Check the hands
Ilargi: The YoY Case/Shiller housing index came in ugly today. "S&P/Case-Shiller index of property values in 20 cities fell 4.5 percent in June from a year earlier, after a 4.6 percent drop in the 12 months ended in May that was the biggest since 2009." Still, I saw headlines that claimed "Case Shiller: Home Prices increased in June", this one at Calculated Risk. Here's thinking that's perhaps a little more optimism than we deserve.
Now, I know Bill McBride uses seasonally adjusted numbers, while S&P doesn't, but still. Creating the impression that the numbers were somehow positive does not seem warranted by developments, unless perhaps you work at the NAR or Fox, organizations that create their own reality. My problem with it is that it may induce people to make purchasing decisions they will live to regret, possibly for the rest of their lives.
I’m a big fan of CR, don't get me wrong, but this looks too much like spinning, and I wish it wouldn't happen. That "Home Prices increased in June" headline pops up in the same daily read as this from Bloomberg, based on exactly the same sets of numbers [..] "home prices declined for a ninth month." I rest my case. Here's Bill's own graph based on the data, you decide.
At about the same time the housing report came in, US consumer confidence was reported thusly: "The Conference Board’s index slumped to 44.5, the weakest since April 2009, from a revised 59.2 reading in July [..]. It was the biggest point drop since October 2008."
Luckily (?!) the US isn't alone: "European confidence in the economic outlook plunged in August by the most since December 2008 as a persistent debt crisis roiled markets and clouded growth prospects. An index of executive and consumer sentiment in the single-currency region fell to 98.3 from a revised 103 in July [..] "
European stock markets didn't even notice. Only Frankfurt was down. The idea seems to be: Consumers, who needs consumers? Sort of reminds you of the days of old, when "jobless recovery" was all the rage. Not so much now.
If European markets had any sense left, they'd have paid attention to the farce performed inside the EU/IMF/ECB troika over the weekend, with guest roles for the the International Accounting Standards Board (IASB) and the European Banking Authority (EBA).
But first, before I forget it, next week, on September 7, the German constitutional court will rule on the question whether European bail-outs are in accordance with a) German law and -possibly- b) EU law. There's a real possibility that the answer to both will be "no". And then we can have some real fun.
Christine Lagarde, new at the helm of IMF and formerly Finance Minister in France, said in Jackson Hole a few days ago that European banks need urgent recapitalization. ECB president Trichet and the European Commission’s economic chief, Olli Rehn, reacted as if Lagarde was some sort of raving lunatic. Here's thinking that's not wise if you want to hold on to what credibility you have left. It's not like she's not some dumb puppet that you can sweep aside at will. Other than despair, it's hard to see what would lead to such vehement reaction. Roland Gribben at the Telegraph writes:
EU rules out fresh capitalisation for Europe's banksA fresh round of capitalisation for European banks was firmly ruled out by EU officials and bankers when they appeared before an emergency meeting of the European Parliament's economic committee.
The officials poured cold water on calls from Christine Lagarde, head of the International Monetary Fund for "mandatory" recapitalisation to avoid another financial crisis but acknowledged that the EU economy was continuing to weaken.
Jean-Claude Trichet, president of the European Central Bank, said there was no shortage of liquidity in the European banking system. EU economic commissioner Olli Rehn insisted that the health of EU banks had improved over the last year.
Ilargi: That's just hilarious. These banks all on average lost, what, 50%+ in market value over the past year, but their "health" improved?!
No shortage of liquidity whatsoever, right? I wonder about that, seeing this from FT:
European officials round on LagardeEuropean officials rounded on Christine Lagarde on Sunday, accusing the managing director of the International Monetary Fund of making a "confused" and "misguided" attack on the health of Europe’s banks.
Ms Lagarde, the former French finance minister who replaced Dominique Strauss-Kahn as head of the IMF in July, used her address at an annual meeting of central bankers in Jackson Hole, Wyoming, to call for an "urgent" recapitalisation of Europe’s weakest lenders, saying that shoring up the banking system was key to cutting "chains of contagion" across the region.
But officials said Ms Lagarde’s comments missed the point of banks’ current difficulties. "The key issue is funding," said one experienced central banker. "Banks in some countries have had trouble securing liquidity in recent weeks and that pressure is going to mount. To talk about capital is a confused message. Everybody – politicians, regulators, other officials – is quite concerned."
Ms Lagarde’s allusion this weekend to the potential use of the European Financial Stability Fund, a €440bn bail-out fund, as a means to recapitalise banks by force, would be far better directed towards a liquidity solution, some officials said. No headway has been made towards the idea of EFSF-guaranteed bank bond issuance, they admitted, though that would be the "most sensible solution", according to one.
Jean-Claude Trichet, the president of the European Central Bank, separately dismissed any idea that Europe could face a liquidity shortage in his own Jackson Hole address, saying efforts to combat the financial crisis would prevent such an outcome. "The idea that we could have a liquidity problem in Europe" is "plain wrong," Mr Trichet said.
Ilargi: What? It's not about liquidity, it's about funding, says "one experienced central banker". But then: "[..] the potential use of the European Financial Stability Fund, a €440bn bail-out fund, as a means to recapitalise banks by force, would be far better directed towards a liquidity solution, some officials said." And Ms Lagarde is called "confused" and "misguided"?! These guys seem to give the term "speaking in tongues" a whole new meaning. A forked one.
A relatively unknown source comes to Lagarde's aid, as per Der Spiegel:
Watchdog Worried About Europe's Banking SectorThe head of Europe's banking watchdog has called for the euro rescue fund to provide direct aid to ailing banks to help calm markets. The head of the IMF made a similar demand, exposing an apparent rift with EU governments on how to handle the debt crisis. Berlin and the EU have rejected such changes.
The new powers of the euro bailout fund haven't even been signed off yet by the national parliaments, but there are already calls for its remit to be broadened, causing a fresh headache for Chancellor Angela Merkel.
The European Banking Authority, a supervisory body for banks in the European Union, wants the €440 billion ($635 billion) European Financial Stability Facility to provide direct capital injections to ailing banks. It is an attempt to reassure investors worried about the impact of the debt crisis on bank balance sheets, German business daily Financial Times Deutschland reported on Tuesday.
At present, the EFSF is only permitted to extend funds to individual countries, but those nations can pass the funds on to banks. Direct finance injections by the EFSF would speed up the process, and would in effect turn the fund into a stakeholder of the banks it helps. The demand was made in a letter being sent by EBA chief Andrea Enria to the European finance and economy ministers this week [..]
Ilargi: It's all about the dance around the EFSF. Lagarde wants it used to bolster EU banks. Trichet and his ilk deny that that is even needed. Thing is, it's not nearly large enough once Italy and Spain get squeezed, and the chances that it ever will be are as slim as the facility itself. Despite claims such as these by Christian Reiermann in Der Spiegel:
'The Crisis Will Be Over in Two to Three Years'Klaus Regling, the German CEO of the euro zone's bailout fund, the European Financial Stability Facility, is confident that the monetary union can overcome the current crisis. He considers the euro zone to be in a better position than the US when it comes to public debt, and accuses his fellow Germans of "hysteria." [..]
What is now taking shape at the EFSF's offices at 43, Avenue John F. Kennedy in Luxembourg City is the nucleus of a super-authority with which the 17 countries in the euro zone hope to save their currency. The amount of money it has at its disposal in the event of an emergency -- €440 billion ($634 billion) -- is three times as large as the entire European Union budget. The EFSF and the ESM will have a similarly important effect on the stability of the euro zone as the European Central Bank (ECB).
Birth of a European Monetary Fund
If German Chancellor Angela Merkel and French President Nicolas Sarkozy have their way, Regling's bailout fund will turn into a European Monetary Fund, which, like the International Monetary Fund (IMF), would monitor the financial and economic policies of its member states and, if necessary, come to their rescue with billions in bailout funds.
In some ways, the EFSF's powers go well beyond those of the IMF. The EFSF is supposed to be able to lend money to countries experiencing short-term liquidity problems and use its billions to stabilize tottering banks. The most important of the recent changes is that Regling will be able to intervene in the markets and buy up government bonds to stabilize their prices and yields.
Because the new tasks cannot be effectively addressed with the current workforce, Regling intends to double his staff from 12 to 24 employees in the course of the next year. But he "does not see the need at this time to increase the financial framework of the EFSF," says the 60-year-old CEO. Even when Greece receives help from the fund as part of the second bailout which was agreed at the July 21 summit of euro-zone leaders, more than half of the approved €440 billion will still be left over, Regling says.
Nevertheless, when the EFSF takes over the ECB's task of buying up debt-stricken countries' sovereign bonds in the fall, it could quickly run up against its limits. But Regling shrugs off such concerns. He doesn't say it, but he knows that the finance ministers in the euro zone would beef up his funds if necessary. German Finance Minister Wolfgang Schäuble and his Dutch counterpart, Jan Kees de Jager, have already indicated their willingness to do so.
Ilargi: De Jager has recently declared his firm opposition vs a larger EFSF, and though he shuffles around the musical chairs in the game as much as any politician, plans for a €2 trillion+ EFSF will lead to severe turmoil in Europe, and cost more than one politician his or her career. And they know it. These guys are very close to a check mate.
No matter how justified Lagarde's claims may be, Europe doesn't have the means to fund its banks, has neither the financial nor the political capital, as I've said many times before. And so it has to tear apart the troika that until just a few months ago seemed to be saving Europe. Lagarde is now free to make demands that neither Merkel nor Sarkozy can meet. But that doesn't mean these demands can be met.
There are more tricks being played under the table and behind the veil. Tricks without which reality would look much harsher. Adam Jones and Jennifer Thompson at FT report:
IASB criticises Greek debt writedownsIn a private letter sent to the European Securities and Markets Authority, the European Union’s market regulator, the International Accounting Standards Board criticised the inconsistent way in which banks and insurers have been writing down the value of their Greek sovereign debt. [..]
Financial institutions have slashed billions of euros from the value of their Greek government bond holdings following the country’s second bail-out. The extent to which Greek sovereign debt losses were acknowledged has varied, with some banks and insurers writing down their holdings by a half and others by only a fifth.
The letter did not single out particular countries or banks. But according to one person familiar with the correspondence, it reflected concern at the approach taken by BNP Paribas and CNP Assurances.
The French bank and insurer both announced 21% writedowns, as envisaged by last month’s Greek bail-out. They argued there were no reliable market prices to guide a "fair value" for Greek government debt because of their illiquidity and instead used a "mark to model" valuation. Banks and insurers that used market prices suffered a bigger hit. Royal Bank of Scotland wiped £733m from the value of a £1.45bn Greek government bond portfolio – a 51% cut.
Mr Hoogervorst challenged the justification for a "mark to model" approach and also the valuations these produced. "Although the level of trading activity in Greek government bonds has decreased, transactions are still taking place," he said. "It is hard to imagine that there are buyers willing to buy those bonds at the prices indicated ... it is therefore difficult to justify that those models would meet the objective of a fair-value measurement."
Ilargi: Now that we're talking credibility, one thing seems obvious. If one bank writes down Greek debt by 20%, and another by 51%, you really need to wonder what the value is of a stress test, such as the one only recently completed in Europe. If such a test allows banks to assess the value of -part of?!- their assets on their own recognizance, then the test will be seen as completely useless. Again, it all smacks of despair. And frankly, it's hard to see what else is left for Europe to do.
But, what I wrote three weeks ago is still valid: The Markets Are Not Stupid. They can try, though... Irwin Stelzer in the Wall Street Journal puts it this way:
Telling World's Bankers How It Really IsThe problem in Europe is that politicians think they can fool the markets. Spain is amending its constitution to include a deficit cap in its constitution—the first country to respond to lender-in-chief Angela Merkel's demand that all supplicant nations do so—but the amendment does not include any actual deficit cap.
France has joined Ms. Merkel's call for balanced budgets, but has not balanced its own budget in 35 years, and is unlikely to do so soon as its economy is slowing, and will slow further when planned tax increases on capital gains, businesses, and the rich—who have published a Warren Buffet-style plea to have their taxes raised "reasonably"—are put into effect. Greece has promised to privatize large swathes of its economy, but has not so far sold off any significant assets. Italy has refused to undertake the structural reforms needed to end a decade of economic stagnation. Markets are appropriately skeptical, nay, cynical.
