Tuesday, September 13, 2011

September 13 2011: He Said, She Said

Lewis Wickes Hine Night Shift June 1911
Alexandria, Virginia. "Old Dominion Glass Co. A few of the young boys working on the night shift at the Alexandria glass factory. Negroes work side by side with the white workers"

Ilargi: It's hard to say what it exactly it means when markets start swinging violently up and down like so many crazed baboons, but I don't think it means anything good, even if those same markets managed to escape the red ink at the end of the day.

French problem child Société Générale was down some 9% at one point early on, only to finish the European trading day at +15%. It doesn't even matter that much if that dizzying spell was caused by rumors or simple straight out intervention by the French government or central bank, you'd have to have a case of extreme risk appetite if you're to start buying SocGen tomorrow morning.

The rumor mill and its influence was perhaps best summarized by a commenter at Zero Hedge, who wrote:
"Just heard this: Brandenburg and the Kingdom of Naples are joining with Spanish Netherlands to bail out Sardinia, Livonia and Upper Silesia! We're saved!"

As for the more credible rumors (though they seem to come with as many question marks as the one above), let's stick with the following list from Simone Foxman at Business Insider:

1) Italy-China Bond Purchases

It all started yesterday afternoon, with a Bloomberg blast reporting that China might buy Italian bonds. Markets soared. The blast cited an FT article which no one could find online. The FT also denied that it had published such an article. Markets tanked.

We got to the bottom of this, establishing that the Bloomberg reporter responsible for the report had seen a preview of an FT article on the topic. That article was published later in the day.

Then today, Reuters cited Italian officials who said the talks centered around Chinese industrial assets, not bond purchases. The markets seemed unfazed by this news.

Ilargi: If anyone can see China buying up huge amounts of EU periphery debt, good luck. Here's thinking the Chinese would demand conditions that no country that is still part of the EU could give in to. Sure, China has European bonds, like it has US bonds, but propping up Greece, Italy or Spain at this point would be a great risk, for which "adequate" compensation would be demanded.

Besides, the ECB has bought well over $100 billion in periphery paper recently, and how helpful has that been? It's not like China would spend its entire foreign reserves on the topic, and it needs its printing press to keep the domestic Ponzi going. Hard to see as a life saver, and probably unfunded.

2) BNP Paribas And Dollar Liquidity

This morning, an opinion piece published in the WSJ cited an anonymous source at the bank who said, "We can no longer borrow dollars." The bank quickly denied that, then announced later that it would investigate the article.

Ilargi: Foxman refers here to an article by Nicolas Lecaussin in the Wall Street Journal, which may perhaps contain an improper use of an anonymous source (though we have no way of confirming it either way), but which also contains some numbers that are not in doubt; they are truly shocking, however:

The Trouble With French Banks
[..] BNP, Société Générale and Crédit Agricole together hold nearly $57 billion in Greek sovereign and private debt, versus $34 billion held by the largest German banks and $14 billion at British banks.

French banks also held more than €140 billion in total Spanish debt and almost €400 billion in Italian debt
as of December, according to the latest figures from the Bank for International Settlements. If either of these latter two governments were to default, their banking systems could collapse and take the French system with them.

BNP, Société Générale and Credit Agricole all say that their finances are in order and the market worries are unfounded. But it's difficult for the BNP executive to hide his concern. "Look at the French banks' debt holdings versus those of U.S. banks," he continues. "The total debt of the three big U.S. banks (Bank of America, JP Morgan and Citigroup) is $5.86 trillion, or 39% of GDP, while the debts of BNP, Crédit Agricole and Société Générale come to €4.7 trillion, or 250% of French GDP."

Ilargi: A quick check teaches us that the total combined market cap at the end of the trading day for the three main French banks was just shy of $60 billion, with BNP at $33.64 billion, Crédit Agricole $12.85 billion and Société Générale $13.43 billion (and this after some spectacular gains in late trading). In other words, their exposure to Greek debt is only slightly smaller than their entire present market capitalization, their exposure to Italy almost 7 times bigger than the market cap, and their total debt some 78 times bigger.

Talk about leverage. Even if they can still borrow dollars, one must wonder for how much longer, and at what rates. There's still another rumor that says Paris must recapitalize the banks as early as this week. I wouldn't bet against that.

For all we know, that may have had something to do with the next rumor:

3) Merkozy Announcement

Later on, markets went nuts over news that German Chancellor Angela Merkel and French President Nicolas Sarkozy would give a big announcement today. That soon came to naught and markets dove again.

Ilargi: I'm sure that Merkel and Sarkozy would love to make a big announcement every half hour, provided there's good news to be announced. Unfortunately, there's none. It stands to reason that the next real big announcement both will have to make is the recapitalization of their domestic banks, in the aftermath of the Greek default. Any announcements before that one will be aimed at blowing smoke.

4) Dutch Finance Minister And Greek Default

As if three rumors were not enough already, reports circulated that the Dutch Finance Minister stated his intent to give up on Greece and saw Greek default as unavoidable. The Dutch government lambasted that report. This whole thing happened too quickly for us to tell if the markets moved on this news.

Merkel warned everyone this morning to watch their words when talking about the crisis, but clearly this isn't happening. These reports have (at least allegedly) come from reputable news sources, and it remains to be seen whether they hold merit.

Ilargi: Merkel can't even keep her own party members in line; three separate German government sources were anonymously talking about a Greek default over the weekend. The Dutch guy probably said this, just not necessarily for public consumption. And even that we don’t know. The three members of Merkels government, as well as this finance minister, may all be part of a carefully laid out plan to test the waters.

5) Geithner And Expanding The Size Of The EFSF

Reuters reported earlier today that U.S. Treasury Secretary Timothy Geithner would urge European Finance Ministers to expand the size of the European Financial Stability Fund when he meets with them tomorrow in Wroclaw, Poland. Now a Bloomberg update says that CNBC says that Reuters says that Geithner won't advocate a bigger fund at the meeting.

Ilargi: No doubt Geithner might want to see Europe expand the EFSF into the heavens above. But it's still not going to happen. The advocates of the expansion may count themselves lucky if the fund is enlarged to €440 billion before Christmas. This is by no means done. Further expansion could take much longer still, if it ever happens. And time is not on the side of any of the leading figures involved. Least of all of president Obama, as John Ellis points out at Business Insider:

Merkel Will Press Obama And The Fed To Help Bail Out The Eurozone
In the days leading up to the collapse of Lehman Brothers, then French Finance Minister (now IMF Managing Director) Chistine Lagarde told then-Treasury Secretary Hank Paulson that he could not allow Lehman to fail. The ramifications would be catastrophic, she said.  She was mostly right.

Three years later, it will be Angela Merkel talking to President Obama,Treasury Secretary Geithner and Federal Reserve Bank Chairman Ben Bernanke with exactly the same message.  The United States government and the Federal Reserve must come to the rescue of the Eurozone or the ramifications will be catastrophic. And she will say that she needs roughly $1 trillion in financial guarantees and liquidity support.  That's the number that will calm the markets.

She will do this publicly (it will be leaked to the FT or the NYT) because (a) she wants to maximize the pressure on the US to ride to the rescue and (b) she wants the blame to fall elsewhere in the event that the "situation" goes haywire. And there will follow perhaps the defining moment of the Obama Presidency. 

If Obama goes forward and provides all or part of the $1 trillion guarantee, he will likely cut his own political throat in so doing. 

If Obama declines to go forward and provide all or part of the $1 trillion guarantee, he will likely preside over the second massively destabilizing financial panic in four years, thus insuring a second Great Recession, thus cutting his own political throat.

Ilargi: In a broader sense, this does not look like such a far-fetched scenario. When everyone ducks for cover, who'll be left standing without his musical chair, new clothes around his ankles, holding a big smelly empty bag?

Damned if you do, doomed if you don't. Don't know if it's any consolation for him, but Obama won't be alone. We'll see a many a political career come to an unglamorous end. Some through hollow rumors, some through hard facts.

Please note: due to trolling, our comments section is closed for the time being. Apologies for that; we’ll find a way to reopen it soon.

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UPDATE Sep 14:

Moody's Cuts SocGen and CreditAgricole, BNPP Still on Review
by Reuters

Moody's Investors Service on Wednesday downgraded two of France's top banks, Societe Generale and Credit Agricole, in a new blow to efforts by European policymakers to restore market confidence in the region. The ratings agency said it was extending its review of BNP Paribas (BNPP), but any downgrade was unlikely to be by more than one notch.

Moody's had put the banks under review for possible downgrade on June 15, citing their exposure to Greece's debt crisis. Moody's at the time had cited French banks' exposure to Greece's debt-stricken economy as the reason behind the review. Outside commentators had said the ratings were ripe for a downgrade because of rising borrowing costs in the face of sovereign debt turmoil.

The agency said that during the review, Moody's concerns about the structural challenges to banks' funding and liquidity profiles increased, in light of worsening of refinancing conditions. Moody's cut SocGen's debt and deposit ratings by one notch to Aa3 from Aa2. The outlook on the long-term debt ratings was negative. Moody's anticipated that the impact of its review on the Bank Financial Strength Rating (BFSR) would be limited to a one-notch downgrade.

For Credit Agricole, Moody's downgraded its BFSR by one notch to C from C+, and cut its long-term debt and deposit ratings by one notch to Aa2 from Aa1. However, Moody's said it believed SocGen has a level of capital that can absorb potential losses it is likely to incur on its Greek government bonds and to remain capitalized at a level consistent with its BFSR even if the creditworthiness of Irish and Portuguese government bonds were to deteriorate further.

