier in connection with a two-year-old prostitution scandal.
Athens, Rome Hold Europe to Ransom
by Simon Nixon - Wall Street Journal
Europe is engaged in a high-stakes game of brinkmanship that poses grave risks to the global economy. At last weekend's Villa d'Este Forum in Italy, European policy makers didn't hide their fury at Greece's back-sliding over promised structural reforms and spending cuts. At the same time, Italian ministers undermined the remaining credibility of Silvio Berlusconi's government with a series of complacent speeches. Given such a dangerous breakdown in trust within Europe, investors are right to fear the worst.
Germany and its Northern European allies believe only intense market pressure can force weak economies to cut spending and improve competitiveness. But Greece has learned that whenever the crisis in Europe's periphery threatens to overwhelm the core, Europe will ignore previous broken promises and step up with a fresh bailout.
Italy now appears to be making the same calculation. The government insists it will fulfill its commitment to balance the budget by 2013, but ministers show no appreciation of the urgent need for structural reforms to address the chronic weakness of an economy that grew on average 0.3% between 2001 and 2010 and experienced a 25% increase in unit labor costs relative to Germany over the same period. Instead, they talk incessantly of euro-zone bonds as a solution to misfortunes they blame largely on external forces.
But Italy's dream of euro-zone bonds is likely to remain a fantasy until trust between member states is restored. This no longer depends simply on implementing austerity budgets. Structural reforms have now taken center stage because they are a test of whether the euro zone is worth saving at all: If countries refuse to improve competitiveness, then any attempted solutions to the immediate sovereign-debt crisis will prove short-lived.
So what can be done about Greece and Italy? Athens rejects accusations it is dragging its feet but has promised to use a 10-day hiatus in talks with the European Central Bank and International Monetary Fund over progress toward its bailout targets to speed up reforms. If it fails to deliver again, European policy makers now talk darkly of a total loss of fiscal sovereignty. How this might work in practice isn't clear.
As for Italy, some now believe its best hope lies with the ECB, which last month threw Rome a life line by agreeing to buy its bonds. If the ECB were to stop buying bonds, the subsequent rise in yields might bring down Mr. Berlusconi's administration, paving the way for President Giorgio Napolitano to appoint a technical government with the constitutional authority to make tough decisions. Then, at least, the long process of rebuilding the credibility of the euro zone's third-biggest economy could begin in earnest.
In Euro Zone, Banking Fear Feeds on Itself
by Landon Thomas Jr. and Nelson D. Schwartz - New York Times
Remember the collapse of Lehman Brothers? Europeans certainly do.
As Europe struggles to contain its government debt crisis, the greatest fear is that one of the Continent’s major banks may fail, setting off a financial panic like the one sparked by Lehman’s bankruptcy in September 2008.
European policy makers, determined to avoid such a catastrophe, are prepared to use hundreds of billions of euros of bailout money to prevent any major bank from failing.But questions continue to mount about the ability of Europe’s banks to ride out the crisis, as some are having a harder time securing loans needed for daily operations.
American financial institutions, seeking to inoculate themselves from the growing risks, are increasingly wary of making new short-term loans in some cases and are pulling back from doing business with their European counterparts — moves that could exacerbate the funding problems of European banks.
Similar withdrawals, on a much larger scale, forced Lehman into bankruptcy, as banks, hedge funds and others took steps to shield their own interests even though it helped set in motion the broader market crisis. Turmoil in Europe could quickly spread across the Atlantic because of the intertwined nature of the global financial system. In addition, it could further damage the already struggling economies elsewhere.
"This crisis has the potential to be a lot worse than Lehman Brothers," said George Soros, the hedge fund investor, citing the lack of an authoritative pan-European body to handle a banking crisis of this severity. "That is why the problem is so serious. You need a crisis to create the political will for Europe to create such an authority, but there is still no understanding as to what the authority will do."
The growing nervousness was reflected in financial markets Tuesday, with stocks in the United States and Europe falling 1 percent and European bank stocks falling 5 percent or more after steep drops in recent weeks. European bank shares are now at their lowest point since March 2009, when the global banking system was still shaky following Lehman’s collapse.
Investors also continued to seek the safety of United States Treasury bonds, as yields on 10-year bonds briefly touched 1.90 percent, the lowest ever, before closing at 1.98 percent.
Adding to the anxiety, several immediate challenges face European officials as they try to calm markets worried about the debt crisis spreading.
In the coming weeks, the 17 countries of the euro currency zone each could agree to a July deal brokered to bail out Greece again and possibly the region’s ailing banks. Along with getting unanimity, more immediate obstacles could trip up the agreement.
On Wednesday, Germany’s top court upheld the legality of Berlin’s rescue packages, but said any future bailouts for debt-stricken euro zone countries must be approved by a parliamentary panel. On Thursday, officials in Finland are to express their conditions for approving the deal, and other countries may follow with their own demands to ensure their loans will be paid back.