Ilargi: Spain, France, Italy, Greece, and feel free to add Portugal, Ireland and Belgium; they all make promises they know they can't keep. And internally they can get away with doing so because everybody knows that meeting the promises will be the end of the road. For all. The problem for them is the markets will not let them get away with it.
Having no credibility left, in the situation they're in, means they're done. Accepting that is just not something politicians and other power hungry folk give in to easily. They all have the same MO as Eurozone finance head Jean Paul Juncker: "When it becomes serious, you have to lie .... " They'd rather take down their entire nations with them than admit defeat. And that's what we're looking at.
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The Bigger Picture: Primer Guide Update
A world of debt: Global liabilities grow faster than GDP
by Saifur Rahman - Gulfnews
Mankind is reeling under a whopping $158 trillion debt pile that, according to analysts and economists, might get out of hand if not dealt with carefully. Gulf News takes a look at how this massive debt pile was created and how the world can get out of this mess...
Every human being on earth currently carries a debt burden of nearly $22,733 on average, if the latest reports are to be believed. Every child is sharing the same debt burden at birth, as debt growth rates beat the global population growth rate. In fact, debt liabilities are growing faster than GDP expansion rates. Overall outstanding debt worldwide has more than doubled in the past ten years to $158 trillion (Dh580 trillion) in 2010, up from $78 trillion in 2000, according to a recent report by global consultancy McKinsey.
The global population is currently estimated at 6.95 billion, whereas worldwide gross domestic product (GDP) reached $74.54 trillion last year. This translates to a per capita GDP of $10,500, which is less than half of the per capita debt burden of $22,733. In theory, this makes the human population a ‘bankrupt' race and financially the most dangerously exposed and vulnerable in its history. If you think this is bad, then wait for the worst news: The debt toll is rising and it will be higher next year.
The global debt trap
The global debt of $158 trillion includes $41.1 trillion incurred by governments worldwide up to last year, accounting for 69 per cent of global GDP. This is expected to rise to $46.12 trillion in 2012, according to the Economist Intelligence Unit (EIU). "Debt also grew faster than GDP over this period, with the ratio of global debt to world GDP increasing from 218 per cent in 2000 to 266 per cent in 2010," McKinsey said.
Around $48 trillion of the total debt outstanding was that of governments and financial institutions. In both the US and Western Europe in 2010, the ratio of public debt stood at more than 70 per cent of the GDP, McKinsey said. "Developed countries may need to undergo years of spending cuts and higher taxes in order to get their fiscal houses in order," it added.
Many governments in the developed world have resorted to massive stimulus measures to bolster their economies since the 2008 global financial meltdown. "Public debt outstanding [measured as marketable government debt securities] stood at $41.1 trillion at the end of 2010, an increase of nearly $25 trillion since 2000. This was equivalent to 69 per cent of global GDP, or 23 percentage points higher than in 2000. In just the past two years, public debt has grown by $9.4 trillion — or 13 percentage points of GDP," McKinsey said.
The government debt worldwide was $31.7 trillion in 2008. Last year alone, government debt accounted for about 80 per cent of the overall growth in total outstanding debt. World governments owe the money to their own citizens and lenders. The rising total debt is important for two reasons.
First, when debt rises faster than economic output (as it has been doing in recent years), higher government debt implies more state interference in the economy and higher taxes in the future, EIU explains in its global debt clock — which is ticking every second. "Second, debt must be rolled over at regular intervals. This creates a recurring popularity test for individual governments, rather as reality TV show contestants face a public phone vote every week," it says.
"Fail that vote, as the Greek government did in early 2010, and the country can be plunged into imminent crisis. So the higher the global government debt total, the greater the risk of fiscal crisis, and the bigger the economic impact such crises will have."
Greece, Ireland, Portugal, Spain, the UK and the US are caught in a debt trap. For some governments, the only escape is to do the same things that an average household must do when it can't make ends meet — sell off assets, slash spending, scrape for extra earnings, downsize, and make sacrifices. They are cutting healthcare and pensions for millions of citizens, laying off hundreds of thousands of government employees, or worse. For others, like the US, the primary response so far has been to run the money printing presses — all with untold consequences.
The national debt of the United States — the world's biggest economy — reached $14.62 trillion in recent months — close to its GDP. According to the IMF, US public debt will reach 99 per cent of its $14.65 trillion GDP in 2011 and 103 per cent in 2012. In the United States, debt per citizen is more than double the global average, standing at $46,884, while its burden per taxpayer has reached a whopping $130,662 — according to US Debt Clock.
Born into debt
"Every American born today owes $46,884 to the federal government the day she or he is born. And we are transferring a tremendous amount of debt to the new generation, much of it owed to overseas creditors who expect to be repaid by our children with interest," US Senator Mark Kirk said recently. The latest push to raise America's debt limit of $14.29 trillion by $2.4 trillion earlier this month that placed the country's policymakers in direct confrontation with opposition politicians — is another example of how difficult things could become. By August 2, a possible US default was creating a worldwide panic.
But how did all this happen? The US Treasury has borrowed trillions of dollars over the past decade, much of it from foreign investors, to help finance two long wars, rescue its financial system, and promote economic growth through fiscal stimulus. "The government must be able to issue new debt as long as it continues to run a budget deficit — the current shortfall is about $125 billion per month," Jonathan Masters, Associate Staff Writer, of Council on Foreign Relations, says. The debt limit was instituted with the Second Liberty Bond Act of 1917, and Congress has raised the cap 74 times since 1962.
"It took the first 204 years of our nation's history to accumulate $1 trillion in debt. And now we are doing that every two or three years," Jim Cooper, US Congressman, said. The Budget Control Act of 2011 of the US now allows up to a $2.4 trillion rise in the debt ceiling (in three tranches), and immediately institutes ten-year discretionary spending caps totalling nearly $1 trillion.
Eurozone — the trouble zone
"In recent months the major areas of uncertainty for the global economy have revolved around the crisis in the Eurozone, the future path of monetary and fiscal policy in the United States, and the fight against inflation in emerging markets," says Ira Kalish, Director of Global Economics, Deloitte Research. "Failure to resolve these issues will have a negative impact on global growth and stability."
In its report, Deloitte Research says, despite the problems in the housing market and sovereign debt in Europe, the case for growth in the United States seems to be more compelling at the moment. "As for Europe, recovery will depend on implementing a permanent solution to the debt crisis. Lowering inflation and steadily increasing average earnings will be key to recovery in the United Kingdom," it says.
The authorities in Europe and the US must focus on radical structural reform that brings hope to the markets that the debt situation is being seriously tackled, feels Gary Dugan, chief investment officer for Private Banking at Emirates NBD. "Investors now recognise the Eurozone is at the epicentre of the world's fears. As the dust settles on problems in the United States [at least for the moment] investors have come to recognise the Eurozone as the weakest link in the global economy," Dugan says.
"Whilst the United States faces its own problems as an integrated economy it has the ability to address its problems far quicker than the Eurozone. In Europe it is incumbent upon each government to address its problems separately with only mild pressure from the European Central Bank [ECB] or the European parliament. "Rules that were in place about how much debt a country can have and how much of a budget deficit any country can run in any one particular year have largely been ignored and now lack credibility."
None of the rules are working anymore, it seems. In fact, the rules of managing economies have changed drastically. Where this will land the human race — no one knows, including bankers and economists.
Market volatility
The last two weeks have been a rollercoaster ride in the markets. Already concerned about signs of economic weakness, investors have reacted dramatically to the dysfunction in Brussels, Frankfurt and Washington. European policymakers have responded to their crisis with a series of indecisive measures, including a counter-intuitive tightening of monetary policy by the European Central Bank, said a Bank of America Merill Lynch report. "Apparently, we are told, raising interest rates can control inflation without hurting growth or financial markets.
"Closer to home, fiscal authorities have bombarded the markets with a quadraphonic message of hopelessness: 1. The US has a huge fiscal problem, 2. They are too dysfunctional to deal with it, 3. Threatening to default on the debt is an acceptable form of negotiation, and 4. We will continue to tighten policy regardless of how the economy is doing," it said.
"Unfortunately, this leaves the Fed in a familiar spot, cleaning up everyone else's mess. Back in 2008, the Fed was left to deal with the emerging financial crisis, while the ECB hiked rates and Congress refused to take any action, until the stock market was in full collapse."
Ben Bernanke, Chairman of the US Federal Reserve, has pointed out that monetary policy cannot solve all of the world's problems. Moreover, each new round of unconventional policy is likely to have a smaller effect than the last. "This is particularly the case when the Fed faces a bevy of dissent from both inside and outside the Committee," Ethan S. Harris, Economist at BofA Merill Lynch, said.
Nonetheless, the Fed is not impotent. However, there are two reasons for concern. First, a number of sectors have yet to recover from the previous crisis. Banks have rebuilt their capital and are in better shape. However, both the housing sector and state and local governments are quite vulnerable. If the economy does go back into recession, it could reignite the negative feedback loop between employment, home prices and mortgage delinquencies, BofA economists argue.
Hope against hope
The best case for a recovery is that the market panic stops and some of the recent shocks fade. Oil prices have already come off their highs and Japanese supply chains are recovering from the impact of the recent earthquake and tsunami. Moreover, while the Fed has no room to cut interest rates, the ECB and most emerging market central banks have room to ease, it says. "Europe could take the big step of fiscal integration and centralised debt financing—this is the natural end game for the union. Over the longer term, we could see a pickup in foreign investment, a re-opening of immigration to skilled workers and a productivity boom triggered by technological innovation," it says.
While risks are skewed to the downside, the economy will continue to recover slowly. "The recovery will likely come in fits and starts, and we should not be surprised if there are more dead spots that may feel like a recession. "We learned from historical episodes that the healing process from a balance sheet recession is slow and often bumpy," Harris says.
How and why did the world get into this huge ‘trap’?
To begin with, it is the advanced or developed industrialised countries that have a huge and unsustainable debt problem, says Dr Nasser Saidi, chief economist of Dubai International Financial Centre (DIFC). By contrast, emerging market economies (with few exceptions) have healthy national balance sheets, strong macro-economic conditions and sound fiscal policies. The OECD forecasts that advanced economies — without major corrective changes in fiscal policies — will have debt to GDP ratios in excess of 115 per cent by 2015.
What led to this growing debt problem? "We need to distinguish between secular, trend factors that underlie government budget deficits and debt accumulation from cyclical factors and the results of interventionist government policies," says Dr Saidi.
The trend factors are related to the demographics of ageing populations in advanced economies (Japan, Europe and to a lesser extent the US) and the role of entitlement and health policies: social security, national health programmes (Medicare, Medicaid).
The ageing population that characterises Japan, Europe and the US has contributed to the current situation in two ways. First of all, an uneven growth of working-age and retirement-age population means that a decreasing number of tax-payers have to provide the financial resources for an increasing number of people that become eligible for old-age pensions, he explains. "There is large transfer of resources from the young to the elderly causing the generation that is entering the job market now to finance not only their own future retirement, but also of their parents. Rather than increase the taxation burden [considered high already in Europe] politicians have taken the easy way out: increased borrowing," he says.
"The political cycle in advanced economies is heavily biased towards running deficits and increasing debt. The related issue is that people are living longer: life expectancy in the advanced economies has increased from an average 71 years in 1970 to 78 years in 2009. This results in higher public [and private] spending on health and medical as well as other entitlements and growing budget deficits."
The cyclical factors relate to the impact of the Great Contraction and the Great Financial Crisis. Recessions typically lead to increased government spending through the operation of automatic fiscal stabilisers (e.g. unemployment benefits) while tax revenues decline as a result of lower income; the result is higher deficit spending and debt accumulation.
This expected deficit increasing cyclical effect was exacerbated by unprecedented fiscal stimulus, bail-outs of banks and financial institutions and the ‘socialisation' of private debt, when governments and central banks took over liabilities from insolvent banks and financial institutions and other sectors (e.g. car industry). "In the US the situation was aggravated by loose monetary and fiscal policies after 2001, leading to both public and private sector dissaving and reversing a string of government budget surpluses from 1998 to 2001 [with a peak in 2000 when the surplus amounted to $236 billion (Dh866.8 billion]," Dr Saidi argues.
"A policy of low interest rates encouraged private sector dissaving and greater household indebtedness [mortgages in particular], while military spending surged in association with wars in Iraq and Afghanistan. "The US moved from being a net capital exporter to a capital importer, absorbing some two thirds of global saving over the period 2004-2006, resulting in the ‘global imbalance'."