Moody's said that BNPP had a sufficient level of profitability and capital that it can absorb potential losses it is likely to incur over time on its Greek, Portuguese and Irish exposures. BNPP on Wednesday announced a plan to sell 70 billion euros ($95.7 billion) of risk-weighted assets to help ease mounting investor fears about French bank leverage and funding, two days after smaller rival Societe Generale unveiled a similar plan.

France's lenders -- two of which own local banks in Greece -- have the highest overall bank exposure to Greece, according to the Bank for International Settlements. They have begun to take writedowns on their Greek sovereign debt holdings as part of a new rescue package but some say not aggressively enough. Greece vowed on Saturday to stay the course of austerity and avoid bankruptcy as anger at the country's failure to meet fiscal targets under its EU/IMF bailout reached boiling point.

Merkel Will Press Obama And The Fed To Help Bail Out The Eurozone
by John Ellis - Business Insider

We're at the end of "extend and pretend." The crisis of the Eurozone is now acute. The headlines are specific. The best analysis suggests that only extraordinary action can keep it afloat. And even that would work only to delay the inevitable for a month or two more. 

The reality is that the Eurozone no longer offers any good option for continued unity. As an Italian policy-maker told Martin Wolf of the Financial Times, "it would be better to leave (the eurozone) than endure 30 years of pain."

At the center of the storm sits German Chancellor Angela Merkel, who is being told by one and all that she must take extraordinary action to save the day.  But the truth is she doesn't have the authority to do so, doesn't have the votes, doesn't have the political throw-weight to over-ride the judicial, legislative and political vetoes. She won't save the day because she can't. So what does she do? 

In the days leading up to the collapse of Lehman Brothers, then French Finance Minister (now IMF Managing Director) Chistine Lagarde told then-Treasury Secretary Hank Paulson that he could not allow Lehman to fail. The ramifications would be catastrophic, she said.  She was mostly right.

Three years later, it will be Angela Merkel talking to President Obama,Treasury Secretary Geithner and Federal Reserve Bank Chairman Ben Bernanke with exactly the same message.  The United States government and the Federal Reserve must come to the rescue of the Eurozone or the ramifications will be catastrophic. And she will say that she needs roughly $1 trillion in financial guarantees and liquidity support.  That's the number that will calm the markets.

She will do this publicly (it will be leaked to the FT or the NYT) because (a) she wants to maximize the pressure on the US to ride to the rescue and (b) she wants the blame to fall elsewhere in the event that the "situation" goes haywire. And there will follow perhaps the defining moment of the Obama Presidency. 

If Obama goes forward and provides all or part of the $1 trillion guarantee, he will likely cut his own political throat in so doing. 

If Obama declines to go forward and provide all or part of the $1 trillion guarantee, he will likely preside over the second massively destabilizing financial panic in four years, thus insuring a second Great Recession, thus cutting his own political throat.

Sometimes, the choice a president has to make is between really, really bad and truly awful. That's the choice that Angela Merkel will likely drop on President Obama's desk within the next month, and probably sooner rather than later.

Massive default is best way to fix the economy
by Brett Arends - MarketWatch

Clearing away the debt is the only way forward

You want to fix this economic crisis? You want to put people back to work? You want to light a fire under the economy?

There’s a way to do it. Fast. And relatively simple. But you’re not going to like it. You’re not going to like it at all.

Default. A national Chapter 11 bankruptcy. The fastest way to fix this mess is to see tens of millions of homeowners default on their mortgages and other debts, and millions more file for bankruptcy. I told you that you wouldn’t like it. I don’t like it much either. It sticks in the craw that people got to borrow all that money and won’t have to pay it back.

But you know what? The time to stop that was five or 10 years ago, when the money was being lent. It’s gone.

And mass Chapter 11 is, by far, the least obnoxious solution to our problems. That’s because the real cause of our economic slump isn’t too much government or too little government. It isn’t red tape, high taxes, low taxes, the growing divide between the rich and the poor, too much government debt, too little government debt, corporations, poor people, "greed," "socialism," China, Greece, or the legalization of gay marriage. It isn’t, in short, any of the things all the various nitwits say it is.

It’s the debt, stupid. We’re hocked up to the eyeballs, and then some. We’re at the bottom of a lake of debt, lashed to an anchor. American households today owe $13.3 trillion. That has quadrupled in a generation. It has doubled just in the last 11 years. We owe more than any other nation, ever. And for all the yakking about how people are "repairing their balance sheets," they’re not. From the peak, four years ago, they’ve cut their debts by a grand total of 4%. And a lot of that was in write-offs.

More than a quarter of American mortgages are underwater. Many are deeply underwater. In states like Nevada and Florida the figures are astronomical. The key thing to understand is that most of that money has gone to what a fund manager friend of mine calls "money heaven." Most of these debts will never, ever be repaid in real money. Not gonna happen.

Think how corporations handle this kind of situation. It happens all the time. Banks and bondholders find they have lent, say, $1 billion to a company whose assets and earning capacity will only repay, say, $300 million. What happens? Does the company soldier on with $1 billion in debt it can never repay? Do the stockholders send back their dividend checks? Do they sell their homes to pay off the bonds?

Not a chance. The company goes through Chapter 11. The creditors ‘fess up to their blunder, they face up to their losses, and they fix it. They write down the loans and take the equity instead. The balance sheet is cleaned up, and the company starts again. Why not homeowners?

Most of the objections to this idea are well-meant, but misinformed. A fund manager I asked raised the issue of "moral hazard." Why should anyone pay their mortgage if some people were getting a pass, he asked? The answer: For the same reason GE and Verizon kept paying the coupon on their bonds while Lehman Brothers defaulted. You want to keep your credit standing. And you want to keep your equity.

If a company defaults, the stockholders get wiped out. If a homeowner defaults, the bank takes the home. I like keeping my home, as well as my savings, and my credit rating. Most people are the same. Some will say the financial impact would be terrible. But the banks would just be facing up to reality. And a lot of these mortgages are already trading at distressed levels. Some will say, "why should people get away with borrowing imprudently?" The response: Why should the banks get away with lending imprudently?

There’s no point telling people not to borrow money. They always will. I have yet to see a Wall Street executive turn down free money. I have yet to see a company in an IPO say, "Don’t give us so much money!" People like money. They will take as much as they are offered. In a free economy, the people who are supposed to ration the loans are the lenders. Banks are supposed to lend carefully and responsibly. What else are they paid for? Accepting deposits? You could hire people on minimum wage to do that.

Some will say, "it’s immoral" for borrowers to default. Alas, most of these people are being inconsistent. They are usually the first ones to defend a company when it closes down a factory and ships the jobs to China, or pays the CEO $50 million for doing a bad job, on the grounds that "this ain’t morality, pal, this is business!" But when Main Street wants to do the same thing, they start screaming "Morality! Morality!"

We don’t live in an economy based on morals and fairness. T Mobile doesn’t charge me what’s "fair" each month. They charge me what’s on the contract. Your employer doesn’t pay you more if you need more. He pays you your economic value. Did Dick Grasso give back his bonus? Bob Nardelli? Dick Fuld? We operate in an economy based very firmly on contracts, and nothing else. Companies, and the wealthy, live by the letter of the law.

American mortgage contracts allow for default. Half of the states in this country are "non-recourse," which broadly speaking means you can send in the keys and walk away from a bad loan. The other half are sort of "semi-recourse." The bank can come after you for any shortfall, but only in a limited way. Broadly speaking they can’t touch retirement accounts and basic assets. You can typically keep your car, personal effects, often things like life insurance.

Most of the people who are deeply underwater don’t have that much anyway. And the banks knew this. When they were lending $500,000 to a bus driver with $1,000 in his checking account, they knew that their loan was only guaranteed by the value of the home. If they didn’t know it, they should have. Their incompetence is not our problem.

It’s tempting to say, "if someone borrows money, they should repay it." Generally speaking, I agree. I pay all my debts. But while that makes sense when applied to any individual, it doesn’t work so well when it’s applied to everyone.

We have tens of millions who cannot repay their debts. But they are all trying to. That sucks huge amounts of money out of the economy. And that means these people cannot function properly as consumers or workers. That’s the reason people aren’t coming into your restaurant. It’s the reason people aren’t taking your yoga class. It’s the reason they haven’t hired you to redo the kitchen.

And so tens or hundreds of millions of perfectly responsible business owners and employees are also suffering from this slump. That’s the reason we have a shortage of demand. That’s the reason no one is hiring. Even worse: People who are underwater on their mortgage, but who do not want to default, cannot move to where the jobs are either. They are stuck with their home.

You want to break this logjam? Try Chapter 11 for the nation. Massive defaults. Clear the decks, clean the books.

What are the alternatives? Government cutbacks, higher taxes, and a balanced budget? In a normal economy, fine. But in this situation, when the private sector is also slashing its spending, that could lead to absolute catastrophe. That’s what happened in the Great Depression. And our debt levels are worse than in the Great Depression.

Government borrowing? That’s the Keynesian solution. "The consumer can no longer borrow like a crazy person," says the Keynesian, "so Uncle Sam has to do so instead." It’s just transferring private madness to public madness. Inflation? That’s probably the least bad alternative. But it’s just default by another name. And instead of taking money from the imprudent banks that caused the problem, it robs grandma’s savings.