Though they have not succeeded in calming the markets, European leaders have taken a series of steps to avert a Lehman-like failure. New credit lines have been opened by the European Central Bank for institutions that need funds, while the proposed Greek bailout would provide loans to countries that need to recapitalize their banks. In addition, the central bank has been buying up bonds from Italy and Spain, among other countries, to keep interest rates from spiking. Many of these have been bought from European banks, effectively allowing them to shed troubled assets for cash.
While the problems in smaller countries like Greece and Ireland are not new, in recent weeks the concerns have spread to banking giants in countries like Germany and France that are crucial to the functioning of the global financial system and are closely linked with their American counterparts. What is more, worries have surfaced about the outlook for Italy, whose debt dwarfs that of other smaller troubled borrowers like Greece.
"It seems like the banking sector globally is being hurt on multiple fronts," said Philip Finch, a bank strategist with UBS in London. "It’s definitely getting worse."
In Europe, the worry is that government bonds owned by European banks could fall sharply in value if economically distressed countries cannot pay back their loans. That would saddle the most exposed banks with huge losses. As a result, banks are reluctant to lend money to one another and are hoarding cash. "If sentiment continues to deteriorate, ultimately we’ll see a deposit run," Mr. Finch said. "I’m extremely worried about that."
Mr. Finch said European banks needed to raise at least 150 billion euros in new capital, even if they do not experience large losses on sovereign debt. With stock prices so low, though, that is difficult to do, and any new offerings of company stock would dilute the value of existing shares. American money market funds, long a reliable financing source for capital starved European banks, have sharply cut back on their exposure — starting in Spain and Italy but now also France — making it harder for European banks to loan dollars.
The 10 biggest money market funds in the United States cut their exposure to European banks by a further 9 percent in July, or $30 billion, after a reduction of 20 percent in June, the Institute of International Finance said in a report issued Monday.
"U.S. investors remain very sensitive to the headlines out of Europe," said Alex Roever, who tracks short-term credit markets for JPMorgan Chase. "The sell-off that we’ve seen in European bank stocks is going to reinforce that and investors are likely to stay hyper-cautious. European banks are not borrowing as much, and they’re not borrowing for as long as they could three months ago."
Nevertheless, American institutions remain vulnerable to problems their French counterparts might encounter. At the end of the second quarter, JPMorgan Chase reported total cross-border exposure of $49 billion to France, while Citigroup had $44 billion and Bank of America had $20 billion.
French banks, which have huge holdings of sovereign debt from countries across Europe, have been among the hardest hit, despite the French government’s efforts to protect them. The authorities imposed a temporary ban on short-selling last month after shares in Société Générale, a bank considered too big to fail, tumbled on rumors it may be insolvent.
But shares of Société Générale are still sliding amid concern that it, like BNP Paribas and other major French banks, is having trouble raising dollars to finance its American and other dollar-based operations. Société Générale officials say that the market’s fears are unfounded. The bank’s chief executive, Frédéric Oudéa, has described rumors that Société Générale was having trouble raising money as "fantasy." The shares closed down 6 percent Tuesday at 18.93 euros. Three months ago the shares were at 40. What is more, French banks, like other European banks, are able to obtain financing from the European Central Bank if necessary.
Meanwhile, problems in Spain were highlighted on Tuesday when one of Spain’s largest savings banks, Caja de Ahorros del Mediterráneo, reported a startling increase in bad loans to 19 percent of overall lending from 9 percent at the end of last year. Still, the huge stockpile of euros that banks have stashed away at the European Central Bank at rock-bottom interest rates — last night it hit a recent high of 166 billion euros — suggests that no bank is close to a Lehman-like failure.
The risk now is that Europe’s resistance to recapitalizing its banks could turn into a broader crisis. Daniel Gros, director of the Center for European Policy Studies in Brussels, had a blunt explanation of why European governments have so far refused to recapitalize their banks. "They don’t have the money and they are in the pockets of their bankers," Mr. Gros said. Policy makers in the United States and Britain, where compulsory infusions of new capital played a crucial role in calming the markets in 2008, have long urged Europe to do the same.
Swiss National Bank stuns market with franc action
by Peter Garnham and Haig Simonian - FT
The Swiss National Bank stunned financial markets on Tuesday by setting a ceiling for the Swiss franc against the euro in an attempt to prevent the strength of its currency from pushing its economy into recession.
The central bank said it would set a minimum exchange rate of SFr1.20 against the euro. The SNB action came after previous measures to weaken its currency proved ineffective as the worsening eurozone crisis prompted a flight to safety by investors, boosting haven demand for the franc and sending it up to record levels.
Analysts said the move raised the stakes in the global currency war as countries vie to protect their exporters and, by removing a release valve for investors looking for a haven from current market turmoil, could heighten instability on financial markets. "The start of full-on currency wars has started in earnest," said Maurice Pomery, chief executive at Strategic Alpha. "After currency wars come trade wars and as we see the exporting world pressured as the developed world contracts, tensions will rise."