What is the way out?
There is no easy way out.
Advanced economies will require deep and sweeping reforms to their taxation systems and to their entitlement programmes. Fiscal sustainability requires higher tax rates and the countering of demographic pressures, Dr Saidi says. "The choices are stark and limited: retirement ages need to be gradually extended to 70 or higher, given increased life expectancy; this should be accompanied by a reduction in the size and coverage of entitlement programmes," he says.
For the US, the long term fiscal sustainability menu will need to include a major reduction in military expenditures and agricultural subsidies. For Europe, dealing with the demographics will also entail loosening of the strict emigration policies in place now: Europe has to draw on the relatively young populations of the Southern Mediterranean in order to pay for its pensions.
None of the above choices are politi cally palatable and we should not expect governments to willingly take hard choices. "The lessons from history are clear: faced with large debt burdens, governments are unlikely to substantially increase taxation or effect permanent reductions in spending; they are more likely to default or reduce the real value of their obligations through inflation," he says.
To convince their creditors and financial markets, governments will need to invest in credible institutions. Increasingly, governments are turning towards setting up of independent fiscal advisory councils and the adoption of fiscal rules. "Such fiscal councils should also be adopting new and different ways of looking at governments fiscal accounts. We should move toward ‘generational accounting' systems: a method for estimating the economic impact of fiscal policy on different generations — including future ones. "The idea is to evaluate the intergenerational effects of alternative government fiscal policies," he says.
But Saidi says to keep the economic growth momentum, governments are forced to spend, rather than repay debts. Modern political systems — in advanced economies predominantly — have a built-in bias to deficit spending. Most spending once instituted is difficult to roll back and raising taxes is not a vote getter, he explained.
"This is exacerbated by the political cycle and short-time horizon of governments and elected politicians: if you are elected for three to four years or you are a government with a short expected lifetime, you will tend to spend, not tax in order to get re-elected or to pass the consequences of your fiscal follies to subsequent governments," he says.
Income disparity
Of the global population, nearly half or 3.25 billion earn less than $2 (Dh7.3) a day, whereas the number of millionaires has obly crossed ten million — reflecting a widening wealth gap that could threaten social stability. According to the latest World Wealth Report by Merill Lynch and Capgemini, the population of global high networth individuals (HNWI) increased 8.3 per cent last year to 10.9 million and HNWI financial wealth grew 9.7 per cent to reach $42.7 trillion. The global population of Ultra-HNWIs grew by 10.2 per cent in 2010 and its wealth by 11.5 per cent.
"In its beginnings, the credit system sneaks in as a modest helper of accumulation and draws by invisible threads the money resources scattered all over the surface of society into the hands of individual or associated capitalists. "But soon it becomes a new and formidable weapon in the competitive struggle, and finally it transforms itself into an immense social mechanism for the centralisation of capital."
However, the rising debt toll is becoming the single biggest headache for governments and economists worldwide and is gradually reaching a point where no one can protect humans from ‘insolvency'. The Arab spring is a reminder of how things can flare up if not dealt with properly.
Three years after Lehman, a new debt crisis looms
by Larry Elliott - Guardian
Economic recovery has proved both slow and costly, and the risk remains of a relapse into recession
The F word is back. Back in the financial markets, back in the conclaves of central bank governors, back among the manufacturers and the high-street retailers. The four-letter word is fear.
Back in the spring, few imagined that we would be approaching the third anniversary of the collapse of Lehman Brothers on 15 September with such a sense of unease. The belief in early 2011 was that economic recovery was now well enough embedded for central banks to start raising interest rates and for finance ministries to crack on with the job of reducing budget deficits.
Although pockets of optimism remain, the mood today is different. Ben Bernanke, the chairman of the Federal Reserve, has said the US central bank will discuss possible ways to stimulate growth when it meets next month. The Bank of England appears to be heading in a similar direction. There is anxiety at the International Monetary Fund that blanket austerity will tip fragile western economies back into recession. Concerns are once again being expressed about the health of the banks, about America's national debt and, above all, about whether the eurozone can survive its current crisis intact.
Standard Chartered and HSBC were the two UK-based banks to emerge relatively unscathed from the first financial crisis, partly because their global reach allowed them to benefit from the rapid recovery in Asia. This, though, is how the chief economists at the two banks see things.
"America is drowning in debt, Europe is imploding as problems in the euro area intensify, while, in contrast, Asia's economy is cooling, as growth rates moderate from a strong to a solid pace," says Gerard Lyons at Standard Chartered. Putting the possibility of a recession in the US as high as one in three and of an eventual euro crisis as high as one in two, Lyons adds: "It should be little surprise that there is increased uncertainty and heightened risk aversion across financial markets."
Stephen King at HSBC describes the world as a "frozen economic tundra", with the power of central bankers to influence events on the wane. "After the Great Recession, there has sadly been no 'Great Recovery'," King says. He too is unsurprised that investors are rushing for the exit, given the bickering between Democrats and Republicans on how to tackle America's budget problems, and the inability of Europe's politicians to sort out the single currency.
"The west is increasingly looking like a bad version of Japan. And, like Japan, our political leaders are offering few answers."
Collapse
This is not how it was supposed to be. It took time for policymakers to comprehend the enormity of the shock administered to the global economy by the collapse of the US housing market, but once the penny dropped in the autumn of 2008, they were at pains to show that lessons had been learned from the 1930s. Banks were recapitalised to prevent them from going bust, interest rates were slashed, money was created, public spending was increased.
To widespread relief, there was no second Great Depression. Unemployment in the US rose to almost 10% but not the 25% seen in the 1930s. Industrial production and international trade started to pick up in the spring of 2009. By and large, countries resisted the temptations of protectionism.
Over time, however, it has become clear that the recovery has been both slow and costly. If it is aborted, the risk is that the global economy will return to where this all started in 2007, with another crisis in the banking system. The recovery has been slow because the crisis was caused by over-indebtedness among private individuals and banks.
Both, in the jargon of the markets, were over-leveraged: they had borrowed an awful lot of money, in other words, in anticipation of asset prices going up and up. When the bubbles burst, households and banks realised how exposed they were. As a result, they started to pay off their debts and even when the cost of borrowing came down to virtually zero, the demand for credit remained weak.
As HSBC's King notes: "The ambient noise of deleveraging is now deafening." But western economies have become so dependent on debt-driven growth in the good years that they are finding the sobering-up process painful. As things stand, it will take the UK longer to return to pre-recession levels of output than it did in the 1930s.
What's more, this lacklustre recovery has not come cheap. As private demand fell, governments stepped up their spending. They cranked up the electronic printing presses, they bought shares in banks and they allowed budget deficits to balloon, gambling that any damage to the public finances would be temporary. Again, things have hardly gone according to plan.
Quantitative easing has proved a double-edged sword: it has flooded financial markets with cash and may well have underpinned activity. But it has also pushed up commodity prices, leading to higher inflation and a squeeze on real incomes that has held back recovery.
By effectively nationalising a good chunk of the debts accumulated by the private sector, western governments have now raised concerns about their own solvency. The US has seen its credit rating downgraded; Europe's problems are even more acute after bailouts for Greece (twice), Ireland and Portugal, followed in the past month by emergency action by the European Central Bank to drive down the interest rate on Italian and Spanish bonds.
Just as in the summer of 2008, the assumption is that the global economy will experience a slowdown but not a full-blown contraction. Central banks are still providing massive amounts of monetary stimulus through record-low interest rates, even though finance ministries are tightening fiscal policy by raising taxes and trimming spending. Large corporations outside of the banking sector have money in the bank that could be used for new investment. And consumers should feel better off next year as inflation falls.
Soft landing
Financial markets want to believe the "soft landing" scenario but somehow can't quite bring themselves to do so. The fear comes from the knowledge that commercial banks in Europe are up to their eyeballs in sovereign debt from the weaker peripheral countries, so a default would trigger a feedback loop back into the financial system. Banks have more capital than they had three years ago and are less heavily leveraged. Yet there are doubts about whether they could survive a double-dip recession. And until consumers are spending more freely, there will be a temptation for companies to hoard their cash rather than invest it.
Economic downturns usually go through five distinct phases: bubble, denial, acceptance, panic and recovery. This fifth phase officially started two and a half years ago, but the drip-drip of disappointing news from the around the world in recent weeks has made financial markets highly averse to taking risks. Higher unemployment, slower growth, currency tensions have all led to a rush for safe havens.
The markets are now wondering whether this is one of the rare crises that has a sixth phase – relapse. At root, the suspicion is that the problems that caused the crisis in the first place have not been solved, that politicians are offering weak leadership, and that the next few months could see the start of phase two of the Great Contraction.
IASB criticises Greek debt writedowns
by Adam Jones and Jennifer Thompson - FT
Some European financial institutions should have taken bigger losses on their Greek government bond holdings in recent results announcements, according to the body that sets their accounting rules.
In a private letter sent to the European Securities and Markets Authority, the European Union’s market regulator, the International Accounting Standards Board criticised the inconsistent way in which banks and insurers have been writing down the value of their Greek sovereign debt. "This is a matter of great concern to us," Hans Hoogervorst, IASB chairman, said in the letter, which was seen by the Financial Times.
People familiar with the IASB’s letter said the intervention was unprecedented and reflected its belief that some European companies had not been making enough provisions for Greek sovereign debt losses.
Financial institutions have slashed billions of euros from the value of their Greek government bond holdings following the country’s second bail-out. The extent to which Greek sovereign debt losses were acknowledged has varied, with some banks and insurers writing down their holdings by a half and others by only a fifth.
The letter did not single out particular countries or banks. But according to one person familiar with the correspondence, it reflected concern at the approach taken by BNP Paribas and CNP Assurances.
The French bank and insurer both announced 21 per cent writedowns, as envisaged by last month’s Greek bail-out. They argued there were no reliable market prices to guide a "fair value" for Greek government debt because of their illiquidity and instead used a "mark to model" valuation. Banks and insurers that used market prices suffered a bigger hit. Royal Bank of Scotland wiped £733m from the value of a £1.45bn Greek government bond portfolio – a 51 per cent cut.
Mr Hoogervorst challenged the justification for a "mark to model" approach and also the valuations these produced. "Although the level of trading activity in Greek government bonds has decreased, transactions are still taking place," he said. "It is hard to imagine that there are buyers willing to buy those bonds at the prices indicated ... it is therefore difficult to justify that those models would meet the objective of a fair-value measurement."
Separately, EU officials insisted on Monday that bank capitalisation levels were adequate. "EU banks are significantly better capitalised now than they were one year ago," said Olli Rehn, the European Commission’s economic chief.
Watchdog Worried About Europe's Banking Sector
by Spiegel
The head of Europe's banking watchdog has called for the euro rescue fund to provide direct aid to ailing banks to help calm markets. The head of the IMF made a similar demand, exposing an apparent rift with EU governments on how to handle the debt crisis. Berlin and the EU have rejected such changes.
The new powers of the euro bailout fund haven't even been signed off yet by the national parliaments, but there are already calls for its remit to be broadened, causing a fresh headache for Chancellor Angela Merkel.
The European Banking Authority, a supervisory body for banks in the European Union, wants the €440 billion ($635 billion) European Financial Stability Facility to provide direct capital injections to ailing banks. It is an attempt to reassure investors worried about the impact of the debt crisis on bank balance sheets, German business daily Financial Times Deutschland reported on Tuesday.
At present, the EFSF is only permitted to extend funds to individual countries, but those nations can pass the funds on to banks. Direct finance injections by the EFSF would speed up the process, and would in effect turn the fund into a stakeholder of the banks it helps. The demand was made in a letter being sent by EBA chief Andrea Enria to the European finance and economy ministers this week, the newspaper reported.
The move is intended to help to calm markets after French and Italian banks suffered steep share price falls on worries about their financial health, prompting France, Italy, Spain and Belgium to impose short-selling bans on financial stocks. Pressure on European banks to raise more capital increased in July after European stress tests found that eight banks failed to meet capital requirements.
Enria's letter fuels pressure on euro-zone governments to do more to tackle the European debt crisis after the new head of the International Monetary Fund, Christine Lagarde, urged the EU on Saturday to force its banks to beef up their capital.
Rift Between EU and IMF?
Lagarde, speaking at a meeting of central bankers in Jackson Hole, Wyoming, on Saturday, urged politicians to "act now" to counter global economic risks. "Banks need urgent recapitalization," said Lagarde, the former French finance minister. "The most efficient solution would be mandatory substantial recapitalization -- seeking private resources first, but using public funds if necessary."