Twice before, advanced economies have gone through what we are going through now — namely a massive hangover after a massive debt binge. The first was the U.S. in the 1930s, the second was Japan in the 1990s. The U.S. didn’t get out of it until the 1940s unleashed inflation and reduced the debt’s value in real terms.

Japan still hasn’t gotten out of it. They have deflation, while government debt has skyrocketed. The correct moral hazard is to punish the banks who lent imprudently by making them eat their own losses.

I told you that you wouldn’t like it. I don’t either. But the alternatives are worse.

Counting the cost if EMU fails
by Alan Wheatley - Reuters

Greece's exit from the euro zone would inflict untold damage on Europe's economy, further burnish the attractiveness of a rising Asia and hasten the emergence of China's yuan as a global currency.

Until recently, even thinking about the consequences of a break-up of the euro was, well, unthinkable. No longer. Doubts over how much more austerity recession-hit Greece can endure are growing by the day. They are matched by doubts as to how long political and public opinion in Germany, the euro zone's paymaster, will stand for keeping Athens and others on the bloc's periphery afloat with emergency loans and bond purchases by the European Central Bank. Some within the ECB are equally unhappy about it.

If the outcome of the mounting crisis is unpredictable, so are the consequences. Domenico Lombardi with the Brookings Institution, a Washington think tank, said the economies of the euro zone are so inter-connected that the secession of one of the 17 members would open up a Pandora's box.

Greece could not quit or be expelled from the bloc in a surgical manner. Markets would then line up Italy in their sights. If Rome were then forced out, France's banks -- already under pressure from short-term funding strains -- could melt down because of their exposure to Italian debt. "It would be almost impossible to draw the line. You could devise a framework for an orderly exit in normal circumstances, but we have gone much too far for that," said Lombardi, a former executive director of the International Monetary Fund. He put the chances of a euro zone break-up at fifty-fifty.

Echoing that view, U.S. President Barack Obama said an even bigger problem than Greece is what may happen if Spain and Italy come under renewed attack. In a sign of the dangers that the crisis poses for the already weak U.S. economy, Treasury Secretary Timothy Geithner heads to Europe on Friday for the second time in a week for an unprecedented meeting with euro zone finance ministers.

All Eyes On Italy
One starting point in trying to assess the economic fall-out is the September 2008 bankruptcy of investment bank Lehman Brothers, which dragged the global financial system to the precipice and tipped much of the world into recession. The shock was all the more severe because many investors were betting the U.S. government would bail out Lehman, just as it had arranged a firesale of rival Bear Stearns earlier in the year.

By contrast, the market for credit default swaps is pricing in a 90 percent-plus probability that Greece will default on its debt, fanning open talk -- hotly denied by Athens -- that the next step would be to quit the euro zone altogether. Even though Greece's travails are well known, a genuine hint that it might throw in the towel would trigger market mayhem, with Italy particularly exposed, said Nicholas Spiro, managing director of Spiro Sovereign Strategy, a London consultancy.

"The fear and panic that this would cause is incalculable," Spiro said. "The issue is whatever happens in Greece is perceived as a template for what could happen elsewhere. It would be disastrous for Italy."

A Greek exit is often viewed as positive for the euro's exchange rate, said William Buiter, Citi's chief economist. "We fear, however, that it would be a financial and economic disaster not only for Greece, but also for 16 continuing euro area member states, and that it would also have severe economic and political implications for the whole of the EU and the wider global economy," Buiter said in a report issued on Tuesday.

China Watches And Waits
The rush to safe-haven assets and to square positions after a break-up of European Monetary Union would be akin to the aftermath of Lehman's default, according to Seamus Mac Gorain with J.P. Morgan Securities in London. In a note to clients, he argued that the dollar would be the currency to benefit most from what would be a "seismic" event. "For one, heightened volatility would prompt investors to buy back funding currencies. Second, euro break-up would undermine its challenge to the dollar as a reserve currency," Mac Gorain wrote. The dollar is also the obvious candidate if importers and exporters, anticipating the collapse of the euro, were to seek to trade in an alternative currency, he added.

Fragmentation of the euro would also open the door for China to accelerate the international use of the yuan. Beijing started promoting the yuan as an invoicing and settlement currency after Lehman's bankruptcy led to a drying-up of dollars to finance trade. China's exports slumped, costing millions of jobs. About 7 percent of Chinese trade is now conducted in yuan, also known as the renminbi, and that share would be sure to jump if the euro broke up.

"Strategically, it would help drive the globalization of the yuan," said Ding Yifan, a deputy director of the Development Research Center, a think tank in Beijing under the State Council, China's cabinet. Indeed, Ding said the risk was that the pace of internationalization would be too fast for comfort. "This is an opportunity for China, but also a challenge, because China does not want to move too fast," he said.

Asia Cleans Up
Rob Subbaraman, Nomura's chief Asia economist based in Hong Kong, agreed that China was likely to speed up use of the yuan beyond its borders, activate yuan swap lines and take other measures to help Asia's economies if the euro broke up. And because the euro zone's problems are likely to reduce Europe's long-term growth potential, Asian companies will have an extra incentive to invest more in their own region and in other emerging markets, he said.

But in the short term, Asia could not escape unscathed from a collapse of the euro. Nearly all countries in the region export more to Europe than they do to the United States, and the exposure of European banks to Asia ex-Japan, at $1.4 trillion, is three times greater than that of U.S. banks. "If there's a meltdown, the home bias of U.S. and European investors will kick in, particularly European banks. The risk of them cutting their credit lines in Asia could be quite big," Subbaraman said.

That is what happened after Lehman went bust. Nearly $80 billion left Asia in the fourth quarter of 2008 and the first three quarters of 2009. But in the following 18 months, nearly $500 billion of capital flowed back, Nomura calculates.

If the euro's malaise causes history to be repeated, the reflows of money to Asia are likely to be on an even larger scale as investors weigh up which region has the brightest prospects, Subbaraman said. "The relative strengths of Asia and the West are just becoming more and more stark in terms of fundamentals and the room for policy maneuver," he said.
And that could be one of the lasting lessons of the battle for the euro.

US congress faces fall crunch time
by Seung Min Kim - Politico

Can Congress ever cut a deal before the eleventh hour? This September will be the month to find out.

In the next few weeks, Congress will face a flurry of deadlines, from the expiring gas tax to paying for the nation’s transportation projects, not to mention funding the entire federal government — raising the question of whether it will once again push Uncle Sam to the brink.

If recent history is any indication, lawmakers won’t be able to help themselves. In the span of six months, they barely averted a government shutdown this spring, flirted with default over the debt ceiling and blew a deadline to fund the Federal Aviation Administration, forcing worker furloughs. "Honestly, it’s very difficult in this environment, partly because each side’s political base demands that you fight to the end," said Rep. Tom Cole (R-Okla.). "They believe if you get something done early, you probably didn’t fight hard enough."

Time is short for Congress’s fall to-do list, with the deadlines stacked one on top of the other — setting up a test of whether lawmakers can buckle down and get the work done. "Given the pace and the productivity this year, we’re going to have to really change our ways very rapidly," said Rep. Gerry Connolly (D-Va.). "We’re going to have an unbelievably full plate."

First up is funding for the FAA. The government’s authority to do so will run out Friday, a date set after Congress left town in early August without extending the agency’s funding, furloughing 4,000 FAA employees and sidelining 70,000 construction workers, while losing $400 million in uncollected taxes. After a two-week partial shutdown of the agency, Congress agreed to keep the FAA running until Friday.

Next up is the deadline for the federal gas tax and the ability to pay for transportation projects, which both expire Sept. 30. House Republicans want a six-year, $230 billion extension of transportation funding, while Senate Democrats are calling for a two-year, $109 billion bill. "We’d love to see long-term authorization done, but certainly I don’t think I or anyone else is confident that you’re going to see a long-term bill written by Sept. 30," said Rob Healy, vice president of governmental affairs for the American Public Transportation Association.

And if the gas tax isn’t renewed in time, the government could lose $700 million per week in uncollected revenue, according to the watchdog group Taxpayers for Common Sense. Congressional leaders reached a deal late Friday on the FAA and surface transportation measures that would keep the FAA running until January and highway programs funded until March. The legislation is likely to be considered on the floor early this week.

Meanwhile, Congress has not enacted a single appropriations bill for the coming fiscal year, which it is supposed to do by Sept. 30. The House has passed six of 12 appropriations bills, while the Senate has passed just one. A short-term bill, or continuing resolution, will be necessary.

Congressional leaders have made it clear they want to avoid a spending fight. The agreement reached in August that raised the nation’s debt ceiling established a $1.043 trillion spending cap, and House Majority Leader Eric Cantor (R-Va.) said in an August memo to his colleagues that "it is in our interest" to stick to that funding level. House Minority Whip Steny Hoyer (D-Md.) said after the partisan rancor over the debt limit, there’s no appetite for another bruising legislative battle.

But conservatives in the House could push for a lower spending level outlined in the budget penned by House Budget Committee Chairman Paul Ryan, which caps spending at $1.019 trillion for fiscal 2012. Cantor has announced that the House will take up a continuing resolution during the week of Sept. 19.

Maryland Rep. Chris Van Hollen, the top Democrat on the House Budget Committee, said he doubts the fight will end in a government shutdown or a serious threat of one, like this spring.