The surprise move prompted the franc to fall 8.2 per cent against the euro to SFr1.2015 in a matter of minutes and to lose 8.8 per cent against the dollar to SFr0.8563. Switzerland’s stock market surged, with Zurich’s SMI gaining 4 per cent.
The SNB said the current massive overvaluation of the Swiss franc posed an acute threat to the Swiss economy and carried the risk of pushing it into deflation.
"The Swiss National Bank is therefore aiming for a substantial and sustained weakening of the Swiss franc," the central bank said in a statement.
"With immediate effect, it will no longer tolerate an exchange rate in the euro against the Swiss franc below the minimum rate of SFr1.20. The SNB will enforce this minimum rate with the utmost determination and is prepared to buy foreign currency in unlimited quantities." The SNB added that: "even at a rate of SFr1.20 per euro, the Swiss franc is still high and should continue to weaken over time. If the economic outlook and deflationary risks so require, the SNB will take further measures."
The move was a significant departure for the central bank, which in recent weeks has been attempting to rein in the franc by flooding the money market with liquidity and using FX swaps to drive interest rates lower.
The commitment could expose the SNB to further massive losses. The central bank, which is in part privately owned, lost almost SFr20bn last year after fruitless interventions in the foreign exchange markets in 2010 left it holding massive quantities of euros and dollars, whose value steadily declined in Swiss franc terms.
Although the SNB abandoned its intervention strategy in July 2010, the bank suffered further losses of about SFr10bn in the first half of this year as its foreign currency holdings further declined in value against the surging franc. Many predicted that the market would test the central bank’s resolve, given that a major source of the strength of the franc – concerns over eurozone government debt – were beyond its control.
Lena Komileva, a strategist at Brown Brothers Harriman, said the move marked a shift in the SNB’s strategy to weaken the franc from a covert psychological war with the market to open arm-wrestling.
"Since the euro remains in a vortex of deteriorating structural, cyclical and financial systemic risks, the incentives for the market are now aligned one-way to sell the euro at the overvalued level set by the SNB," she said. "This will leave the SNB intervening in the market on a continuous daily basis to protect the peg, with volatile and disorderly euro capital markets only diminishing the SNB’s psychological threat."
Guido Mantega, Brazil’s finance minister who warned on currency wars last year, described the setting of a peg by the Swiss central bank as an act of "desperation". Brazil has launched numerous currency and capital controls to try to limit the real’s appreciation. "We don’t need to [set a peg]. It’s always better to work with a floating exchange rate," he said.
Analysts said the SNB’s intervention could prompt retaliatory action from other central banks, potentially prompting Tokyo to launch a fresh attempt to weaken the yen, which like the franc has been driven to record levels as investors have sought a haven from market turmoil. "The announcement now raises the potential risk that other central banks will also make surprise announcements to deal with this new round of risk aversion," said Divyang Shah, analyst at IFR Markets.
Separately, one of Switzerland’s leading economic forecasters warned on Tuesday the economy was on the brink of a recession because of the strong currency and weakening world economy. BAK Basel cut its forecast for Swiss economic growth next year to just 0.8 per cent, less than half the 1.9 per cent estimated for this year.
Fears that bond markets are turning Japanese
by Richard Milne and Michael Mackenzie - FT
It might only be a number or a psychological barrier for markets. But the 2 per cent level that 10-year US Treasury and German Bund yields have dived under in the past few days is hugely significant.
The only other big western government bond market to go below 2 per cent in recent times was Japan. Since it dropped beneath that level in 1997, it has only risen above 2 per cent for a few weeks in 1999 and an even shorter period in 2006. Otherwise Japanese yields have been marooned at historically low yields for the past 14 years.
That was accompanied by an extraordinary collapse in Japanese stocks with the Nikkei 225 now standing at under a quarter of its peak level of 1989. It is a profoundly sobering thought for western investors who saw Treasuries yesterday hit their lowest yields since 1950 and Bunds their lowest ever while stock markets continued their summer slump. If it persists, it would threaten to change some of the main tenets of asset allocation and investing.
"It is decision time for investors," says Rod Davidson, head of fixed income at Alliance Trust Asset Management in Edinburgh. "If you believe in a Japan-style situation, almost all bets are off. Equities suffer, corporate credit widens and you would want to own long-dated government bonds. But there are question marks over even that as you start to worry about the solvency of governments."
But how likely is it that western bonds and equities do go fully Japanese? Some investors, shareholders in particular, remain relatively cautious of making the suggestion, not least because of its implications. The comparison between bond and equity yields is one of the most frequently used valuation tools and a firm part of many asset allocation decisions. A continued slide in bond yields would turn this on its head.
However, if the past few decades of market history holds true, that leaves a large group of investors to believe that equities look better value currently than bonds. The FTSE indices for the US, UK and eurozone have dividend yields of 2, 3.5 and 4.5 per cent, according to FTSE data. That compares with US, UK and German 10-year government bond yields of 1.95, 2.3 and 1.81 per cent on Tuesday, according to Tradeweb.