EU and German officials rejected Lagarde's demand on Monday, saying there was no need for further recapitalization over and above measures that have already been taken after the last stress tests. The apparent rift between the EU and IMF in the assessement of the risk to banks and the measures needed to contain them could heighten market concerns about how the debt crisis is being handled.
"We see the concern but have already taken measures," a spokeswoman for German Finance Minister Wolfgang Schäuble said on Monday in response to Lagarde's comments. The spokeswoman added that tougher equity capital standards were already being adopted under the Basel III accord on capital adequacy, agreed in response to the 2008 financial crisis.
Merkel can ill afford to back even greater powers for the EFSF because a number of parliamentarians in her center-right coalition are already unhappy with planned changes to the fund agreed at the EU summit on July 21. Merkel's majority is at risk in a crucial parliamentary vote on those changes due to be held at the end of September.
The July 21 deal gave the bailout fund new powers to assist countries before they are shut out of credit markets and to buy government bonds in the secondary market. Those changes, commentators say, have put the euro zone on the path to a fiscal union, and lawmakers from Merkel's coalition are worried that the reforms will enshrine a lasting system in which German taxpayers are made to foot the bill for rescuing spendthrift nations.
'The Crisis Will Be Over in Two to Three Years'
by Christian Reiermann - Spiegel
Klaus Regling, the German CEO of the euro zone's bailout fund, the European Financial Stability Facility, is confident that the monetary union can overcome the current crisis. He considers the euro zone to be in a better position than the US when it comes to public debt, and accuses his fellow Germans of "hysteria."
The picture, a Balinese island landscape, is still leaning against the wall where it was a year ago. Back then, the European Financial Stability Facility (EFSF) had just recently been set up, and its chief executive officer, Germany's Klaus Regling, was too busy to hang the souvenir from Indonesia on the wall.
He is still just as busy today. Three European bailout packages later, it is clear that the EFSF and the European Stability Mechanism (ESM), which will succeed it in 2013, will have even more to do in the future. European heads of state and government recently decided to substantially upgrade both funds.
What is now taking shape at the EFSF's offices at 43, Avenue John F. Kennedy in Luxembourg City is the nucleus of a super-authority with which the 17 countries in the euro zone hope to save their currency. The amount of money it has at its disposal in the event of an emergency -- €440 billion ($634 billion) -- is three times as large as the entire European Union budget. The EFSF and the ESM will have a similarly important effect on the stability of the euro zone as the European Central Bank (ECB).
Birth of a European Monetary Fund
If German Chancellor Angela Merkel and French President Nicolas Sarkozy have their way, Regling's bailout fund will turn into a European Monetary Fund, which, like the International Monetary Fund (IMF), would monitor the financial and economic policies of its member states and, if necessary, come to their rescue with billions in bailout funds.
In some ways, the EFSF's powers go well beyond those of the IMF. The EFSF is supposed to be able to lend money to countries experiencing short-term liquidity problems and use its billions to stabilize tottering banks. The most important of the recent changes is that Regling will be able to intervene in the markets and buy up government bonds to stabilize their prices and yields.
Because the new tasks cannot be effectively addressed with the current workforce, Regling intends to double his staff from 12 to 24 employees in the course of the next year. But he "does not see the need at this time to increase the financial framework of the EFSF," says the 60-year-old CEO. Even when Greece receives help from the fund as part of the second bailout which was agreed at the July 21 summit of euro-zone leaders, more than half of the approved €440 billion will still be left over, Regling says.
Nevertheless, when the EFSF takes over the ECB's task of buying up debt-stricken countries' sovereign bonds in the fall, it could quickly run up against its limits. But Regling shrugs off such concerns. He doesn't say it, but he knows that the finance ministers in the euro zone would beef up his funds if necessary. German Finance Minister Wolfgang Schäuble and his Dutch counterpart, Jan Kees de Jager, have already indicated their willingness to do so.
Profitable Business
Regling believes that the bond purchases are a profitable business for the ECB, as they will also be for the EFSF later. The central bank, he says, buys the bonds at a discount. If it held the securities until maturity, it would receive their face value. "It keeps the difference as profit," he explains.
Of course, such demonstrative confidence is all part of Regling's job. In a sense, he is a global salesman for the euro. His goal is to make it clear to international investors that an investment in the common currency is worthwhile in the long term, because the member states, with his help, will do everything in their power to keep the euro.
At times, Regling exudes optimism to the point of excess. "The fundamentals are improving in all countries in the euro zone," he says. According to Regling, the currency zone is in a better position than the United States and Japan when it comes to government debt and budget deficits. "For example, the US deficit is three times as high as the deficit in the euro zone," he says. In addition, he points out, austerity plans have been approved for each country in the currency zone, something which the United States is a long way from doing.
Does it concern him that the financial markets are in turmoil because of the problems in Europe? Not really, it seems. Ireland, for example, has already overcome the worst, he says, adding that the country has regained a large part of its competitiveness. "The financial markets just need to properly recognize that."
With regard to the financial markets, Regling says, "the crisis confirms that markets sometimes act unpredictably and irrationally." Now that he is on the subject, the rescuer of the euro takes aim at his fellow Germans. "To a certain extent, hysteria reigns in Germany," says Regling. The Germans, in his view, believe that things can always get worse. "But that isn't true. The signs point toward improvement."
'The Currency Union Is Not Going to Break Apart'
Regling also views all the manic fear in Germany of a so-called transfer union as "nonsense." In the "only case of insolvency in the euro zone," namely Greece, only private-sector creditors -- and no public ones -- have been asked to contribute so far. "Only if Greece was expelled from the currency union, as some economists have demanded, would there be a high probability of transfer payments," he says. At that point, the country would no longer be able to pay back the loans it had taken out from its partner countries, which would continue being denominated in euros.
Indeed, Regling's long-term faith in the euro remains unshaken. "The currency union is not going to break apart, because strong and weak countries have a common interest in its survival." The economic price of its failure would be too high, he says. "The chances that the euro will be abandoned by anyone, no matter who, are practically zero."
The fact that things have already almost reached that point in the past doesn't change Regling's mind. A year ago, he predicted that "the most likely scenario" was that he and his EFSF would not actually have to intervene. The facility's very existence would be enough to calm the markets down, he argued at the time.
However, things turned out differently. Sometimes an optimist is nothing but a person who refuses to let themselves be discouraged by their own mistakes. Indeed, Regling believes that there is "good reason to hope that the crisis will be over in two to three years' time." The precondition for this, he adds, is that the euro-zone countries continue their austerity and reform plans and that the global economy doesn't collapse.
Lagarde spells out ugly truth on debt
by FT Editorial Staff
Jackson Hole may be a central bankers’ conference, but the most important thing to come out of this year’s gathering had nothing to do with central banking policy.
Christine Lagarde has said publicly what most policymakers have avoided addressing since the crisis began. Using her new bully pulpit at the International Monetary Fund she has conceded that the common problem facing the developed world is an excessive overhang of claims on debt that financed worthless investments. These claims will have to be liquidated, and the quicker the better.
Ms Lagarde deserves praise for spelling out the problem and issuing a call to action. But to resolve it also requires policymakers to decide where the losses should fall. She thinks they should land on taxpayers; this is wrongheaded. She focused on two big risks: the continuing frailty of European banks, and the continuing house price falls in the US and the growing number of homeowners trapped in negative equity.
Both threaten the recovery. Doubts about the health of European banks, could, if untreated, lead to another credit squeeze. The recent round of stress tests has not dispelled fears that undercapitalised institutions have been banking on a recovery to allow them to retain sufficient earnings to repair balance sheets. Meanwhile, the US mortgage mess crimps consumer spending by saddling distressed homeowners with excessive liabilities and preventing them from moving to where the jobs are.
What is welcome is Ms Lagarde’s willingness to embrace radical responses to both. In Europe, she endorses tougher stress-tests and a more coercive approach to balance-sheet repair. This newspaper could not agree more. In the US, she calls for writing-off more of the principal on mortgages. It will be vital to distinguish between mortgages that were recklessly extended and those that were not.
Where the FT disagrees, is in Ms Lagarde’s willingness to allow taxpayers to act as unpaid lifeguards for the financial system – rescuing the banks if private investors will not. This shifting of risk from bondholders was a bad idea in Ireland and generalising it across the eurozone will not improve it. It would be better to fill capital holes by mandatory debt to equity swaps that put unsecured bondholders where they belong – behind both taxpayers and depositors.
But if Ms Lagarde does not have all the answers she has at least started the debate. Now politicians need to show similar courage and look reality unsparingly in the eye.
Telling World's Bankers How It Really Is
by Irwin Stelzer - Wall Street Journal
She came to Jackson Hole, Wyo., to speak truth to the confessedly powerless. And because Christine Lagarde, head of the International Monetary Fund, is not a central banker, but a politician, she could speak truth in the simple language that politicians understand.
Here we have Jean-Claude Trichet, head of the European Central Bank, on Saturday: "Smooth factor sustainability could rid us of the Harrod-Domar boom-bust cycle." Surely a rallying cry that will resonate in the corridors of power in Berlin, Washington, Brussels, Paris and wherever policy makers gather. Add to that Federal Reserve Chairman Ben Bernanke's confession of virtual impotence and his insistence that the next moves to prevent another recession are up to politicians, not the central bankers, who have almost run out of ammunition.
This is a view in which Mr. Trichet implicitly concurs when he says that future growth will depend on the pace of technological progress, productivity, the removal of economic rigidities and all of the things repeatedly addressed at the serial meetings and by the serial pronouncements of European politicians, but beyond the purview of central bankers.
Since central bankers feel they can do little more than fiddle while the European and U.S. economies burn out, and often speak in a language that is inaccessible, it is worth attending to Ms. Largarde's (mostly) plain speaking. The IMF managing director said straight out what the central bankers could only hint at, that the "dangerous new phase" into which the world economy is entering is exacerbated by the fact that "policy makers do not have the conviction" to take the decisions necessary to meet the crisis.
Most of all, they need to force the recapitalization of Europe's banks, using public funds if need be, a view vehemently rejected by Brussels. Ms. Lagarde was implying that the stress tests imposed on euro-zone banks only a short while ago were a nonsense—almost all banks passed muster, something she hailed as a sign of the sector's strength when she was France's finance minister. But new office, new perspective.
There is no question that the Greek banking system has proved to be the Achilles' heel of the euro zone: We can't yet tell whether this weekend's merger of the nation's second- and third-largest lenders will significantly strengthen the sector. With the economy likely to decline this year by 5% or more, rather than by the 3.8% Greece's finance minister predicted only last month, panicked depositors are withdrawing funds, moving them out of the country or into vaults and mattresses, or simply using the savings to make up for lost wages. All in all, some €50 billion ($72 billion) has been pulled out of Greek banks by households and businesses, a 20% drop from the September 2009 deposit peak.
But Greece shouldn't bear all of the blame for the 25% decline in European bank shares this year. Investors worry that German banks are exposed to shaky sovereign debt and French banks even more so, and that all of Europe's banks are having trouble raising funds. U.S. money-market funds are fleeing European exposures; banks are refusing to lend to one another, preferring to hoard cash by depositing it at Mr. Trichet's ECB; and what lending there is is for short periods, often shorter than a week. As the Economist puts it, in the markets on which the banks rely for funding, "the life is being squeezed out of Europe's banks."
This and the impending recession are avoidable, say the trio of Mr. Bernanke, Mr. Trichet and Ms. Lagarde, if only the politicians would act. In America, address the issue of "fiscal sustainability" without disregarding "the fragility of the current economic recovery" (Bernanke), and cut the deficit with both tax increases and spending cuts (Lagarde); in the euro zone vigorously implement structural reforms in the labor market and distribute wealth so as "to ensure some acceptable social balance" (Trichet); in Europe recapitalize the banks, and in China allow the currency to appreciate, boosting domestic demand and "rebalancing" world trade (Lagarde).
Which brings us back to the IMF managing director's charge that policy makers lack the conviction to make these policy decisions. It is fruitless to ask Europe's politicians to honor the broken promises of reform enshrined in EU treaties for two decades, or to ask President Barack Obama to restore civility to American political discourse by holding a tea party for his Republican opponents. They won't, at least until—or perhaps even if—bad morphs into worse.