"While the agreement had many flaws, one of the benefits was greater predictability with respect to the appropriations process," Van Hollen said. "It didn’t guarantee that we would avoid a government shutdown, but it significantly reduced the risks and people playing that kind of game of chicken."

A Senate Appropriations Committee aide agreed. "Given that both houses agreed to a top-line discretionary number in the recent budget deal, there is no reason a short-term measure designed to maintain government operations should be a subject of controversy," the aide said.

Amid the ticking clocks, Congress will be faced with how to handle federal aid in the aftermath of Hurricane Irene, which ravaged the East Coast, killed at least 40 people and racked up $1.5 billion in estimated damage. And much of the attention will be sucked up by the deficit-slashing supercommittee, which had its first public hearing Thursday.

With everything on Congress’s plate, outside observers are frustrated that Congress is working in fits and starts. Todd Hauptli, a senior executive vice president for the American Association of Airport Executives, said airports in the northern part of the country lost precious time to do construction work because they weren’t sure they could get federal funding.

"It’s awful to have the stopping and starting and the uncertainty surrounding these extensions," Hauptli said. "When you have a short construction season, you have to be ready to go. A number of folks really lost out."

Van Hollen said he sympathizes. "Look, there’s no doubt that we’d be better off if we didn’t push these deadlines," the lawmaker said. "We should pass these things to provide greater predictability and move on … because otherwise, you’re in a stop-and-go sort of frame. It would be much better for the process if we could clear the decks and the issue of the deadlines so we can focus on the bigger issues."

Number of poor in America hit record 46 million in 2010
by David Morgan - Reuters

The number of Americans living below the poverty line rose to a record 46 million last year, the government said on Tuesday, underscoring the challenges facing President Barack Obama and Congress as they try to tackle high unemployment and a moribund economy.

The Census Bureau's annual report on income, poverty and health insurance coverage said the national poverty rate climbed for a third consecutive year to 15.1 percent in 2010 as the economy struggled to recover from the recession that began in December 2007 and ended in June 2009. That marked a 0.8 percent increase from 2009, when there were 43.6 million Americans living in poverty.

The number of poor Americans in 2010 was the largest in the 52 years that the Census Bureau has been publishing poverty estimates, the report said, while the poverty rate was the highest since 1993. The specter of economic deterioration also afflicted working Americans who saw their median income decline 2.3 percent to an annual $49,445. About 1.5 million fewer Americans were covered by employer-sponsored health insurance plans, while the number of people covered by government health insurance increased by nearly 2 million.

All told, the number of Americans with no health insurance hovered at 49.9 million, up slightly from 49 million in 2010. The economic deterioration depicted by the figures is likely to have continued into 2011 as economic growth diminished, unemployment remained stuck above 9 percent and fears grew of a possible double-dip recession.

The report of rising poverty coincides with Obama's push for a $450 billion job creation package, and deliberations by a congressional "super committee" tasked with cutting at least $1.2 trillion from the budget deficit over 10 years. Faced with deteriorating job approval ratings, the president is trying to convince Republicans in Congress to support his package.

Analysts said poverty-related issues have relatively little hold on politicians in Washington but hoped the new figures would encourage the bipartisan super committee to avoid deficit cuts that would hurt the poor. The United States has long had one of the highest poverty rates in the developed world. Among 34 countries tracked by the Paris-based Organization for Economic Cooperation and Development, only Chile, Israel and Mexico have higher rates of poverty.

Why An American Working Class Revolt Might Not Be Unthinkable
by Mark Thoma - The Fiscal Times

It was encouraging to see President Obama pivot from deficit reduction to job creation in his widely anticipated speech last week. The president proposed a combination of spending and tax reduction policies, and he surprised many people with the boldness of his proposals and his passion and commitment to the issue. Unfortunately, Obama’s plan is unlikely to be much help to struggling labor markets.

Fourteen million people are unemployed, long-term unemployment remains near record highs, the ratio of job seekers to job openings is 4.3 to 1, and the employment to population ratio has dropped precipitously. While concerns over the deficit are valid for the long run, they shouldn’t prevent us from doing more to help the jobless. (The debt dilemma is predominantly a health-care-cost issue, and whether or not we help the jobless doesn’t much change its magnitude.)

The real problem is the political atmosphere. Republicans may go along with doing just enough to look cooperative rather than obstructionist -- but no more than that. And the job-creation policies that emerge from Congress are unlikely to make a dent in chronic unemployment. In fact what emerges won’t be anywhere near the $445 billion program the president has called for, which itself is short of the dramatic intervention needed to really make a difference.

I don’t expect we’ll get much more help from the Fed either. There is quite a bit of disagreement among monetary policymakers over whether further easing would do more harm than good, and inflation hawks are standing in the way of those who want to aggressively attack unemployment. As with Congress, the Fed is likely to adopt a compromise position and do the minimum it can while still looking as though it is trying to meet its obligation to promote full employment.
Thus, despite the President’s newfound interest in job creation, and the call from some at the Fed to treat unemployment the same way they would treat elevated inflation – as though “their hair was on fire” – the actual policies that come out of Congress and the Fed are unlikely to be sufficient.
It’s time for this to change. The loss of 8.75 million payroll jobs since the recession began should be a national emergency. But it’s not, and the question is why. Why has deficit reduction taken precedence over job creation? Why is our political system broken to the extent that a whole segment of the population is not being adequately represented in Congress?

Many of the policies enacted during and after the Great Depression not only addressed economic problems but also directly or indirectly reduced the ability of special interests to capture the political process. Some of the change was due to the effects of the Depression itself, but polices that imposed regulations on the financial sector, broke up monopolies, reduced inequality through highly progressive taxes, and accorded new powers to unions were important factors in shifting the balance of power toward the typical household.

But since the 1970s many of these changes have been reversed. Inequality has reverted to levels unseen since the Gilded Age, financial regulation has waned, monopoly power has increased, union power has been lost, and much of the disgust with the political process revolves around the feeling that politicians are out of touch with the interests of the working class.
We need a serious discussion of this issue, followed by changes that shift political power toward the working class. But who will start the conversation? Congress has no interest in doing so; things are quite lucrative as they are. Unions used to have a voice, but they have been all but eliminated as a political force. The press could serve as the gatekeeper, but too many news outlets are controlled by the very interests that the press needs to confront. Presidential leadership could make a difference, but this president does not seem inclined to take a strong stand on behalf of the working class despite the surprising boldness of his job-creation speech.
Another option is that the working class will say enough is enough and demand change. There was a time when I would have scoffed at the idea of a mass revolt against entrenched political interests and the incivility that comes with it. We aren’t there yet – there’s still time for change – but the signs of unrest are growing, and if we continue along a two-tiered path that ignores the needs of such a large proportion of society, it can no longer be ruled out.

Volcker Rule Delay Is Likely
by Victoria Mcgrane and Aaron Lucchetti - Wall Street Journal

U.S. financial regulators are likely to miss an October deadline for the Volcker rule, a hotly contested part of last year's financial-overhaul law that limits financial firms from trading with their own money.

According to the Dodd-Frank law, regulators have until Oct. 18 to "adopt rules to carry out" the provision. But regulators haven't agreed yet on even a draft proposal of the rule, which is named for former Federal Reserve Chairman Paul Volcker, who first proposed the trading curbs.

A proposed rule might be released as soon as this week, according to people familiar with the situation. After that initial step, the draft version of the Volcker rule will go out for public comment, most likely for 60 days. Regulators can make changes based on comments before issuing a final rule. That means the rule likely won't take effect for months.

The slip is a sign of the Volcker rule's complexity and controversy. Depending on how regulators write the regulations, reining in the ability of banks to engage in so-called proprietary trading for their own account could cost billions of dollars in annual revenue, according to analyst estimates.

The Securities Industry and Financial Markets Association and consulting firm Oliver Wyman warned in a December study that the Volcker rule could lead to "higher funding and debt costs for U.S. companies" and increased inefficiencies in trading that would lead to "lower returns over time for investors." "It's something I'm looking for a few times a day," said Rob Toomey, managing director at Sifma, referring to an announcement of the proposed Volcker rule by regulators. He originally expected a rule proposal to come out in August.

Lawmakers from both political parties have said they would prefer that U.S. regulators write rules carefully rather than get them done fast simply for the sake of meeting deadlines. Officials also are working on a slew of other regulations stemming from the Dodd-Frank law, and missed deadlines have been common. "The rule must be written right. If a small delay will help that process, it is acceptable," said Julie Edwards, a spokeswoman for Sen. Jeff Merkley (D., Ore.), who was one of the provision's proponents in Congress. "The important thing is that we have a strong rule that provides stability and certainty to Main Street."

Under the law, the Volcker rule is supposed to take effect no later than July 21, 2012, exactly two years after the passage of Dodd-Frank. Financial firms affected by the Volcker rule will have at least two years—and possibly several more—to bring their trading activities into compliance. Wall Street firms are hoping for a flexible standard that allows regulators to judge firms' risk-taking on a case-by-case basis. Under this approach, firms could make arguments about why a particular trading position is a legitimate hedge designed to reduce the risk of suffering losses.

Still, other firms are gearing up for a proposal that gives more prescriptive guidelines about the type of trades that would run afoul of the Volcker rule. Some industry executives expect the draft rule to err on the stricter side, but they believe regulators will use industry comments to justify softening the rule before making it final. A Wall Street lobbyist predicted that one of the several agencies working on the Volcker rule will publish a draft of the proposed rules this month, with other regulators following in October. That would give the financial industry and American public more time to present comments about the proposal.