"The level of bond yields themselves is not telling you that equities are a value trap," says Mislav Matejka, equity strategist at JPMorgan. He argues that a crucial difference to Japan is that companies are "strong and profitable" in the west unlike the experience in the 1990s in Tokyo.
But others are gloomier, arguing that bond investors have been ahead of stock markets throughout the crisis. "Every time we have seen a divergence between the Treasury and equity markets, bonds have been right and it appears to be the case once more," says Jack Ablin, chief investment officer at Harris Private Bank. "The current level of the S&P 500 is pricing in a decline of 20 per cent for earnings, but if we get a recession, I’m concerned that profits could fall further."
Bond investors are by their nature more pessimistic, often doing well when fears about the economy are at their worst. So it is unsurprising to find many of them buying into the Japan argument. "The US faces a lost decade and we are already three years into this," says David Ader, analyst at CRT Capital. "The US has followed Japan with a housing collapse and a generic deleveraging that leaves us with banks still not willing to lend and businesses not expanding."
He also thinks the US, like the case with Japan, has its own version of political weakness and demographic concerns, led by baby boomers facing retirement. He therefore thinks 10-year yields could go to 1.65-1.75 per cent should US growth stall at 1 per cent.
But not all bond investors believe that the lurch lower can continue for much longer. Mr Davidson points to the fact that most traders have only known declining US yields as they have consistently fallen over the past three decades. "We have been dumbfounded at the levels yields have reached. We don’t really believe the move but it is hard to fight it," he adds.
Bond traders are expecting further policy initiatives from both central banks and governments. In particular, they anticipate the Federal Reserve will undertake further easing, possibly buying more longer-term Treasuries in order to narrow the gap to shorter-dated yields. But, with the 10-year note yield already below 2 per cent, the bond market has largely priced in such a move already.
Instead, some fret that the effectiveness of new stimulus measures is wearing off. "The perspective has changed, the debt stimulus of the past 30 years has met its conclusion, but we are still trying to squeeze the last remnants of toothpaste out of the tube," says Mr Ablin.
The worries about a Japanisation of western markets remain acute. One reality seems inescapable whichever way investors vote. As Mr Matejka says: "It is very reasonable to believe that potential growth in the developed world will be lower than it was in the past 20 years. Therefore the rates of return on most asset classes should be lower."
Italy makes last-minute budget U-turn
by Guy Dinmore in Rome and Rachel Sanderson - FT
Silvio Berlusconi’s centre-right government caved in to pressure from bond markets and European partners late on Tuesday by announcing a last-minute U-turn to strengthen Italy’s proposed austerity package.
After more than three weeks of flip-flopping, the prime minister’s office announced that the highest value added tax band would be increased to 21 per cent from 20 per cent; that a 3 per cent wealth tax would be imposed on top earners, and that introduction of a later retirement age for women would be brought forward. The cabinet also plans to meet again on Thursday to discuss proposed changes to the constitution to enforce balanced budgets and simplify multiple tiers of local government.
The amendments bolster a budget bill that had been criticised by both the European Central Bank and the European Commission and dismissed by bond market investors as inadequate. Prevarication in Rome had added to the sense of crisis gripping the eurozone over the sovereign debt levels of a widening circle of member states, with Italy’s debt equal to 120 per cent of gross domestic product considered too vast for an external bailout.
Rather than restoring confidence , the latest changes reinforced the image of a government in disarray. The amendments represented climbdowns for all major figures involved in the messy budget process. Giulio Tremonti, finance minister, had opposed an increase in VAT; Mr Berlusconi had blocked a wealth tax, and Umberto Bossi, leader of the allied Northern League, had resisted pension changes.
Adding to the confusion, Ignazio La Russa, defence minister, told reporters late on Tuesday that the new wealth tax would be applied to incomes over €300,000 euros rather than €500,000 previously communicated. "Of the three new measures, only the VAT hike will have an immediate and sizeable impact on the budget … In order for investors to take a more positive view on Italy, measures to boost economic growth will also be necessary," said Riccardo Barbieri Hermitte, chief European economist at Mizuho International.
Business leaders in Milan agreed the budget could only be the start and that the economy needed greater structural reforms. "The market wants to see substantial cuts in spending. Some increased taxes will not be enough to diminish all concerns," a senior banker said. The changes are likely to fuel further opposition in the streets following an eight-hour national strike staged by the main trade union federation on Tuesday in protest against a budget widely seen as unfairly punishing lower income earners. Opposition parties were quick to condemn the new measures.
Milan’s stock market recouped some of its losses after the news but still closed down nearly two per cent. Italian bond markets, however, reversed an 11-day losing streak, the longest since the launch of the euro, with yields on 10-year bonds falling to 5.48 per cent. Traders estimated that the ECB, seeking to shore up confidence, had bought about €3bn in Italian and Spanish bonds on Tuesday.