The problem in Europe is that politicians think they can fool the markets. Spain is amending its constitution to include a deficit cap in its constitution—the first country to respond to lender-in-chief Angela Merkel's demand that all supplicant nations do so—but the amendment does not include any actual deficit cap.
France has joined Ms. Merkel's call for balanced budgets, but has not balanced its own budget in 35 years, and is unlikely to do so soon as its economy is slowing, and will slow further when planned tax increases on capital gains, businesses, and the rich—who have published a Warren Buffet-style plea to have their taxes raised "reasonably"—are put into effect. Greece has promised to privatize large swathes of its economy, but has not so far sold off any significant assets. Italy has refused to undertake the structural reforms needed to end a decade of economic stagnation. Markets are appropriately skeptical, nay, cynical.
It would have been easier for Italy and other countries to make the needed changes in policy when rapid growth enabled Ms. Merkel to call on Germans' better natures and willingness to support them and the euro. With growth halted, any such generosity she might have been able to coax out of her electorate is a thing of the past. We might yet see a downsized euro zone.
European officials round on Lagarde
by Patrick Jenkins, Megan Murphy, Ralph Atkins and Peter Spiegel - FT
European officials rounded on Christine Lagarde on Sunday, accusing the managing director of the International Monetary Fund of making a "confused" and "misguided" attack on the health of Europe’s banks.
Ms Lagarde, the former French finance minister who replaced Dominique Strauss-Kahn as head of the IMF in July, used her address at an annual meeting of central bankers in Jackson Hole, Wyoming, to call for an "urgent" recapitalisation of Europe’s weakest lenders, saying that shoring up the banking system was key to cutting "chains of contagion" across the region.
But officials said Ms Lagarde’s comments missed the point of banks’ current difficulties. "The key issue is funding," said one experienced central banker. "Banks in some countries have had trouble securing liquidity in recent weeks and that pressure is going to mount. To talk about capital is a confused message. Everybody – politicians, regulators, other officials – is quite concerned."
Officials, nervous that Ms Lagarde’s statement would further spook bank investors, said they planned to urge the former French finance minister to clarify her statement.
European politicians and regulators are still struggling to come up with a mechanism that will calm investors’ skittishness about banks’ exposure to sovereign debt across the southern eurozone. A high-profile pan-European "stress test" of bank balance sheets has failed to allay investors’ concerns about their ability to withstand a default by a European government, or a severe deterioration in their credit portfolios across the region.
"We have to break the link between the sovereigns and the banks, particularly in Spain and Italy," said one regulator.
Ms Lagarde’s allusion this weekend to the potential use of the European Financial Stability Fund, a €440bn bail-out fund, as a means to recapitalise banks by force, would be far better directed towards a liquidity solution, some officials said. No headway has been made towards the idea of EFSF-guaranteed bank bond issuance, they admitted, though that would be the "most sensible solution", according to one.
Jean-Claude Trichet, the president of the European Central Bank, separately dismissed any idea that Europe could face a liquidity shortage in his own Jackson Hole address, saying efforts to combat the financial crisis would prevent such an outcome. "The idea that we could have a liquidity problem in Europe" is "plain wrong," Mr Trichet said.
The results of last month’s stress tests revealed that nine of the 91 banks tested "failed", with a core tier one capital ratio – a key measure of financial strength – of less than 5 per cent. National regulators are due to report back in October on headway made in forcing through recapitalisations at banks that failed, or came close to failing, the tests.
European banks set cash test by IMF chief
by Ambrose Evans-Pritchard - Telegraph
European banks face ordeal by fire this week after the International Monetary Fund called for "urgent" action to shore up their defences, if necessary with state money and under legal compulsion.
Christine Lagarde, the IMF’s new chief, set off tremors at the Jackson Hole summit over the weekend with warnings that the global financial system is on very thin ice and vulnerable to the slightest shock. "We are in a dangerous new phase. The stakes are clear: we risk seeing the fragile recovery derailed, so we must act now," she said.
"Banks need urgent recapitalisation. If it is not addressed we could easily see the further spread of economic weakness to core countries, even a debilitating liquidity crisis. The most efficient solution would be mandatory substantial recapitalisation," she said.
Europe’s lenders are already reeling from a share price collapse since the debt crisis spread to Italy and Spain, threatening to overwhelm Europe’s bail-out fund and leave banks exposed to sovereign defaults. Shares of Intesa SanPaulo, Credit Agricole and Commerzbank are all below the extremes seen during the panic in March 2009.
Europe’s inter-bank market is effectively frozen and EMU banks have lost access to America’s $7trillion (£4.3trillion) money markets. Lenders have parked €126bn (£112bn) at the European Central Bank for safety rather than risk exposure to peers.
The IMF exhorted Europe’s banks over the last two years to beef up their capital base while the rally lasted. Many failed to do so and will now face harsher terms. Some may fall under state control, wiping out shareholders.
The eurozone economy ground to a halt in the second quarter, tightening the noose on EMU’s weaker states and their banks. Julian Callow from Barclays Capital said Europe is already in "industrial recession" and risks tipping into outright economic slump. "The recent slide is eerily reminiscent of the pattern during the third quarter of 2008," he said.
Mrs Lagarde issued a thinly-veiled attack on the ECB’s rate rises and Europe’s fiscal austerity drive. "Monetary policy should remain highly accommodative, as the risk of recession outweighs the risk of inflation. Fiscal policy must navigate between the twin perils of losing credibility and undercutting recovery," she said.
Tim Congdon from International Monetary Research said it is folly to force Europe’s banks to raise money too quickly or crystallize losses abruptly. This will cause a monetary implosion and a repeat of the 2008 disaster. He said the ECB’s restrictive policies over the last 18 months and the lack of EMU fiscal union have doomed the euro. to certain break-up.
"It cannot be saved. Banks will suffer large losses," he said.
EU rules out fresh capitalisation for Europe's banks
by Roland Gribben - Telegraph
A fresh round of capitalisation for European banks was firmly ruled out by EU officials and bankers when they appeared before an emergency meeting of the European Parliament's economic committee.
The officials poured cold water on calls from Christine Lagarde, head of the International Monetary Fund for "mandatory" recapitalisation to avoid another financial crisis but acknowledged that the EU economy was continuing to weaken.
Jean-Claude Trichet, president of the European Central Bank, said there was no shortage of liquidity in the European banking system. EU economic commissioner Olli Rehn insisted that the health of EU banks had improved over the last year. Mr Trichet declared: "There is no liquidity or collateral shortage for the European banking system." Both urged eurozone Governments to move faster to implement the July 21 heads of agreements which makes provision for a second bail out for the weaker states.
Mr Rehn said targets set for privatising state assets in Greece might have to be revised because of the weakness of the Athens stock exchange. MEPs were told that faster progress was being made by other countries. Ireland's competitiveness has improved considerably while Portugal was said to be "progressing well." Mr Rehn was gloomy about the economic outlook warning that after expanding by just 0.2pc in the second quarter the short-term indicators pointed to a "further moderation of growth." He said he was seriously concerned that the financial turbulence would spill over and harm the recovery of the "real economy."
MEPs were critical about the way the debt crisis had been handled with many calling for closer integration to reduce the risks of a collapse of the euro. Mr Rehn made it clear that there would be no rush to push ahead with the proposals to use euro-zone bonds, opposed by Germany and France to ease the crisis. He said they would have "unavoidable implications for fiscal sovereignty".
Jean-Claude Juncker, Luxembourg prime minister and Eurogroup president, joined by Mr Rehn in acknowledging that the markets had not been convinced by the euro-zone action programme. They admitted "we dragged our feet behind the financial markets."
Polish finance minister Jacek Rostowski, said he was well aware of the catastrophic consequences of a failure of the euro-zone recovery programme and "the dramatic consequences for the UK." He added: "That is why George Osborne and I are saying we have always been fully in favour of deeper (euro-zone) integration."
Europe’s Big Mistake
by James Surowiecki - New Yorker
In July, 2008, on the eve of the biggest financial crisis in memory, the European Central Bank did something both predictable and stupid: it raised interest rates. The move was predictable because the E.C.B.’s president, Jean-Claude Trichet, was an inflation hawk; he worried about rising oil and food prices and saw a rate hike as a way of tamping them down. But the move was also remarkably ill timed.
The crisis was already under way, European economic growth had slowed to a crawl, and within a couple of months the global economy had collapsed, inflation had disappeared, and the E.C.B. was forced to slash interest rates, in an attempt to avert economic disaster. That July rate hike was like kicking the economy when it was down.
One might have thought that the E.C.B. would learn from the experience. No such luck. This year, Europe has been wrestling with high unemployment, slow growth, and a continuing debt crisis, with the economies of Portugal, Ireland, Italy, Greece, and Spain (the so-called PIIGS) struggling to avoid default.
Given the situation, Trichet could have decided to keep interest rates where they were, as both the Federal Reserve and the Bank of England have done. Instead, the E.C.B. raised interest rates in April and, once more, in July. Again, as if on cue, European economic growth stalled and the continent’s debt crisis deepened, which has created problems for markets around the world.
Policymakers make bad decisions all the time, of course. The E.C.B.’s failures, however, are the result not of mere bad judgment but of obsession. That obsession may not have created Europe’s problems, but it has amplified them. The continent’s economic woes boil down, really, to two issues: too much debt and too little growth.
These things are connected to each other: the PIIGS are struggling with their debt loads largely because their economies are growing too slowly. By raising interest rates, the E.C.B. increased borrowing costs and slowed economic growth—the opposite of what was needed. And, while the E.C.B. did step up and buy Italian and Spanish government bonds last month, in order to keep those countries afloat, by doing this it was plugging a hole that its own actions had done much to create.
The E.C.B.’s actions have been especially damaging because they’ve come at a time when, in response to the debt crisis, European countries have been forced to take austerity measures, slashing government spending and raising taxes. When fiscal policy is contractionary, expansionary monetary policy can help make up the difference. This is what the Federal Reserve has tried to do in the U.S.—albeit not aggressively enough. The E.C.B., by contrast, has decided to tighten, which means that both fiscal policy and monetary policy are hitting the brakes on the economy.
The perplexing thing about the E.C.B.’s approach is that it’s hard to see who benefits. The traditional explanation for the bank’s anti-inflationary zeal hinges on the fact that the continent’s stronger economies, in particular Germany’s, don’t need any help growing, and don’t like the fact that inflation reduces the real value of assets. So while the PIIGS might prefer a monetary policy that shrank debts and spurred growth, Germany wants low inflation, and Germany wins.
Yet right now the entire continent would benefit from easier money. Germany’s economy may have been doing well earlier this year, but it isn’t anymore; in the past quarter, it grew just 0.1 per cent, more slowly than the U.S.’s. Germany is heavily dependent on exports, including exports to the rest of Europe, which means that it can prosper only if other countries do. On top of that, the debt crisis has hurt German banks, which had lent heavily to the PIIGS. Once upon a time, you could argue that the E.C.B.’s approach was helping Europe’s big economies at the expense of the smaller ones. But the current tight-money strategy is making every country a loser.
To be fair, the E.C.B. isn’t alone in its paranoia about inflation. That bias reflects the preferences of many voters, whose hatred of inflation tends to be disproportionate to its real costs. (Cue Rick Perry saying that looser monetary policy would be "almost treasonous.")
Most studies of moderate inflation find that its costs are quite small, but a study of elections in thirteen European countries from the nineteen-sixties to the nineties found that voters were far more likely to toss out politicians when inflation rose than when unemployment did. Inflation hits everyone, after all, even those who have jobs, and it’s easier to get angry about expensive gasoline than about that raise you might have got if the economy were stronger.
Still, the fact that the E.C.B.’s attitude is widely shared doesn’t make it any more excusable. In times of crisis, policymakers need to identify the threats that matter most. Today, rising prices are not a real threat to Europe; recession and debt default are. Trichet is fond of pointing out that the E.C.B.’s primary mandate is to maintain "price stability." But prices in Europe, where inflation is around 2.5 per cent, are not unstable.
And, by acting as if Europe were in danger of repeating the nineteen-twenties, when Weimar Germany succumbed to hyperinflation, Trichet is running the risk of repeating the mistakes of the early thirties, when central bankers’ tight-money policies and zeal for austerity made a bad situation much, much worse. (It’s worth remembering that it was the Depression, not hyperinflation, that toppled the Weimar government and brought Hitler to power.)
The E.C.B. has spent this year fighting off the phantom danger of inflation. It’s time for it to face up to the real danger of recession.