Regulators, however, believe there is some wiggle room in Dodd-Frank, because it doesn't specify that the final Volcker rule be adopted by Oct. 18, according to people familiar with the matter. Some officials believe the law says they only must vote on a draft proposal by that date, these people said. One bank lawyer expressed concern that regulators could wind up delaying the proposal for so long that there isn't enough time for industry participants to comment. Another possibility is that firms won't be able to prepare fast enough for the implementation of the Volcker rule next summer.

"Right now, it's better that the regulators take the time to get it right rather than focus on the Oct. 18 deadline," said Margaret Tahyar, a partner specializing in financial regulation at law firm Davis Polk & Wardwell LLP. "But if too many weeks go by without proposed rules, the concern about time to prepare for implementation will rise."

Central Bankers Can Be Lousy Gold Traders
by Liam Denning - Wall Street Journal

Vilified for everything from currency manipulation to arid oratory, central bankers also turn out to be lousy gold traders. From 1989 to 2008, the world's central banks disposed of a net 190 million ounces at an average price of about $398 each, according to data from the World Gold Council. Since then, they have bought back a net 28 million ounces—at nearly three times the price.

If the world's central banks were a single entity, this sell-low-buy-high approach would be perverse. In reality, the big sellers were mainly to be found in Europe, with the U.K.'s sale of more than half its gold reserves at $275 per ounce only the most infamous example. (Gold now commands more than $1,850 an ounce.) The big buyers in recent years have been emerging economies like China and Russia.

European central banks' antipathy reflected an unwinding of the legacy of Bretton Woods. Even at prices of less than $300, gold accounted for 30% of the euro zone's reserves at the start of 2000, compared with a world average of 12%.

One financial crisis later, Europe's central banks have slowed their selling. That is despite the fact that, even though they have less physical gold, price appreciation since 2000 means gold now accounts for 61% of euro-zone reserves. Their renewed hoarding has effectively removed supply from the market just as counterparts elsewhere have bought more.

So far this year, a net 6.7 million ounces have been added to official reserves world-wide, according to the World Gold Council. That is more than all of last year and almost 2.5 times this year's net inflows to physically backed exchange-traded funds. Given that demand for gold excluding official reserves dropped by 3.2 million ounces in the first half of the year, central-bank buying has been crucial to boosting prices.

Central-bank support looks dependable for the foreseeable future, what with the euro zone in turmoil and the Swiss putting up roadblocks to their safe-haven franc. Investors shouldn't get carried away, however. For example, with only 1.6% of China's official reserves in gold as of the first quarter, some dream of what a 5% target for the central bank would do to demand. Based on first-quarter data, China would need to add 74 million ounces to get there. Problem is, that is equivalent to 58% of all forms of demand for gold last year.

If China were to increase its gold holdings so aggressively, it would drive the price up exponentially. This would feed back into its existing reserves, meaning gold would hit 5% of the total without the need to acquire the full physical amount. Jewelry demand—53% of the total—would likely collapse. It would also tempt other central banks, sensing a bubble forming, to sell. For example, Portugal, which struggles with a few funding issues these days, still has 81% of its reserves in gold.

Relying for support on the central banks they so often deride must make gold bugs uncomfortable. It should.

'Endgame' for eurozone approaching fast, warn analysts
by Max Julius - Citywire.co.uk

Divisions at the European Central Bank (ECB), a torrid month for equities, fears over French banks and talk of an imminent Greek default – among other things – have led analysts to predict: the eurozone project is fast entering its ‘endgame’. ‘September is likely to be a defining month for the euro area’s destiny,’ wrote Julian Callow, chief European economist at Barclays Capital.

Strategists at JP Morgan, for their part, have pointed to ‘a growing sense that the crisis is reaching a climax’, saying that the ‘endgame on EMU [European Monetary Union] is approaching fast.' And Jim O'Neill, chairman of Goldman Sachs Asset Management, warned: ‘Not only does it seem as though something "big" has to happen with Greece pretty soon, but something "big" needs to happen for European bank capital, the clarity and determination of ECB policy making and, most importantly, where Germany wants to lead EMU.’

Greek default 'more or less unavoidable'
O'Neill’s comments came shortly before German Chancellor Angela Merkel tried to quash talk that a sovereign default by Greece was at hand, saying policymakers were using all the tools they had to prevent such an event. But Barack Obama, US president, has reportedly voiced concerns over the ability of European leaders to tackle the crisis – and his treasury secretary, Timothy Geithner, will take the unprecedented step of attending a meeting of EU finance ministers on Friday.

Following the talks, Greece’s international lenders are set to write a fifth ‘progress report’ on the debt-ridden nation. Without positive comment, the payment of the next tranche of over €8 billion (£6.9 billion) would be impossible, noted Lutz Karpowitz, strategist at Commerzbank, in which case Greece would be unable to meet its obligations in October at the latest. ‘The question of whether or not Greece will default is pretty much solved for the financial markets, though,’ he added. ‘From the point of view of the markets, a short-term default of Greece is more or less unavoidable.’

Concern over the impact of such a move on French banks, amid speculation that Moody’s will downgrade the lenders on Thursday, has sent their share prices down sharply in recent days.

Elsewhere, Italy’s borrowing costs leapt on Tuesday, with the yield – or implied interest rate – on benchmark 10-year government bonds rising as high as 5.77%, approaching levels regarded as unsustainable. The jump came as the country was forced to pay higher prices to sell new five-year notes after demand dwindled, and following the departure of a senior ECB official amid divisions over the bank’s programme of purchasing eurozone government paper.

Strategists at Morgan Stanley cited the spread of sovereign debt concerns to Italy as ‘a significant escalation’ of crisis. ‘It gives credence to the concept that the periphery is infecting the core, as opposed to the core bailing out the periphery,’ they said.

What should policymakers do?
Despite the talk of an ‘endgame’ being reached, the resolution of the crisis still appears far off. According to Morgan Stanley, stock markets are unlikely to trough until ‘long-lasting solutions’ are found. This requires, the bank said, massive monetary stimulus in the form of quantitative easing (or printing money like the UK and US, from which the ECB has so far shied away. New tax policies to boost long-term productivity and employment and more debt write-downs of over-extended consumer, banks – and countries – were also needed, it said.

BarCap’s Callow extended this theme, pointing out that there was a growing recognition among officials and politicians that for the monetary union to function better in the long run, it would need to have much tougher fiscal enforcement. He cited comments from Jean-Claude Trichet, the outgoing ECB president, and Mark Rutte, Dutch prime minister, as signalling a new thrust towards a fiscal union. But ‘the road to achieving this is likely to be long and challenging,’ he added.

Meanwhile, the JP Morgan strategists stressed that the euro’s very survival hinged on the adoption of a common fiscal policy, but said this was unlikely to happen before conditions ‘become a lot worse.’ ‘Member states have been fighting this dramatic loss of fiscal sovereignty, and will surrender only if the alternative of a much more damaging EMU breakup is imminent,’ they warned.

Europe's banks are staring into the abyss
by Jeremy Warner - Telegraph

Where now for European banks? Sir Howard Davies, former chairman of Britain's Financial Services Authority, said on BBC Radio's Today programme on Tuesday morning that he thought the French government was only days away from having to recapitalise the country's banking system for a second time. It's hard to disagree.

The panic seems to have been temporarily stemmed by a statement from BNP Paribas to the effect that it wasn't having the problems widely reported of finding dollar funding. There was also an emphatic denial of discussions over state intervention. But no-one is kidding themselves. Italy had to pay the highest spread since joining the euro to sell its bonds on Tuesday. There are growing fears over whether Europe's largest borrower can stay the course.

The eurozone sovereign debt crisis is meanwhile exacting a devastating toll on the European banking system as a whole, the UK included. With their high exposure to eurozone debt, the problem is particularly acute for the French banking goliaths, BNP Paribas and Societe Generale.

BNP alone has a eurozone sovereign debt exposure of some €75bn, amounting to roughly 6pc of total assets, including €14bn of Greek debt and €21bn of Italian government bonds. And that's just BNP. The other two major French banks, SocGen and Credit Agricole each have exposures of a similar order of magnitude. Collectively, French banks have €56bn of Greek sovereign bonds alone. They've so far only written down this Greek debt by around 20pc, or in line with the restructuring agreed at the time of the last bailout.

That's nowhere near mark to market. In the increasingly likely event of Germany kicking the Greeks out of the eurozone altogether, Greek debt will become close to worthless. Greece is already effectively a cash only economy. Most forms of credit has effectively dried up, the Greek banking system is finished, and capital controls to prevent what little money that remains from leaving the country are surely only a matter of time. European banking must prepare for the worst as far as Greece is concerned.

As for the remainder of the eurozone sovereign exposure, there's been no write down at all among banks on these bonds. If there's a wider problem of default, the bad debt recognition has yet to come.

How come European banks have got so much of the stuff? Well ironically, this is one lending decision gone wrong that the banks cannot be blamed for. In response to the original banking crisis, regulators ordered banks substantially to increase their liquidity buffers. Government bonds are generally viewed as the most liquid and least risky assets to hold, so that's where the money went.

That these regulatory obligations also helped governments fund their ever growing deficits is by the by. In any case, nowhere is the law of unintended consequences more in evidence than in financial regulation. By seeking to address the last crisis with greater liquidity buffers, regulators succeeded only in sowing the seeds for the next one. A banking crisis that transmogrified into a sovereign debt crisis now shows every sign of transmogrifying back into another banking crisis.