The government announced it would curtail debate over the legislation by calling for a vote of confidence in the senate on Wednesday. Final approval from the lower house by the end of the week will test the strength of Mr Berlusconi’s thin majority.
German austerity drive risks Euro-slump
by Ambrose Evans-Pritchard - Telegraph
German finance minister Wolfgang Schäuble has vowed to halt rescue payments to Greece unless the country complies totally with the EU-IMF demands, brushing aside warnings that a Greek collapse would set off a disastrous chain reaction and a global banking crisis.
"The next tranche can be paid only when the conditions have been met. There is no room for manouvre here," he told the Bundestag. Yields on 10-year Greek debt spiked to a fresh record of 19.8pc on fears of a disorderly default.
The tough words reflect sentiment in Berlin that Greece should be left to its fate or even be ejected from the monetary union, even though the chief reason Greece has failed to meet its deficit target is the crushing effect of recession. The economy will have shrunk by 12pc by the end of this year, playing havoc with debt dynamics.
Mr Schäuble rebuffed calls from the International Monetary Fund for a softening of Europe’s austerity drive. "Piling on more debt now will stunt rather than stimulate growth in the long run. Highly indebted Western democracies need to cut expenditures, increase revenues and remove structural hindrances in their economies, however politically painful," he wrote.
German insistence on deflation polices is causing near universal despair. Spain’s leader Jose Luis Zapatero - who told union leaders at a closed-door gathering that the economy was "sliding into the abyss" - called for global action "through the G7 or the G20" to shore up Europe’s financial system.
Berkeley professor Barry Eichengreen said Europe’s rescue fund (EFSF) is too small to save the eurozone, leaving the creditor powers of Asia as the last hope. "Europe’s leaders have shown themselves incapable of breaking the vicious cycle, raising the danger of the European crisis becoming a global crisis. It is now past due time for the IMF and G20 to intervene," he said.
"Asia’s own stability hinges on the stability of the world economy," he said, callling for a variant of the "Brady bond" plan used in Latin America. Charles Dumas from Lombard Street Research said German policies - enforced by EU bodies - will doom the eurozone to a slump. "Here is the stubborn folly of the sound-money men of the 1930s," he said.
"Pursuit of debt reduction by deflation only - in a world whose savings rate is already at an all-time high - means Euroland recession next year could well be prolonged and deepened into depression. At the root of this are fallacious and malignant policies," he said.
Mr Dumas said Germany is not only pursuing a "predatory trade policy" within EMU through a misaligned currency but is also blindly forcing a downward slide for the whole system by compelling the deficit states to choke demand without offsetting stimulus in Germany and creditor states. German factory orders fell 2.8pc in July and confidence indicators have plunged, suggesting that Germany itself may be near recession. Car parts giant Bosch said the economy was in an "extremely critical condition".
Political pain was in evidence in cities across Italy on Tuesday as protesters scuffled with police and trade unions launched a general strike to protest austerity. Italy’s cabinet agreed to further measures to stave off a spiralling debt crisis, accepting a rise in value added tax from 20pc to 21pc, a higher retirement age for women after 2014, and a 3pc wealth tax on those earning more than €500,000, on top of swingeing cuts to the regions.
Premier Silvio Berlusconi appeared to backslide last week. He was forced to submit after Italy’s 10-year yields surged to 5.57pc and spreads over Bunds hit fresh highs. Yields had dropped earlier to 5pc after the European Central Bank launched mass bond purchases. However, the ECB is switching intervention on and off to pressure the government. Mario Draghi, the Bank of Italy’s governor and the ECB’s next chief, said Rome should not "count on" intervention.
Separately, Slovakia said its parliament would not ratify the July deal to boost the EFSF rescue fund before December, meaning that it will not be operational before February. It is unclear whether the ECB can step in to hold the line in Italy and Spain for that long. An internal vote on the EFSF package by parties in Chancellor Angela Merkel’s coalition in Germany showed that 25 of her Bundestag deputies will vote against the measure or abstain, risking the downfall of the government.
Germany’s consitutional court is expected to demand further powers for the Bundestag when it rules on the legality of Europe’s bail-out machinery on Wednesday. There is an outside "tail risk" that it will go further, restricting Germany’s ability to participate in rescues until there is a fresh EU Treaty. That would be an earthquake.
BNP Paribas Says It Has 'Excess' of Dollar Short-Term Liquidity
by Fabio Benedetti-Valentini - Bloomberg
BNP Paribas SA, France’s largest bank, said it has "an excess of short-term liquidity" in U.S. dollars and that the company has to deposit the extra funds at the U.S. Federal Reserve. "It is an additional clue of how much jammed the interbank market is," said Christophe Nijdam, a Paris-based analyst at AlphaValue. "There is no obligation to deposit excess U.S. dollar funds at the Fed as far as I know. It could be deposited with other banks."