Euro bail-out in doubt as "hysteria" sweeps Germany
by Ambrose Evans-Pritchard - Telegraph
German Chancellor Angela Merkel no longer has enough coalition votes in the Bundestag to secure backing for Europe's revamped rescue machinery, threatening a consitutional crisis in Germany and a fresh eruption of the euro debt saga.
Mrs Merkel has cancelled a high-profile trip to Russia on September 7, the crucial day when the package goes to the Bundestag and the country's constitutional court rules on the legality of the EU's bail-out machinery. If the court rules that the €440bn rescue fund (EFSF) breaches Treaty law or undermines German fiscal sovereignty, it risks setting off an instant brushfire across monetary union.
The seething discontent in Germany over Europe's debt crisis has spread to all the key institutions of the state. "Hysteria is sweeping Germany " said Klaus Regling, the EFSF's director. German media reported that the latest tally of votes in the Bundestag shows that 23 members from Mrs Merkel's own coalition plan to vote against the package, including twelve of the 44 members of Bavaria's Social Christians (CSU). This may force the Chancellor to rely on opposition votes, risking a government collapse.
Christian Wulff, Germany's president, stunned the country last week by accusing the European Central Bank of going "far beyond its mandate" with mass purchases of Spanish and Italian debt, and warning that the Europe's headlong rush towards fiscal union stikes at the "very core" of democracy. "Decisions have to be made in parliament in a liberal democracy. That is where legitimacy lies," he said.
A day earlier the Bundesbank had fired its own volley, condemning the ECB's bond purchases and warning the EU is drifting towards debt union without "democratic legitimacy" or treaty backing. Joahannes Singhammer, leader of the CSU's Bundestag group, accused the ECB of acting "dangerously" by jumping the gun before parliaments had voted. The ECB is implicitly acting on behalf of the rescue fund until it is ratified.
A CSU document to be released on Monday flatly rebuts the latest accord between Chancellor Merkel and French president Nicholas Sarkozy, saying plans for an "economic government for eurozone states" are unacceptable. It demands treaty changes to let EMU states go bankrupt, and to eject them from the euro altogether for serial abuses. "An unlimited transfer union and pooling of debts for any length of time would imply a shared financial government and decisively change the character of a European confederation of states," said the draft, obtained by Der Spiegel.
Mrs Merkel faces mutiny even within her own Christian Democrat (CDU) family. Wolfgang Bossbach, the spokesman for internal affairs, said he would oppose the package. "I can't vote against my own conviction," he said.
The Bundestag is expected to decide late next month on the package, which empowers the EFSF to buy bonds pre-emptively and recapitalize banks. While the bill is likely to pass, the furious debate leaves no doubt that Germany will resist moves to boost the EFSF's firepower yet further. Most City banks say the fund needs €2 trillion to stop the crisis engulfing Spain and Italy. Mrs Merkel's aides say she is facing "war on every front". The next month will decide her future, Germany's destiny, and the fate of monetary union.
Why yes, the Greek collateral grab is a big honking default risk
by Joseph Cotterill - FT
Over a week after FT Alphaville first revealed how Greece’s Finnish collateral “deal” threatened a default on its foreign-law bonds, given negative pledge clauses in the contracts…From Handelsblatt on Thursday:
The eurozone will not agree the agreement between Finland and Greece on collateral. “This is off the table,” ["Das ist vom Tisch"] Wolfgang Schaeuble, the [German] finance minister, said to a meeting of the CDU/CSU parliamentary group, sources told Handelsblatt.
Financial experts have warned [the Eurogroup] against allowing donor states to receive collateral on EFSF loans. In this case, Greece could get a wave of lawsuits from private creditors, the Handelsblatt learned from diplomatic circles in the EU. Private investors could rely on a so-called “negative pledge clause” in Greek government bondsWhich would be the clause we’ve picked over here, here, and here.
In a nutshell, the negative pledge clause provides that Greece must secure the bonds on an equal basis, if it should ever secure ‘external indebtedness’, as defined in the contract. The definition covers any money borrowed under a foreign law, it would appear. (Though it’d depend on what a court would say, if it comes to that!) EFSF loans are governed under English law for example. (There might be ways for Greece to pledge collateral via a Greek-law vehicle of some sort, although we aren’t sure.) But essentially, the Finnish demands for superior collateral currently stand to jeopardise the clause.
We’ve considered the pros and cons of the argument for whether it might be a CDS credit event as well as whether the collateral would be an event of default. Handelsblatt misses one big nuance though: this affects Greece’s foreign-law bonds, not the circa 90 per cent of Greek bonds that are governed by Greek law. But it’s a huge, huge deal not only for holders of these bonds, but possibly for holders of bonds and other contracts (repos?) that also contain cross-default clauses. Net notional on Greece CDS is relatively small, but there’s also a serious problem for the eurozone’s supposed commitment to avoid any trigger of credit default swaps on a member-state, not to mention the stigma of default on any part of a member’s debts.
The point is, this goes way beyond the fear (enunciated by Moody’s recently) that the Finnish collateral deal will delay or even stop the bailout. (Though that would risk a default on all of Greece’s debt.)
The rot’s gone a bit deeper than that now because of the complexity of the negative pledge issue. That’s why we wouldn’t put much store by Schaeuble’s peremptory statement that the issue has gone away.
Wait to see what the Finns say first of all. They have been insisting throughout this week that collateral (in some form) is a red line for them, but collateral in just about any form will trigger this negative pledge clause. Notably at pixel time an EU spokesman said that the talks on Greek collateral had no deadline. Therefore, no decision!
Just ask yourself one question. If you were an investor considering whether to trust Greece and take part in an expensive bond swap, the point of which is to avoid a disorderly default, what would you think about the kind of credibility and commitment shown in this Finnish farce? (Reuters was reporting that this bond swap had 50 per cent participation at pixel time, below the actual 90 per cent target. Not much time left.)
We’re not sure. Is ‘hoist with one’s own petard’ a popular phrase in Brussels?
Finland’s Greek collateral plan breaks negative pledge [updated]
by Joseph Cotterill - FT
You might have heard of the latest Finnish proposal to collateralise loans to Greece. This would transfer Greek privatisation assets to a Luxembourg-based société anonyme to be held as security against default, according to Reuters, which also has the proposal text.Here’s a nice diagram of it all works:
Here’s a not-so nice bombshell that seems to have been missed:
We’d hate to say we told you so. But we did. This is firstly another official acknowledgement that the negative pledge clause — which forbids Greece securing foreign-law or foreign-currency “external indebtedness” on terms prejudicial to its foreign law bonds — does present a serious problem. Notably, it’s a serious problem even for proposals based on SPVs, which had been seen as a way to avoid a negative pledge trigger.
Still. What Finland has unfortunately omitted to add: if there is no bondholder waiver, and if Greece does not secure the foreign-law bonds on the same basis, Greece will default on these bonds. It would be the first sovereign default in modern Western Europe. Possibly a credit event too.
We’re not even sure that Greece could actually provide sufficient assets to collateralise both the EFSF loans and foreign-law bonds. These assets are already marked for privatisation and there may simply not be enough to go round even if they weren’t being sold.
Amazingly, Finland has spun the negative pledge problem and its massive risk of default as an opportunity for credit enhancement:
You couldn’t make this stuff up.
Update 10:25am UK time — You can still consider ways around the negative pledge issue however, surmounting the current Finnish proposal.
One idea suggested to us on Monday is for the EFSF to lend to the SPV itself rather than to Greece directly. In that case, the EFSF is not a secured creditor of Greece per se. It’s not a million miles from how current Greek government securitisation vehicles work. These have existed for years without triggering negative pledge clauses so we’re interested to see if there is a solution here. We’ve altered the diagram above with our rubbish MS Paint skills to note the EFSF change…
Thoughts?
Finland's demands for collateral could leave Greek bailout in ruins
by Heather Stewart - Observer
Row over collateral for emergency loans to Athens reveals cracks in the eurozone
For Greek politicians, the past month must have been a blessed relief, as the centre of Europe's sovereign debt crisis moved elsewhere. Italian trade unionists are gearing up for a general strike against austerity measures; Nicolas Sarkozy is slapping a supertax on the super-rich; and Spain is promising to make it unconstitutional to let the public finances get out of control. But as September rolls around and the beaches clear, Greece is once again the focus of financial markets' fears.
In July, Athens secured a second bailout package worth €109bn (£96bn), which involved "haircuts" for holders of Greek debt, and contributions from its eurozone neighbours. Both parts of that deal now look distinctly shaky. Finland, where the anti-European True Finns party scored well in recent elections, has demanded that Athens put up collateral against the Finnish share of the latest loan.
Other small but angry nations, including Austria, Slovenia and Slovakia, responded by saying that if Finland was getting collateral, they wanted some too. Eurozone finance ministers were discussing the issue this weekend; but the Finns appear reluctant to back down.
When questions emerged about what collateral Athens has left, given the €50bn privatisation plans it has already signed up to as a condition of the bailout, one Finnish minister reportedly said they would accept assets already earmarked for privatisation. Great swathes of Greek infrastructure are up for sale, from airports to casinos.
Setting aside collateral will reduce Greece's room for manoeuvre by tying up its assets; but, much more importantly, the row has laid bare the disarray in the eurozone. "At every step, we're seeing the authorities pushed back further," says Neil Mellor, of BNY Mellon. "It's fire-fighting, pure and simple, and it's not obvious what happens next."
The resulting alarm among investors sent the yield on Greek bonds – the interest rate the government would have to pay to borrow in the open markets – back to record highs last week. It's as if the July rescue never happened – and it raises doubts about other elements of the emergency deal agreed at the time, including the new role of the European Financial Stability Facility (EFSF), which Sarkozy suggested was a fledgling European International Monetary Fund.
Changes to the EFSF need to be agreed by all member governments, and the squabble about collateral underlines the wide political divergences across the single currency zone. The "voluntary" bond swap at the heart of the bailout also appeared to be in doubt this weekend, after Greece said it would pull out unless 90% of its creditors – mainly European banks – agreed to take part. Greek banks start reporting their results this week, and with government bonds making up much of their capital, they are expected to warn of losses of up to €5bn if the haircuts go ahead.
Greek banks have also suffered rapid declines in deposits in recent months, as consumers withdraw savings to spend, and wealthy Greeks squirrel away their assets in safe havens abroad.
This fresh outbreak of the jitters is happening against a sharp deterioration in the economic outlook right across the continent. Even in Germany, GDP growth has slowed to a crawl, and business confidence has plunged. The latest round of tax rises and spending cuts, with France, Spain and Italy all announcing new fiscal tightening since the beginning of August, are only likely to depress growth yet further.
In Greece, weaker growth could mean the fiscal sums no longer add up. Analysts are beginning to speculate that even after passing a highly contentious package of austerity measures in June, the government could miss its deficit reduction targets.
"There are signs that the Greek deficit is still not on track, despite the latest package that was agreed in July," said Julian Callow, of Barclays Capital. Athens' tax and spending plans are based on the assumption that the economy will contract by 4.5% this year. That is a catastrophic recession by any standard but it now looks too optimistic: Callow expects a contraction of 5.5%, perhaps even 6%.
Europe's sovereign debt crisis is far from over. It's not clear exactly what will spark the next outbreak of panic in financial markets but, with the banks due to report, the Finns digging their heels in, and the IMF flying in to assess Athens' compliance with its fiscal targets in the next few days, Greece looks like a pretty good bet. As Callow says, "Greece is really the epicentre right now, and has a lot of capacity to be a very negative force for financial markets in Europe in the weeks ahead, if things don't go exactly according to plan."
Finland’s Collateral Demand Fueled by Greek Bailout Fatigue
by Kati Pohjanpalo - Bloomberg
Finland’s demands for collateral on new Greek loans leaves European Union leaders putting the rescue plan at risk by appeasing the AAA-rated nation, or helping bring an even more anti-bailout government to power by defying the Finns.
Prime Minister Jyrki Katainen "can’t back down on the collateral demand as his government would likely collapse," said Timo Tyrvaeinen, Chief Economist at Aktia Oyj in Helsinki. "That could mean new elections quite soon" and risk the euro- skeptic Finns party, which has rejected all bailouts, coming to power.
Luxembourg Prime Minister Jean-Claude Juncker, who also chairs the euro-area finance meetings, said yesterday he was "confident" an agreement could be reached by mid-September, while criticizing the call for collateral. "I don’t like this mechanism and I don’t like the bilateral arrangements," he told the European Parliament’s economic committee in Brussels, referring to Finland’s agreement with Greece for protection.