Much of the selling pressure on European banks has come from the US. American investors and lenders look at Europe and see a Continent apparently incapable of gripping its problems. With the debt crisis approaching some kind of self evident denouement, there's no-one in charge, only denial and blame. Policymakers seem more concerned with the irrelevancies of moral hazard than on finding solutions. If it wasn't so tragic, it would be laughable. Europe is fiddling while Rome burns.

When the banking crisis first broke, Europeans tended to regard it as wholly an Anglo-Saxon problem. There was some recapitalisation of French and German banks that went on in late 2008, early 2009, but it wasn't nearly as big as in the UK and the US, and within a year, the French banks had in any case largely repaid all their state support. Problem over, it was thought.

The same refusal to face up to underlying solvency concerns continues to dominate Contintental attitudes to the crisis. There is a collective sense of denial. BNP for one insists that it is in nothing like the same poor shape as many UK and US banks back in 2008. Profits are still buoyant, delinquency subdued, and capital more than adequate, BNP insists. Unfortunately, that's not what the markets are saying.

Record quantities of European term funding are set to mature in the first quarter of next year. It's not clear that the European Central Bank can cope with the sort of liquidity support that banks will require if markets refuse to refinance it. Europe's financial and monetary system is falling apart.

Since French banks are widely thought of as essentially arms of the French state, is there actually any point in recapitalising them? In France, the public subsidy issue which has so exercised the Vickers Commission on banking in the UK is taken for granted. Banks are understood to be underwritten by the state, and therefore require less capital and can hand the benefits of cheaper funding onto to their customers. Why not then just make this implicit support explicit?

You only need to take one look at what happened to Ireland to see why. In the early days of the crisis, the Irish government promised to stand behind all banking liabilities. By doing so, it ended up pushing the entire country into bankruptcy. No. France and Germany need to recapitalise their banks. The sooner they do so, the sooner the wider programme of debt forgiveness necessary to set the European economy back on a sustainable footing can begin.

Greece has cash until October: deputy finance minister
by Angeliki Koutantou - Reuters

Debt-laden Greece has cash to operate until next month, the country's deputy finance minister said on Monday, highlighting the country's need to qualify for the next tranche out of its ongoing EU/IMF bailout. Filippos Sachinidis's statements confirm previous comments by Greek officials, made on condition of anonymity, that the country had cash for only a few more weeks.

"We have definitely maneuvering space within October," Sachinidis said in an interview on television channel Mega, responding to questions how much longer the government will be able to pay wages and pensions. "We are trying to make sure the state can continue to operate without problems," he added.

Greece's international lenders threatened last week to withhold the sixth bailout payment of about 8 billion euros ($11 million) because of the country's repeated fiscal slippages. The Greek government announced on Sunday a new property tax to make sure it will meet its budget targets and qualify for the tranche. The EU's Commissioner for Monetary Affairs, Olli Rehn, welcomed the move, saying it went "a long way" toward meeting the country's targets.

Only Drachmaization can save Greece and euro
by Martin Hutchinson - Reuters

Regional comparisons suggest Greek living standards have risen far beyond productivity since it joined the European Union, making austerity inadequate to rebalance the economy. Drachmaization would allow market forces to set Greek wage levels, induce other indebted EU members to reform without EU prodding and thus solidify the euro.

Greece’s dramatic rise in living standards to a 2008 GDP per capita of $30,400, almost the EU average, was caused not by an exceptional surge in Greek productivity, but mostly by massive subsidization and borrowing. Greece’s continuing current account deficit, estimated by the Economist at 8.3 percent of GDP in 2011 in spite of deep recession, indicates that the country remains deeply uncompetitive.

In comparison, Greece’s neighbors Bulgaria and Macedonia had 2008 GDP per capita of $14,000 and $10,700 respectively, yet it is now 20 years since communism fell and market forces are dominant in both economies. Another comparison is Portugal, which joined the EU shortly after Greece. Its GDP per capita is somewhat less inflated at $24,900.

This suggests that Greece may require living standards to decline perhaps 30-40 percent to become competitive. Such an adjustment is impossible through austerity alone; the unrest in Greece surrounding recent negotiations shows that further major austerity could produce a political backlash deeply damaging to Greece’s future. Thus, assuming further massive subsidization by EU taxpayers is politically unlikely, a Greek replacement of the euro by a new drachma becomes the only practical alternative.

This would be problematic but not impossible. The two most relevant precedents are: Argentina which in 2001-02 abandoned a 1-1 peso/dollar link; and the former Soviet and Yugoslav states which introduced new currencies.

In Argentina, the government first imposed a limitation of around $250 per week on cash withdrawals from banks. Peso convertibility was abandoned in January 2002 and an official exchange rate of 1.4 pesos per dollar was created, at which all dollar bank accounts were compulsorily converted into pesos. Since the free-market peso/dollar rate settled at around 4 pesos per dollar, most capital losses were borne by savers, not banks.

Logistically, security printing of drachma banknotes would not initially be necessary. When Slovenia introduced the tolar in October 1991 as Yugoslavia was breaking up, it operated for over a year with a paper currency without security printing. In Greece cash transactions could alternatively be made in euros, available from the banks at a free-market rate once bank accounts had been converted into drachmas.

The exchange would require some unpleasant temporary restrictions. As well as restricting cash withdrawals from banks, exchange controls would be needed short term and the Schengen rights of free movement between Greece and other EU countries might have to be temporarily suspended. With these restrictions, conversion should require a bank holiday no longer than the eight-day period imposed by the United States in 1933.

Economically, the drachma’s value would decline sharply, but the drop in living standards would be smaller — the Athens price of a Mercedes would jump, but those of haircuts and Moussaka would not rise immediately. The equilibrium drachma rate would make Greek workers internationally competitive, producing a decline in living standards probably between the 50 percent necessary to reach Bulgarian levels and the 18 percent needed to match Portugal, whose 2008 living standards were also over-inflated.

Greece would quickly achieve a trade surplus, with ultra-cheap tourist offerings, and Greek unemployment would rapidly decline from its current level above 16 percent. A debt restructuring similar to Argentina’s would then be undertaken, reducing the debt’s present value by around the same percentage as the Greek reduction in living standards.

This would be painful, although the increased economic vibrancy and decline in unemployment would for most Greeks make it preferable to several years of outside-imposed austerity and political chaos. For the EU and the euro, it would be highly beneficial, eliminating most of the moral hazard currently inherent in the euro zone’s fiscal and monetary arrangements. The decline in Greek living standards imposed by drachmaization would strongly encourage the euro zone’s other economic weak sisters to impose the austerity and reforms needed to make their economies competitive.

The euro would emerge stronger because Maastricht-type fiscal and economic discipline would appear to be the necessity of a cruel market, and not something bargained at an EU summit and chiseled through fudging figures. Finally, such an outcome would make central EU control of member state finances unnecessary as good behavior would result from self-discipline alone.

Merkel hits out at talk of Greek default
by Quentin Peel, Richard Milne and Ralph Atkins - FT

Angela Merkel, Germany’s chancellor, sought on Tuesday to quash speculation that a Greek default was imminent, insisting that no such event could happen before 2013 even as markets continued to gyrate wildly over eurozone fears.

Mixed messages from members of Germany’s ruling centre-right coalition have fed recent market turmoil. But the chancellor slapped down her political partners for speculating about Greek insolvency, or even an exit by Athens from the euro. "Everyone should weigh their words very carefully. What we do not need is alarm in financial markets," she said. "There is already enough uncertainty."

Her intervention came in a radio interview, 24 hours after Philipp Rösler, her vice-chancellor and economy minister, called for the "orderly insolvency" of Greece to be put on the political agenda, once "the necessary instruments are available." Ms Merkel said that such a situation would not arise before 2013, when the eurozone’s permanent rescue fund, the European Stability Mechanism, is due to come into operation.

She spoke as it was confirmed in Berlin and Paris that Ms Merkel and Nicolas Sarkozy, the French president, would hold a conference call on Wednesday with George Papandreou, the Greek prime minister. The purpose would be to assure Mr Papandreou of their support for his "almost superhuman efforts" in reforming the Greek economy and curbing its borrowing, according to one senior official. At the same time they would urge him to deliver measurable progress on Greece’s promises in exchange for the next tranche of its rescue package from the European Union and International Monetary Fund the official added.

Amid the continued uncertainty, markets experienced extreme volatility with French banks the focus of attention. Société Générale fell 8 per cent in morning trading before rebounding to close up 15 per cent. "It is very difficult for people to trade in these markets. The market sells off and rallies on spurious rumours," said Gary Jenkins, head of fixed income at Evolution Securities.

Sergio Marchionne, the chief executive of Fiat and Chrysler, the Italian and US carmakers, underlined the concerns of business leaders, saying at the Frankfurt motor show: "I think there is a possibility, if the wrong steps are taken, that the system goes off the rails. The problems must be confronted in a serious way. It is not pleasant right now. We are not totally calm about this instability and the way in which the European crisis is being managed."

Jens Weidmann, president of the Bundesbank, also called for bolder action from EU governments. In a speech in Cologne, he warned that a decision "would have to be taken soon" on either a "big jump" towards political union or a return to a monetary union based strictly on countries taking responsibility for their own finances. The middle way of pooling responsibility but retaining national fiscal policies "threatens to collapse under its own inconsistency," he said.