BNP Paribas has "a sizeable liquidity buffer," the Paris- based bank said in a note to clients and investors dated Sept. 6 and obtained by Bloomberg. The lender joins Societe Generale SA and Credit Agricole SA, France’s second- and third-biggest banks, respectively, in providing details on financing from U.S. money-market funds. Societe Generale has fallen 52 percent this year in Paris trading amid funding concerns and the European sovereign-debt crisis. BNP Paribas has declined 36 percent in the period.
In August, BNP "experienced a shortening in maturities available and some decrease in the amounts coming from U.S. money-market funds," the bank said. The company gets U.S. dollar short-term funding from sources including corporates, central banks and wealth-management clients with financing in the currency spread across the U.S., Gulf countries, Asia- Pacific and Western Europe, it said, without giving any figure for U.S. dollar funding needs.
Passing On Costs
"Alternative U.S. dollar funding sources are of course more expensive and we have to pass that additional cost on to our U.S. dollar borrowing clients," BNP Paribas said. "In practice, some of them may not accept and U.S. dollar funding needs may come down." "This shows a bias in favor of trading activities rather than financing the real economy," said AlphaValue’s Nijdam. For a bank, "it’s much easier and faster to decrease the trading book rather than the loan book," he said.
The reduction in the willingness of banks to lend to each other is mostly an anticipation of new Basel rules and "not mainly due to counterparty risk issues," the French lender said. The interbank market situation today "is very different" compared with the crisis that followed Lehman Brothers Holdings Inc.’s 2008 collapse, the company said. BNP Paribas reiterated that it has about 150 billion euros ($211 billion) of assets eligible to central banks, including $30 billion eligible to the Fed, according to the note. The lender also repeated it completed its 2011 medium- and long-term funding program of 35 billion euros.
The euro region has a "core of wealthy and sound countries," BNP Paribas said. The bank doesn’t see a "specific risk" that France’s sovereign debt might be downgraded after Standard & Poor’s last month lowered the U.S.’s credit rating to AA+ from AAA on Aug. 5. BNP Paribas should "gradually" comply with capital requirements for systemically important financial institutions with no need of any capital injection, it said.
Many baby boomers don't plan to leave their children an inheritance
by Walter Hamilton - Los Angeles Times
Unlike previous generations, some baby boomers believe they've already given their children enough, and they plan to spend the money they've saved on themselves.
Carol Willison has made lots of financial sacrifices for her two children over the years, including paying most of her older daughter's medical school tuition. But Willison's generosity has reached its limits. Not only doesn't the 60-year-old Seattle woman plan to leave her daughters an inheritance when she dies, she's trying to spend every last dime on herself before she goes. "My goal is when they carry me away in that box that my bank account is going to say zero," Willison said. "I'm going to spoil myself now."
Upending the conventional notion of parents carefully tending their financial estates to be passed down at the reading of their wills, many baby boomers say they instead plan to spend the money on themselves while they're alive. In a survey of millionaire boomers by investment firm U.S. Trust, only 49% said it was important to leave money to their children when they die. The low rate was a big surprise for a company that for decades has advised wealthy people how to leave money to their heirs. "We were like 'wow,'" said Keith Banks, U.S. Trust president.
Whether to leave an inheritance is a decision increasingly faced by many of the nation's 77 million baby boomers, and it's becoming all the more complicated by the troubled economy. Boomers are caught between the desire to enjoy their long-awaited golden years and the pressure of various financial concerns, such as fear of outliving their savings and the need to help parents, children or siblings who have their own money struggles.
Many boomers, who range in age from roughly 47 to 65, simply believe that after years of hard work they can spend their money as they choose, experts say. They spent their lives building businesses and careers, often at the expense of their health or personal relationships. And after years of footing the bill for their kids' pricey educations, they see no reason to curb their spending impulses in their later years.
Besides, they figure, their kids will get something since nobody can synchronize their demise precisely to the emptying of their bank accounts. "I do not see my baby boomer clients giving up a vacation or wine or dinners out so that they can leave more money to their children, because they feel like they've already done it for their kids," said Susan Colpitts, executive vice president of a wealth management firm in Norfolk, Va. "They say, 'If there's something at the end I'd love [the kids] to have it, but what's important for me now is to get what I've earned, which is to travel and have a nice bottle of wine,'" Colpitts said.
Many boomers already are giving the equivalent of an inheritance, except they're doling out the cash while they're still alive, said Ken Dychtwald, chief executive of research firm Age Wave. They're supporting elderly parents, adult children or other family members who are suffering professional or financial woes. "How can you say no when a child asks ask for a down payment for a house or money to remodel their house to have a bedroom for a second child?" Dychtwald said. "A lot of boomers are finding that family members are taking cash advances on those inheritances right now."