The collateral flap reflects the bailout fatigue that is spreading particularly in the more fiscally prudent countries of northern Europe, fueling support for political parties opposed to aid to the region’s more profligate members. National politics is increasingly at odds with efforts to forge European unity, complicating a comprehensive response to the debt crisis that now threatens Spain, Italy and France.
July Summit
EU leaders initially agreed to Katainen’s demands for protection at the July 21 summit that hashed out the 159 billion-euro ($231 billion) rescue for Greece. Then details of the collateral deal Finland negotiated with Greece emerged this month, triggering a backlash and demands for similar treatment from nations including Austria and the Netherlands, threatening to delay or scupper the Greek plan.
Far from resolving the debt crisis, contagion continued after the summit and the European Central Bank began buying Spanish and Italian bonds to help bring down yields that reached euro-era records. Divisions over collateral contributed to a further slump in Greek bonds with the yield on the country’s two-year notes topping 45 percent yesterday. "What’s at stake is ultimately, if you were to put this to the extreme, the entire second rescue package for Greece by the euro area," Frank Engels, co-head of European economy at Barclays Capital in Frankfurt, said by phone on Aug. 26.
German Backlash
Chancellor Angela Merkel also faces a growing storm in her coalition over the bailouts of Greece, Portugal and Ireland. Her Free Democratic Party coalition partner has threatened to oppose the start of a permanent EU bailout mechanism set to take effect in 2013.
Anti-bailout forces were already on the ascendency in Finland prior to the new Greek deal. It took Katainen two months and he needed backing of six parties to build a ruling coalition after winning elections in April that saw a surge in support for the Finns party. Finance Minister Jutta Urpilainen, who heads the Social Democrats, campaigned on the collateral issues as she tried to beat back the challenge from the Finns, who emerged as the third-biggest party in the vote.
It would be "totally irresponsible" of the Finnish government "to throw in the towel" and back down on its demands, Urpilainen said on Aug. 25. Her Social Democratic party is the second-biggest in the coalition. Finland responded to the criticism from its EU partners, by offering to broaden a collateral deal to include other nations who might want similar protection.
'Excessive Collateralization'
Extending the deal could "blow-up" the rescue plan, Austria’s Finance Minister Maria Fekter said on Aug. 18. European Commission spokesman Amadeu Altafaj said on Aug. 19 that the EU must avoid "excessive collateralization" in the Greek bailout.
Greek Finance Minister Evangelos Venizelos on Aug. 21 called on European Union officials to quickly resolve the issue of additional countries following Finland in calling for collateral to participate in a new Greek aid package.
Greece received a three-year, 110 billion-euro rescue in 2010 from the European Union and International Monetary Fund that anticipated the country returning to financial markets next year. With its 10-year bond yielding about 18 percent, financing in the markets proved unrealistic and the EU was forced to draw up a second rescue package to fully fund Greece for three years.
"It’s getting very tight in terms of the time lines" for approving the economic measures to stabilize the region, Engels said. "By end September we could be very close to agreement on all this and then move forward, if there is a willingness to agree on this, that is a big ‘if’ I think."
Doubts over German role in Greek debt deal
by James Wilson - FT
German "bad bank" agencies holding billions of euros of Greek debt have still to decide whether to join a bond swap designed to cut Athens’ refinancing burden as part of an EU bail-out. Two of the German banks that are among the country’s largest holders of Greek bonds have also to commit themselves to the €135bn debt swap plan set to be launched next month.
The uncertainty over which institutions will support the deal comes as Greece is warning that the swap might not go ahead if fewer than 90 per cent of private investors agree to participate. Some of Germany’s biggest holders of Greek debt are agencies set up with public sector support to wind down toxic and unwanted assets that had to be unloaded from stricken banks’ balance sheets during the financial crisis.
About €7.4bn of Greek sovereign debt is held by FMS Wertmanagement, a "bad bank" to which €175bn in assets were transferred from Hypo Real Estate, a property lender. Erste Abwicklungsanstalt, to which assets from WestLB were transferred, has a further €1.1bn of Greek public sector exposure. Because the agencies are not banks and are backed by public sector guarantees, the extent to which they may take part in the bond swap aimed at private creditors remains unclear, in spite of their large holdings.
FMS holds more than twice as much Greek debt as Commerzbank, which is Athens’ biggest private-sector German creditor. EAA has taken a 21 per cent writedown on its Greek holdings, in line with advice from a German accounting body following the announcement last month of the private-sector restructuring offer, which is being co-ordinated by the Institute of International Finance, a global banking sector lobby group.
However, EAA has said it "remains to be seen whether or to [what] extent EAA will participate...in the IIF offer of private creditors and suffer losses from the restructuring of Greece’s liabilities". FMS also told the Financial Times that it had not taken a decision on participation.
All of EAA’s Greek debt matures before 2020 and so would, in theory, be eligible for the IIF-backed swap, under which bonds due by that date would be exchanged or rolled over. Most of FMS’s Greek assets mature after 2020.
Germany’s largest co-operative bank, DZ Bank, and its largest public-sector bank, Landesbank Baden-Württemberg, have also yet to confirm whether they will support the IIF-backed deal. Greece has set a deadline of September 9 for banks to make non-binding offers. DZ Bank, which in last month’s EU bank stress tests reported €731m of Greek exposure, is likely on Monday to announce partial writedowns along with its financial results for the first half of 2011.
LBBW said last week it had written down its Greek state exposure by around 50 per cent to about €400m. Commerzbank, Deutsche Bank and BayernLB have all given explicit backing to the IIF initiative, as have insurers Munich Re and Allianz and DekaBank, an asset manager.
"Commodity Prices Seem Much Too High"
by Cullen Roche - PragCap
I rarely use technical analysis in my work, but there are times when a picture really is worth a thousand words. Sometimes a chart can help an investor to visualize market relationships better than raw data can. In this way, technical analysis can be particularly helpful in gauging risks and potential mean reverting situations. One such potential mean reverting situation is the long-term outlook for commodity prices. This is, in my opinion, particularly important given Wall Street’s recent attempts to push the “commodities are an investment class” theme.As I’ve previously mentioned, betting on the actual commodities is never an investment. In fact, over the long-term, commodities have very poor real returns. Rather, an investor who is looking to benefit from a commodity bull market or the negative correlation of some commodities, is better off investing in the ingenuity of the corporations that benefit from these markets. In this manner, you are actually buying human ingenuity rather than buying physical commodities which are the equivalent of selling human ingenuity.
In a recent strategy note, analysts at Societe Generale discussed the long-term surge in some commodity prices and why it could be foreshadowing of a mean reverting event:
“Commodity prices seem much too high as economic growth is slowing. Over the past three years, all commodities have touched historical highs. The most recent high seen for Gold, in August, was sparked by forex fears.
Oil prices used to be very sensitive to US growth, but things are different this time, as emerging market demand partly outpaces that of the US, maintaining global oil demand at high levels. But, now the surge in Gold suggests that markets are looking for safe haven investments, as was the case in the 1930s and the 1970s.
Hence, financial markets begin to doubt that the current forecast for global growth of 4% pa is sustainable, thus, commodity prices seem much too high at this stage of the economic cycle.”Now, I don’t like lumping gold into this analysis because I think gold has some intangible components that make it more unique than other commodities, but I am generally skeptical of the idea that broad commodities are going to sustain high real prices in the same manner that other asset classes have historically.
As Jeremy Grantham believes, this time would truly have to be different in order for this to persist. Of course, this is not my way of saying that one should go out and short all commodities. Quite the contrary. It just means that you have to recognize that you’re speculating when you buy raw commodities and if you’re trading that might suit your needs perfectly fine.
If instead, you are an investor with a long-term diversified focus you would be wise to focus on the underlying ingenuity that benefits from commodity markets by investing in the actual corporations themselves. Don’t fall for Wall Street’s latest sale’s pitch which is trying to push investors into physical commodities of all sorts. History is not on your side.
Iceland Revives Carry Trade as Swaps Show Default Risk Is Below EU Average
by Omar R. Valdimarsson - Bloomberg
Iceland’s decision to break with global crisis-fighting efforts and raise interest rates this month may presage the return of the very same carry trade that channeled fast money into the country before its banking crisis.
Iceland raised its main interest rate on Aug. 17 by a quarter point to 4.5 percent, the first increase since its banks collapsed almost three years ago. The central bank, which also raised its economic forecast for 2011, is increasing rates as it eases capital controls that have locked in $4.3 billion in krona assets since 2008. The move may revive a trade popular before the crisis: borrowing in low-yielding currencies and carrying the funds into higher-yielding markets such as the krona.
"The central bank has stated that it wants to open the door to the carry trade," said Asgeir Jonsson, an economist at Reykjavik-based asset manager Gamma. "As greed knows no boundaries, carry traders will always return as long as the yield is favorable."
Iceland, where a 2008 banking implosion left bond investors trying to recoup $85 billion, can now boast a lower risk of default than the average for the European Union. The central bank signaled this month it may continue to raise rates to support the currency as the U.S. and the euro area resort to emergency easing to keep their economies afloat. Iceland’s rate rise comes as investors are turning to emerging markets to tap into faster growth rates and lower debt levels. The Icelandic krona strengthened for a second day, rising 0.3 percent to 113.14 per dollar as of 9:33 a.m. London time.
'Redefining Risk'
Credit default swaps on Iceland’s five-year debt were at 278 basis points on Aug. 26, compared with a 345 basis point average for the 27-member European Union, CMA prices show.
"Investors are redefining risk," Jonsson said. "Now bonds issued by sovereigns in the emerging markets are more desirable than those of countries such as Italy."
Iceland’s economy will next year outgrow the euro area and maintain a smaller budget deficit in the process, the Organization for Economic Cooperation and Development said May 25. The island’s gross domestic product will expand 2.9 percent in 2012, compared with 2 percent in the 17-member euro area. Iceland’s government deficit will narrow to 1.4 percent of GDP, versus a 3 percent shortfall in the euro bloc in 2012, the OECD estimates.
'Road to Recovery'
The island completed a 33-month International Monetary Fund program this month after the Washington-based lender established that all economic "objectives have been met and the country is on the road to recovery," according to an Aug. 26 statement marking the island’s final review. The IMF praised the central bank’s decision to raise rates as an appropriate measure to tame inflation as import prices rise. Consumer price growth held at 5 percent in August, the highest level since June 2010. The krona has lost 6.5 percent versus the euro this year.
By raising rates "we’re making the Icelandic krona more attractive than it otherwise would be," said Thorarinn Petursson, chief economist at the central bank.= While higher rates may boost the krona, such tightening won’t "reduce inflationary expectations, on the contrary they could worsen," saidAsdis Kristjansdottir, an economist at Arion Bank hf. Raising rates will instead hurt "the fragile recovery ahead," she said. Though Iceland has signaled it needs to keep some form of capital controls in place until as late as 2015, the central bank is already easing the restrictions in phases.
Krona Flows
"The moment the market opens up in Iceland, carry traders will return," Jonsson said. "Investors’ risk appetite has increased and is increasing and investors are increasingly putting their money into emerging markets."
Monthly krona flows peaked at 1.2 trillion kronur ($10.6 billion) in March 2008, seven months before Iceland’s biggest banks failed. Iceland’s gross domestic product was 1.5 trillion kronur for that whole year. Flows surged as the central bank pursued a tightening cycle that brought the benchmark rate to 15 percent in March 2008. The rate reached 18 percent that year before the bank finally imposed capital controls to protect the currency from a sell-off after the banks failed. Monthly krona turnover in July 2011 was 5.6 billion kronur.
While the central bank’s Petursson says Iceland is still "quite far away from having to worry about the carry trade," Jonsson warns the transaction "will begin immediately" once the country opens its capital markets. He’s not alone in voicing concerns.
'Iceland’s Demise'
"Iceland should be careful when it comes to opening up the doors for the carry trade, as those kinds of transactions played a role in Iceland’s demise," said Jon Bjarki Bentsson, an economist at Islandsbanki hf. "It would be better if foreigners were drawn to Iceland because of an underlying profitability, not just because short-term interest rates are high."