European Bank Default Insurance Costs At Record
by Art Patnaude and Sarka Halasova - Wall Street Journal

The cost of insuring the debt of European financial companies against default continued pushing to fresh record highs Tuesday, with French and Italian banks leading the way amid concerns about their exposure to the intensifying sovereign debt crisis. After opening the day tighter than the record closing level Monday, the region's credit default swap indexes turned wider for the fourth consecutive day.

Fears about an economic slowdown and the sovereign crisis have seen spreads soar over the past month, although the moves in French and Italian banks Tuesday were based on events at home. Reports overnight that Italy's finance ministry held talks with China's sovereign wealth fund and other Chinese officials in a bid to persuade Beijing to buy large amounts of Italian bonds provided markets with a brief reprieve in early trade, although doubts remain about the likelihood of the plan.

"We rallied on the possibility of the Chinese coming in to buy Italian debt, but the more people looked into it, the more it seemed China would be more likely to be core [European] debt," a financials CDS trader said. While this was pushing Italian bank five-year CDS wider, French banks were moving out due to a Wall Street Journal column about BNP Paribas SA struggling to access funding in dollars, he said.

The opinion piece, written by Nicolas Lecaussin, director of development at France's Institute for Economic and Fiscal Research, cited an unnamed executive at the French bank. The comment has added to concerns of already cautious investors.

The five-year CDS spreads of French banks were leading the iTraxx Senior and Subordinated Financials indexes to new record levels, according to data-provider Markit. By mid-morning, the spread on Societe Generale SA was 0.27 percentage points wider at 4.5 percentage points, while BNP Paribas was 0.18 basis points wider at 3.22 percentage points. Credit Agricole SA was 0.4 percentage points wider at 3.30 percentage points.

CDS are derivatives that function like a default insurance contract for debt. A rise of one basis point in the cost of five-year CDS equates to a $1,000 increase in the annual cost of protecting $10 million of debt for five years. The Italian banks were also suffering, with Intesa Sanpaolo SpA 0.10 percentage points wider at 4.60 percentage points, UniCredit 0.14 percentage points points wider at 5.00 percentage points and Banca Monte dei Paschi di Siena was 0.16 percentage points wider at 5.70 percentage points.

The indexes, whose constituents also include insurers, were trading at their widest-ever levels. The Senior Financials index was 10 wider at 3.22 to 3.26 percentage points, while the Sub Financials index was 0.19 percentage points wider 5.62 to 5.70 percentage points.

The Trouble With French Banks
by Nicolas Lecaussin - Wall Street Journal

'We can no longer borrow dollars. U.S. money-market funds are not lending to us anymore," a bank executive for BNP Paribas, who declines to be named, told me last week. "Since we don't have access to dollars anymore, we're creating a market in euros. This is a first. . . . We hope it will work, otherwise the downward spiral will be hell. We will no longer be trusted at all and no one will lend to us anymore."

He's not the only one worried. France's three biggest banks have been the subject of whisper campaigns about their solvency since the beginning of the summer, and Société Générale has lost 22.5% of its value.

BNP, Société Générale and Crédit Agricole together hold nearly $57 billion in Greek sovereign and private debt, versus $34 billion held by the largest German banks and $14 billion at British banks.

French banks also held more than €140 billion in total Spanish debt and almost €400 billion in Italian debt
as of December, according to the latest figures from the Bank for International Settlements. If either of these latter two governments were to default, their banking systems could collapse and take the French system with them.

BNP, Société Générale and Credit Agricole all say that their finances are in order and the market worries are unfounded. But it's difficult for the BNP executive to hide his concern. "Look at the French banks' debt holdings versus those of U.S. banks," he continues. "The total debt of the three big U.S. banks (Bank of America, JP Morgan and Citigroup) is $5.86 trillion, or 39% of GDP, while the debts of BNP, Crédit Agricole and Société Générale come to €4.7 trillion, or 250% of French GDP."

Analysts are suggesting that the government is set to start nationalizing France's banks. The banks have remained silent on the matter, and the government denies this talk. But the last time the French state intervened in the banking system in a big way, the results were disastrous. As recently as the 1980s, most French banks were owned by the state, and by the 1990s the sector was bordering on bankruptcy. The French banking sector shrank by nearly 50% during the decade, while the those in other countries such as Britain and the U.S. grew by 39% and 50%, respectively.

The most famous case of that time was Crédit Lyonnais, which was plagued by mismanagement throughout the 1980s and 1990s until it shifted its debts and liabilities into a new state-owned company, the Consortium de Réalisation. In 2003 Crédit Lyonnais was taken over by Crédit Agricole, but in July 2008 its bills came due anyway.

An arbitration court ordered the Consortium de Réalisation to pay €240 million to the liquidators of the Bernard Tapie group, along with €105 million in interest and €45 million in moral damages—a total of €395 million for one erstwhile borrower. Meanwhile, the SdBO (Western Bank Corporation), a subsidiary of Crédit Lyonnais, lent sums to the Tapie family that added up to more than two-and-a-half times the bank's total capital. French taxpayers paid out more than €15 billion for the mismanagement of Crédit Lyonnais over the years.

The taxpayer-backed losses of mortgage lender Crédit Foncier came to €2 billion. And the Hervet bank (now part of the HSBC group) announced the first losses in its history after its 1982 nationalization.
These and other disasters were brought on by the bank nationalizations of the early 1980s. But despite the subsequent privatizations, French bank boards are still dominated by the alumni of France's famous ENA, the Ecole Nationale d'Administration, and by officials who have worked at the Ministry of Finance. A study by the Management Institute at the Université de La Rochelle finds that between 1995 and 2004 banks administered by government-linked technocrats were in greater total debt than those that were not.

Whether the market's worst fears are realized or not, French banks certainly maintain an all-too-close relationship to the state. This opaque system doesn't offer outsiders much visibility, save for the knowledge that indebted banks and an indebted French state intend to continue to cover each other, no matter the cost and on taxpayers' backs if they must. If U.S. money-market managers no longer trust the French system, this is a glaring reason why. The fastest way to regain their trust would be to end this system.

Mr. Lecaussin is director of development at France's Institute for Economic and Fiscal Research.

Woes at French Banks Signal a Broader Crisis
by David Gauthier-villars And Nathalie Boschat - Wall Street Journal

France's largest private-sector banks will likely suffer further credit-rating downgrades this week, people familiar with the matter said, the latest sign that the debt crisis on the euro zone's periphery is slowly infecting the core of the region's financial system.

Moody's Investors Service Inc. is expected to cut the ratings of BNP Paribas SA, Société Générale SA and Crédit Agricole SA because of the banks' holdings of Greek government debt, these people said. Such a move would further undermine investor confidence in French banks, which have seen their stock prices tumble in recent weeks amid growing concerns over their exposure to heavily indebted euro-zone countries and a slowdown in Europe's economic growth.

Political brinksmanship over Greece, coupled with the darkening economic outlook across the Continent, has fueled a selloff in European bank shares in recent weeks. The Stoxx Europe 600 banks index is down just over 25% since Aug. 1. Société Générale, France's second-largest listed bank, has been hit particularly hard, dropping almost half of its share price since the beginning of August. Shares in Crédit Agricole, France's No. 3 bank, have dropped 35% in that span, while those of BNP Paribas, the country's largest lender, are off 32%.

On Monday morning in Asia, shares traded lower on European debt concerns. Japan's Nikkei average fell 2.1%, Australia's S&P/ASX 200 dropped 3.0% and New Zealand's NZX-50 lost 1.6%. On Sunday, Société Générale Chief Executive Frederic Oudéa sought to allay investor concerns, saying his bank was solid and would survive even if Greece didn't pay back its debts. "We have fears that are completely excessive," Mr. Oudéa said in an interview with French television channel M6. "Greece is a small economy, a small country that we know how to deal with."

Since the introduction of the euro in 1999, Europe's national borders have essentially disappeared for the region's banks. That deep integration, once seen as a major benefit for the region's financial system, has become a detriment. In recent months, Europe's interbank-lending market has come under increasing strain as banks refuse to lend to one another at affordable rates. That has left many banks in Southern Europe almost completely dependent on the European Central Bank to meet their short-term liquidity needs.

The deepening woes of France's banking sector reflect the vicious cycle Europe faces in trying to bring its nearly two-year-old debt crisis under control. Europe's failure to halt the spread of the problems is forcing the region's leaders to contemplate ever-closer integration within the euro zone, despite growing popular skepticism that binding the region's economies even tighter to one another is the right course.

In a sign of how far those discussions have progressed, U.K. Chancellor of the Exchequer George Osborne said over the weekend that he had discussed introducing a new European treaty with his European Union counterparts that would allow for the changes to the euro zone's architecture. "It's on the cards that a treaty change may be proposed," Mr. Osborne said on the sidelines of the weekend's meeting of finance ministers from the Group of Seven leading nations. "This would be to further integrate the euro zone, further strengthen fiscal integration. I have said there is a remorseless logic from monetary union to fiscal union, and it's in Britain's interests that the euro zone is stable."

The U.K. itself is unlikely to ever join the nations using the euro. Nevertheless, the euro zone is the country's most important trading partner and continued instability within the currency area would inevitably hit the U.K. Europe's leaders sought to end months of uncertainty over Greece's solvency in July by promising it a fresh €109 billion ($148.7 billion) bailout. The deal calmed markets for a time, but winning approval for the plan in euro-zone capitals has been more difficult than expected. Complicating matters, the global economic slowdown has made the plight of the region's weakest members even worse, pushing them further into recession.