Wealthy boomers are holding back on inheritances for other reasons. Some worry that their kids will squander inheritance money or develop a sense of entitlement. One-quarter of boomers worry that their children will become lazy and 1 in 5 fear that the kids will squander the money, according to the U.S. Trust survey. More than half the respondents haven't told their children how much they're worth.
Even people who are leaving an inheritance agonize over those risks. Norma Goldberger and her husband plan to leave money to their three grown children with proceeds from the sale of a successful medical business. But the Ohio couple have struggled with sending the right message and have revised their will three times, she said. "From being self-made I want them to feel [the money] is precious," Goldberger said. "If they get a whole lump at once maybe they wouldn't, and they might blow it all. Not that they're capricious people, but money can corrupt."
Others have held off on inheritances because they're scared of running out of money in a shaky economy. Even the well-to-do have turned cautious, especially out of fear of spiraling medical costs. The concerns are legitimate, financial advisors say, because boomers have longer life expectancies than their parents but fewer safety nets such as pensions to guarantee financial security.
As for Willison, she believes that a lifetime of financial sacrifice for her daughters entitles her to a bit of indulgence. Neither Willison, an office space designer for an energy company, nor her husband, a home appraiser, earned huge salaries, she said. Although they supplemented their salaries with income from rental homes they bought and fixed up, the family lived conservatively, she said.
Their children got scholarship money and held campus jobs during college, but Willison and her husband paid the rest of the tuition to avoid saddling their daughters with student loans. That gave the daughters the financial flexibility to buy houses while still in their 20s. "Not only have they thanked me, both of their husbands have thanked me," Willison said.
Willison's older daughter, Breanne Brown, says her parents deserve to enjoy their savings. "If there's something left, that's great. If not, that's great, too," Brown said. "They worked really hard for everything and they should be able to spend it."
And that's what Willison plans to do as she pursues a lifelong love of travel. She went to Tanzania and Kenya this year. "I'm not going to say, 'Oh gee, I wanted to go to China and I can't because I have to save this money for my kids,'" she said. "I've given them a terrific foundation in life," she said. "I've helped launch them with their education and their careers. If they can't make it on their own now, they can never make it. I've done my job. Now I'm going to enjoy life."
Pension funds in new crisis as deficit hole grows
by Natsuko Waki - Reuters
Pension funds in developed economies are facing a new crisis as falling equities and tumbling bond yields widen their deficits, threatening the incomes and retirement dates of future retirees.
At the heart of their problems is a steady move by pension plans in the United States, euro zone, Japan and the UK to cut exposure to risk after the financial crisis. But this "de-risking" may end up depressing their long-term returns from stock market investment and challenge the conventional wisdom that shares generate higher returns than bonds. With weaker holdings and increased liabilities, companies will find it more difficult to fund existing pension schemes. They may cut new business investments as they use more cash to pay pensions.
For future pensioners, it means they will potentially face a lower retirement income and a longer working life -- or both. This year has been a nightmare for many in the industry -- which controls $35 trillion (22 trillion pounds), or a third of global financial assets -- and funding deficits are posting double-digit rises. "We had a credit crisis and government bond crisis, and the third one we have is the pension crisis. This is the one where everything is going wrong and there's no obvious way out," said Kevin Wesbroom, UK head of global risk services at consultancy Aon Hewitt.
The sharp retreat in stocks through the summer has hurt them again by weakening their asset positions and threatening to erode stock market recoveries seen since the equity collapse surrounding the 2007-2009 credit crisis. Even lower bond yields are proving to be a new headache. "The real killer is liabilities are going up because in the flight to quality everyone gets out of equities and runs for cover in safe assets like government bonds, and yields are falling," said Wesbroom.
Many defined benefit pension plans -- where benefits are pre-determined -- pay a fixed stream of income to retirees. The low-yielding environment makes it harder for the funds to meet these bond-like liabilities, forcing them to accumulate even more fixed income instruments to try to meet their obligations, creating a vicious circle.
Recent data on pension deficits highlight the plight of many pension funds. In the United States, funding deficits of the 100 largest DB plans rose $68 billion to $254 billion in July, according to the Milliman Pension Fund Index. July marked the 10th largest deficit rise in the index's 11 year history.
Even if these companies were to achieve an optimistic annual return of as much as 8 percent and keep the current benchmark yield of 5.12 percent, their funding status is not estimated to improve beyond 93 percent by end-2013 from the current 83 percent. Aon Hewitt estimates deficits of DB pension plans for FTSE 350 companies as of end-August rose 20 billion pounds from July to a 2011 high of 58 billion pounds. Their funding ratio stands at 89.8 percent, down from 94.1 percent three years ago.
The drop in the funding ratio is driven by a rally in the fixed income market. In Europe, the double-A rated corporate bond yield -- one of the benchmark rates used by regulators -- fell 300 basis points in the last three years to 3.55 percent, according to Barclays Capital. The widely used rule of thumb is that a 50 basis points fall in the discount rate roughly results in a 10 percent increase in liabilities. "Things look substantially worse now than they were during the credit crisis," said Pat Race, senior partner at investment consultancy Mercer.