Not all analysts agree that the carry trade is a bad thing. Lars Christensen, chief analyst at Copenhagen-based Danske Bank A/S, said speculative krona purchases shouldn’t hurt the economy provided the extra yield the central bank offers exceeds the risks associated with holding the currency.= "Fundamentally it could be a good idea for Iceland to attract the carry trade, if the carry trade reflects that interest rates are higher than the perceived risk by investors," he said.
Berlusconi Bows to Demands to Overhaul Austerity Plan
by Chiara Vasarri - Bloomberg
Prime Minister Silvio Berlusconi agreed to overhaul the 45 billion-euro ($66 billion) austerity plan that persuaded the European Central Bank to support Italy’s bonds, dropping a tax on the highest earners and limiting funding cuts to regional governments.
Berlusconi and Finance Minister Giulio Tremonti agreed to the changes after a seven-hour meeting yesterday with officials of the Northern League, a key coalition ally opposed to parts of the original plan that aimed to balance the budget in 2013. The overhaul comes as Italy auctions 8 billion euros of bonds today, the first benchmark sale since the ECB began buying on Aug. 8. A spokesman for the Frankfurt-based ECB declined to comment.
"The ECB will raise its voice if there aren’t further guarantees that it’s completely covered," said Marco Valli, UniCredit’s chief euro-zone economist. "It seems now that there will be some kind of revenue shortfall, but we still don’t have all the details and it’s probable that for now, the ECB will be keeping a close eye on this."
The original package was the second austerity plan in a month adopted by the government as Italy tries to convince investors it can tame the euro region’s second-largest debt and avoid following Greece, Ireland and Portugal in seeking a bailout. The plan was thrown together in days and passed by the Cabinet on Aug. 12 after the ECB demanded additional austerity measures to buy Italian bonds, Tremonti has said.
Bonds Decline
The yield on Italy’s benchmark 10-year bond has fallen about 100 basis points since the ECB began buying. The yield rose 2 basis points today to 5.11 percent, the highest in three weeks.
"This is the third time since the middle of July that the Italians have seen different austerity measures imposed on them, and in some aspects this is extremely different from the version passed on Aug. 12," said Alberto Mingardi, director general of the Bruno Leoni institute, a Libertarian research institute. "How can the economic players plan their decisions if the politicians shuffle the deck every week."
The new version of the package, which is due to be voted on by the Senate next week, drops the "solidarity tax" of an additional 5 percent on income of more than 90,000 euros a year, rising to 10 percent for income above 150,000 euros, Berlusconi’s office said in an e-mailed statement.
No VAT Increase
The new plan does not include an increase in value-added tax to compensate for lost revenue, which some lawmakers had called for. The solidarity tax will be replaced with unspecified levies aimed at the wealth of those evading taxes, the note said.
Cuts in funding to regional and local governments, worth 9 billion euros in the original two-year plan, will be scaled back. Those reductions will be trimmed by about 2 billion euros, Roberto Calderoli, minister for legislative simplification, told the Ansa news agency.
"About the credibility of the measures, there is implementation risk," said Silvio Peruzzo, euro-area economist at Royal Bank of Scotland Group Plc in London. "The growth outlook is weakening globally. Some of the measures have to be qualified in terms of the details. This is a feature of any fiscal effort you see anywhere in the globe." The International Monetary Fund will cut its forecast for Italian economic growth next year to 0.7 percent, Ansa news agency reported, citing a draft of the fund’s World Economic Outlook report. Tremonti forecasts growth of 1.3 percent for 2012.
Robin Hood Tax
The statement didn’t say whether plans to raise the capital gains tax to 20 percent from 12.5 percent had been modified, or whether a so-called Robin Hood tax on profit of electricity utilities had been altered.
"Maybe this is not all we wanted, but it is also important to keep a solid majority," Undersecretary for Defense Guido Crosetto, one of the most outspoken critics of the original plan among Berlusconi’s allies, told Ansa.
The new package will go ahead with efforts to reduce the size of the parliament, the statement said. And legislators will still have to pay a solidarity tax of 10 percent on income over 90,000 euros.
Venetians see their economy sink as subsidies dry up
by Phillip Inman - Guardian
Venice gets none of the cash levied on the cruise liners' operators so the city is introducing a tourist tax to help plug the funding gap
Bare brickwork on many of the finest homes in Venice graphically illustrates the funding crisis gripping Italy. Forced to copy the costly techniques of their forebears by regional heritage regulations, homeowners have chosen instead to let their 15th-century palaces crumble.
Before the banking crisis there were subsidies that helped buy costly pink and mauve plasters, pay artisan builders and erect canal-side scaffolding, but Giulio Tremonti, finance minister and chief cost-cutter in Silvio Berlusconi's government, has spent the last three years quietly stripping Venice residents of central government support.
Sandro Simionato, deputy mayor of Venice and its finance chief, says the historic city has seen almost all its central government grants disappear over the last three years, forcing local politicians to introduce means-tested social care for the first time for its rapidly ageing population. Simionato, a member of the leftist Democratic party, argues that the head-in-the-sand attitude of Berlusconi has forced Rome into a headlong panic that has turned a measured programme of cuts into a torrent. The biggest losers are local governments.
It is the same story in many parts of Europe, where politicians look for the easiest and least painful, at least form their perspective, ways of reducing government debts. The picture is closely mirrored in the UK, where local authorities must cope with larger cuts than Whitehall departments and over a tighter timeframe. In Spain, local municipalities have collectively run up debts of €35bn (£31bn) and are struggling to pay their bills. The Zapatero government says it cannot afford to help out.
The scramble for funds in Venice is intense. Tax receipts are down after the collapse of the local casino business. Five years ago casinos provided €104m in taxes to the city; last year it fell to €70m and this year is expected to hit €60m. Simionato hopes to make up the shortfall with a tourist tax he announced last week, which could raise €25m a year from people staying in hotels and apartments. The tax should also limit a surge in tourism that has trebled visitor numbers over 20 years from four million people a year to 12 million in 2010.
Much of the tourism boom comes from the popularity of cruise ships that dock in the port and churn their way between St Marks Square and the Lido for a good look at the city. All the cash from the cruise operators goes to the port authority and not the city coffers.
Other Italian cities are facing a similar squeeze. Rome and Florence have introduced tourism taxes. Berlusconi's administration has also pursued tax rises. A tax on banks and insurance companies is expected to raise €1.8bn over the next three years. The plan raises the corporate tax rate by 0.75 percentage points for banks and by two percentage points for insurance companies. This year the tax authorities warned that it planned to chase €50bn in unpaid tax on money sent abroad, mostly to Switzerland and Luxembourg.
However, many commentators said the situation was likely to worsen after the government agreed to increase capital gains tax (CGT) from 12.5% to 20%. Cost-cutting is also well underway. Teachers have been told to expect larger class sizes of 30 to 35 in the coming year after decades of schooling 25 children a class at most.
Education cuts and the CGT rise are part of a wider €45.5bn package of measures designed to balance the budget and try to convince investors the country can tame the region's second-biggest debt. Further cuts to local and regional government are also planned – saving €9bn over two years – along with an extra 5% tax on people with incomes of more than €90,000 a year and 10% on incomes exceeding €150,000.
What is left of the Venice subsidy could disappear this year. Tremonti has told Venice that a previous commitment to build a £3bn flood barrier, named Moses, consisting of 78 giant steel gates and due to be completed in 2014, has meant an end to all other subsidies. According to Simionato, there will not be much of a city to defend if a lack of maintenance funds means all the damaged buildings have crumbled into the lagoon.
U.S. Consumer Confidence Falls to Two-Year Low
by Timothy R. Homan - Bloomberg
Confidence among U.S. consumers plunged to the lowest level in more than two years as Americans’ outlooks for employment and incomes soured. The Conference Board’s index slumped to 44.5, the weakest since April 2009, from a revised 59.2 reading in July, figures from the New York-based research group showed today. It was the biggest point drop since October 2008. A separate report showed home prices declined for a ninth month.
Treasury yields dropped on concern consumers will pull back on the spending that makes up about 70 percent of the economy, increasing the risk of a recession. An unemployment rate above 9 percent, partisan bickering over the budget deficit and a volatile stock market weighed on sentiment. “This paints a picture of underlying demand weakening,” said Bricklin Dwyer, an economist at BNP Paribas in New York, whose forecast of 45 was most accurate in a Bloomberg News survey. “Consumers are seeing their wealth deteriorate. We’ve seen a huge decline continuing in the housing market. They’ve also been hit on the chin by the equity markets.”
Treasuries climbed, pushing down the yield on the benchmark 10-year note down to 2.18 percent from 2.26 percent late yesterday. After declining as much as 1.2 percent, the Standard & Poor’s 500 Index was down 0.1 percent to 1,209.07 at 12:16 p.m. in New York.
Global Confidence Slump
American consumers aren’t the only ones feeling more glum. European confidence in the economic outlook plunged in August by the most since December 2008 as a persistent debt crisis roiled markets and clouded growth prospects. An index of executive and consumer sentiment in the single-currency region fell to 98.3 from a revised 103 in July, the European Commission in Brussels said today.
The S&P/Case-Shiller index of property values in 20 cities fell 4.5 percent in June from a year earlier, after a 4.6 percent drop in the 12 months ended in May that was the biggest since 2009.
Federal Reserve Bank of Chicago President Charles Evans urged easier monetary policy to keep the recovery going after the central bank on Aug. 9 vowed to keep its benchmark interest rate close to zero at least through mid 2013.
“I would favor more accommodation,” Evans, a voting member of the Fed’s policy-making committee, said today in a CNBC television interview. “I am somewhat nervous about the economic recovery and where we stand at this point.”
Survey Results
Economists predicted the Conference Board’s gauge would fall to 52 in August, according to the median forecast in the Bloomberg survey. The index averaged 98 during the economic expansion that ended in December 2007.
The share of consumers who said jobs are currently hard to get increased to 49.1 percent, the highest since November 2009, from 44.8 percent in July. Confidence dropped in all nine U.S. regions.
“If you were advised to lean on one side or the other, I’d say it’s more likely to be slightly more negative from a sentiment perspective in consumers in the United States,” Glenn Murphy, chief executive officer of Gap Inc., said in an Aug. 18 conference call with analysts. “Maybe the holiday season could be slightly positive, but we’re not counting on it right now.”
San Francisco-based Gap, the largest U.S. apparel chain, reported a 19 percent decline in second-quarter profit as price increases failed to keep up with higher costs to make clothes.
Other Measures
Today’s confidence report is in line with other figures. The Thomson Reuters/University of Michigan final index of consumer sentiment dropped this month to the lowest level since November 2008. The Bloomberg Consumer Comfort Index has been hovering at levels previously consistent with recessions.
A struggling labor market is weighing on consumer sentiment. Employers added 75,000 jobs in August, compared with 117,000 in July, as the unemployment rate held at 9.1 percent, according to the median estimates in a Bloomberg survey ahead of a Sept. 2 report from the Labor Department. “Economic growth has, for the most part, been at rates insufficient to achieve sustained reductions in unemployment,” Fed Chairman Ben S. Bernanke said Aug. 26 at the Jackson Hole, Wyoming, central bank symposium.
The Conference Board’s data showed a measure of present conditions declined to 33.3, the second-lowest this year, from 35.7 in July. The measure of expectations for the next six months slid to 51.9, the weakest since April 2009, from 74.9.
Job Concerns
The percent of respondents expecting more jobs to become available in the next six months fell to 11.4, the lowest since March 2009, from 16.9 the previous month. The proportion expecting their incomes to rise over the next six months declined to 14.3 from 15.9. The percent expecting a drop rose to 18.7, the highest since November 2009. Fewer respondents in the Conference Board’s survey indicated they were planning to buy a house, while more intended to purchase cars or major appliances in the next six months.
The cutoff date for the survey responses in this month’s calculation was Aug. 18, Lynn Franco, director of the Conference Board’s Consumer Research Center, said in an interview. The group looked at the responses received before and after the downgrade of U.S. debt by Standard & Poor’s and saw very little difference, she said. “The decline we saw was already in place before the downgrade, and there was really already a significant change in confidence,” said Franco.
All of the 20 cities in the S&P/Case-Shiller home-price index showed a year-over-year decline in June, led by an 11 percent drop in Minneapolis. Any recovery in home values is probably years away as foreclosures dump more properties onto to the market, while a jobless rate hovering around 9 percent and strict lending rules hurt sales. “Prices aren’t going to rebound back rapidly,” said Paul Dales, a senior U.S. economist at Capital Economics Ltd. in Toronto.