In reaction to the past few years of an equity decline and volatility, many pension funds are indeed planning to buy more bonds, a move highlighted by Mercer's survey of over 1,000 European DB pension funds in May. "Trustees do want to de-risk but financial directors have irrational desire to have equities. They are too wedded to equity markets," Race said. "You still have massive uncertainties with a potential for another dip into recession. I don't see any reversion to days when equities are dominant part of DB plans."
JP Morgan's data shows pension funds and insurance companies in the United States, euro zone, Japan and UK bought $173 billion of bonds in the first quarter, boosting their bond buying for the third quarter in a row. At the same time, they cut equity buying for a fifth quarter in a row, selling $22 billion of stocks in Q1. In Europe, pension funds slashed their weightings for equities to an average of 31.6 percent in 2011 from 43.8 percent in 2006, while fixed income holdings rose to 54 percent from 47.8 percent in the same period, according to Mercer.
Equity Premium Puzzle
Growing pension funds deficits on corporate balance sheets may make it more difficult for companies to access credit and discourage firms which are already hoarding cash from spending cash to expand business.
For wider financial markets, the giant industry's gradual move away from stocks could hit equity risk premium -- excess return of equities over risk-free securities which compensates investors for taking on the relatively higher risk. This may reinvigorate an academic debate where some economic analysis suggests the equity risk premium should be small, in most cases less than half a percentage point, as opposed to the widely-used range of 4-6 percent.
Indeed, 10-year U.S. Treasuries gave higher total returns in the past 10 years on a rolling basis than world stocks. "The puzzle... is that for the past 20 years, there has been no net equity risk premium. With the recent sell-off in risk and the rally in bonds, I think there might have been a net premium on bonds," Stephen Jen, managing partner at SLJ Macro Partners, said in a note to clients. "This has turned financial theory on its head, and managers of pension funds and sovereign wealth funds need to think about this very carefully."
What Did Fannie, Freddie Know?
by Ruth Simon and Nick Timiraos - Wall Street Journal
The 17 lawsuits filed Friday by federal regulators against some of the world's biggest financial institutions hinge on a simple premise: The mortgage loans that banks packaged into securities often didn't meet the underwriting guidelines the banks outlined in their securities filings.
The lawsuits, filed by the Federal Housing Finance Agency, allege that the banks made untrue statements and omitted key facts when they sold mortgage investments to loan giants Fannie Mae and Freddie Mac. The suits involve $196 billion in mortgage bonds packaged by some of the world's biggest banks. In addition to the banks, the suits name more than 100 executives who signed offering statements for the securities. Several of the named banks denied the allegations, didn't respond to requests for comment or declined to comment. The FHFA didn't specify how much it is seeking in damages.
Fannie and Freddie don't make loans directly, but they support housing markets by buying mortgages from banks and then selling them to investors as securities, providing guarantees to investors. During the housing boom, the two companies augmented their role in the housing market by purchasing privately issued mortgage securities as investments. It is those investments at issue in the suits. Analysts said the cases could ultimately turn on whether the FHFA can show that Fannie and Freddie, given all their expertise in evaluating mortgage risks, were misled about the quality of the loans backing those investments.
Citing detailed loan information, the FHFA lawsuits allege that the banks repeatedly misrepresented or made untrue statements about basic characteristics of loans in the securities, such as the portion of borrowers who lived in their homes and the percentage of the property's value being financed. Banks "routinely" packaged loans into securities even though they had been flagged by third-party due diligence firms as not meeting underwriting guidelines, according to the lawsuits.
"It's a great myth that you can't defraud sophisticated financial parties," said William K. Black, a former bank regulator involved with hundreds of successful savings-and-loan-era prosecutions. "Models cannot protect you against fraudulent loans" or inadequate disclosures.
The FHFA's review of a sample of loans in one Goldman Sachs Group Inc. bond deal cited in a lawsuit found that the portion of properties that appeared not to be owner-occupied was nearly double the amount stated in the prospectus supplement.
The banks are likely to argue that Fannie and Freddie knew that the loans were risky and that losses were due to underlying economic conditions, not faulty underwriting. "It will become clear that the plaintiffs knew as much as the defendants about the quality of these loan portfolios," says Andrew Sandler, co-chairman of BuckleySandler LLP, a law firm representing banks in litigation and regulatory enforcement actions.
Roughly a dozen investors and government agencies, including at least five federal home loan banks, American International Group Inc. and the National Credit Union Administration, have filed similar lawsuits.= Both the FHFA and NCUA have an edge over some other plaintiffs because they have subpoena power that has provided them with access to loan files.
Given that evidence from the loan files, "it would be amazing if these complaints do not survive motions to dismiss," said David Grais, an attorney in New York who represents several Federal Home Loan Banks in similar legal actions. Many of the other lawsuits are still in their early stages; most have survived motions to dismiss.