The economic malaise and popular resistance to additional public-spending cuts in Greece has left Athens unable to meet the requirements of its original rescue program. Greece will run out of money within weeks if it can't end a standoff with the International Monetary Fund and the EU. In a last-ditch effort to overcome the impasse with its international lenders, Greece's government said Sunday that it would impose a new property tax to cover a €2 billion shortfall in budget targets this year. Investors worry that if the dispute goes unresolved, Greece could suffer a messy default, with untold consequences for Europe's banks.

French banks' overall exposure to Greece is about €65 billion, according to the Bank of International Settlements. France's three largest private-sector banks had about €6 billion of Greek bonds on their books as of June 30, with €4 billion held by BNP Paribas.

In addition, the second and third largest private-sector banks—Société Générale and Crédit Agricole—own Greek banks outright. Credit Agricole's Emporiki Bank has assets totaling about €26.4 billion, while SocGen's Geniki Bank has assets of €4 billion. Although these banks are tiny by international standards, their owners' direct exposure to the Greek financial system has added to fears that default could unleash a domino effect across Europe as investors struggle to determine which banks are most at risk.

"French banks have not been as cautious on Greece as other European banks, which is making investors nervous," said Geoffroy Perreira, a trader with Paris-based Investment Strategy. Moody's placed the three French banks on negative watch on June 15. The three-month window during which the ratings firm traditionally announces rating decisions is drawing to an end.

SocGen ditches assets as French bank pressure rises
by Elena Berton and Lionel Laurent - Reuters

Societe Generale said it would cut costs and sell assets worth 4 billion euros to bolster capital on Monday, but shares in French banks fell by more than 10 percent on concerns about Greek debt and a possible cut to their credit ratings.

SocGen, BNP Paribas and Credit Agricole are heavily exposed to Greek government debt, which is under intense pressure amid worries about its euro zone membership. French banks are braced for an imminent decision from credit rating agency Moody's, which put them under review for possible downgrade on June 15, several sources told Reuters on Saturday.

Confidence in European lenders' ability to fund themselves in the face of a slowing economy and the unfolding Greek debt drama has evaporated rapidly, with French banks among the hardest hit because they are seen as particularly reliant on short-term funding.

SocGen's announcement on Monday was intended to mitigate some of the negative pressure expected from a Moody's downgrade, said one banking analyst speaking on condition of anonymity. "Some points of the press release are really positive, but I do not think this is having an impact today," he said. "The share price reaction today is completely due to the downgrade from Moody's and the jitters on Greece leaving the euro zone."

In a surprise move, SocGen said it would cut costs and jobs, speeding up the sale of toxic assets, as well as selling units in asset management and financial services. The bank said it is still targeting a core tier 1 ratio "well above" 9 percent by 2013, without having to resort to a capital increase. SocGen shares were down 9.3 percent at 0857 GMT (4:57 a.m. ET), while BNP Paribas was down 11.2 percent and Credit Agricole was 9.9 percent lower. The European bank sector .SX7P was down 3.3 percent.

SocGen, whose shares have been punished in recent weeks amid the deepening sovereign debt crisis in Europe, said it was accelerating a strategic plan announced in June 2010 to cope with new realities, in which funding would be scarcer and more expensive for all banks. It had been under pressure to act after scrapping its 2012 profit target and a sharp summer sell-off driven by fears over its funding firepower.

French lenders -- two of which own local Greek banks -- have the highest overall bank exposure to Greece, according to the Bank of International Settlements, and have begun taking writedowns on Greek holdings as part of a new rescue package. However, SocGen's exposure to peripheral euro zone economies totals 4.3 billion euros ($5.9 billion), which amounts to less than 1 percent of its balance sheet. Its exposure to Greek government bonds was 900 million euros on September 9, down compared with June.

The fall in its shares has led investors and media to speculate about more dramatic moves, such as government intervention or a long-mooted takeover by rival BNP. Asked about the government's plans in a TV interview on Monday, French industry minister, Eric Besson, ruled out a partial nationalization of the banks. "It seems to me to be totally premature and not relevant today to evoke this hypothesis," he told RMC and BFM TV.

Societe Generale CEO Frederic Oudea said that no discussions over possible state intervention had taken place. And in an internal memo sent to staff, SocGen's management said a takeover of the bank was not a solution to its current woes. "A takeover, today, is neither a solution nor at risk -of occurring-: all banks have seen their share prices drop," the memo said. "The level of instability in the environment and the banking system means that all banks are faced with the same problem. [A merger] is not a solution to the current problem, regardless of the players."

SocGen said freeing up 4 billion euros of capital by 2013 by selling assets would improve its core Tier 1 ratio by 100 basis points. During a conference call the bank ruled out additional asset sales beyond 4 billion euros. It also said it had already sold 3.5 billion euros in toxic assets in the third quarter as part of a broader effort to alleviate ongoing concerns over funding and liquidity. On the cost cut front, SocGen is also cutting jobs in Russia, Romania, Poland and Egypt, as well as paring down the cost base at its investment banking business by 5 percent.

Italy turns to China for help in debt crisis
by Guy Dinmore - FT

Italy’s centre-right government is turning to cash-rich China in the hope that Beijing will help rescue it from financial crisis by making "significant" purchases of Italian bonds and investments in strategic companies.

According to Italian officials, Lou Jiwei, chairman of China Investment Corp, one of the world’s largest sovereign wealth funds, led a delegation to Rome last week for talks with Giulio Tremonti, finance minister, and Italy’s Cassa Depositi e Prestiti, a state-controlled entity that has established an Italian Strategic Fund open to foreign investors.

Italian officials were in Beijing two weeks ago to meet CIC and China’s State Administration of Foreign Exchange (Safe), which manages the bulk of China’s $3,200bn foreign exchange reserves. Vittorio Grilli, head of treasury, met Chinese investors in Beijing in August. Italian officials said further negotiations were expected to take place soon.

The possibility of Chinese investment comes at a critical moment for Italy, as markets demand increasingly high yields to buy Italian public sector debt, projected to reach 120 per cent of GDP this year, a ratio second only to Greece in the eurozone.

Mr Tremonti has written extensively in the past about his fears of China’s "reverse colonisation" of Europe. But he has been driven to seek new alternatives as Europe prevaricates over strengthening its bail-out fund and the European Central Bank warns that its month-old bond-buying programme cannot go on indefinitely. In a reflection of Italy’s refinancing problems, the treasury on Monday sold €11.5bn of short-term notes at higher yields.

European analysts were cautious over the outcome of talks. Despite Beijing’s numerous expressions of confidence in the creditworthiness of countries such as Greece and Portugal analysts say Chinese purchases of peripheral European debt have been relatively small.

How much of Italy’s €1,900bn of debt is already held by China is unclear, though one Italian official told the FT that Beijing held about 4 per cent. Italy’s debt crisis has forced the government to consider possible sales of strategic stakes in companies such as Enel, the Italian power utility, and Eni, the oil and gas multinational.

Cassa Depositi e Prestiti is a founding member of the informal "long-term investors club" along with similar institutions in France and Germany. In July it launched its Italian strategic fund with an investment of €4bn that it plans to expand to €7bn with participation from other sources, including foreign institutional investors.

CIC was set up in 2007 with capital of $200bn and its assets under management now total about $410bn. It says it "maintains a strict commercial orientation and is driven by purely economic and financial interests" and that it is committed to "high professional and ethical standards in corporate governance, transparency and accountability". China’s embassy in Rome had no immediate comment.

Stop rejoicing. This was no victory for the eurozone
by Wolfgang Munchau - FT

The two real options for a resolution of the eurozone crisis came into full conflict last week. The first is a common eurozone bond. The second is a monetisation of national debt through the European Central Bank. Angela Merkel rejects the former. Europe’s central bankers reject the latter. Jürgen Stark, a member of the European Central Bank’s executive board, rejects both, and last week resigned in protest. Along with other conservative economists, he is advocating a third way, adjustment through depression – the simultaneous deleveraging of the private and public sector debt.

As an advocate of eurozone bonds, I have to admit their prospect looks grim after last week’s ruling of the German constitutional court. The court upheld the European financial adjustment facility, the crisis mechanism. This was, undoutedly, good news. But after I read the whole ruling, which ran to 29 tightly written pages, I realised that this judgement was not a victory for the eurozone at all. On the contrary, it categorically rules out any policy option beyond what has been agreed so far. I cannot see how it can be consistent with the survival of the eurozone, given the policies of member states and the ECB.

Much of the language in this document is opaque constitutional jargon. But on the issues that matter, the ruling is surprisingly, and depressingly, clear. It says the German government must not accept permanent mechanisms – as opposed to the EFSF, which is temporary – with the following criteria: if they involve a permanent liability to other countries; if these liabilities are very large or incalculable; and if foreign governments, through their actions, can trigger the payment of the guarantees. If I were a plaintiff in this case, I would regard that statement as an open invitation by the court to bring a new case against the European stability mechanism.

The ESM will be the permanent successor to the EFSF from 2013. It fulfils a good subset of those conditions. The justices ruled with a seven to one majority in this case, but later said it was a close decision. If the plaintiffs were to bring a much more focused case against a more ambitious mechanism, they might stand a better chance.

If the ESM is a borderline case under German constitutional law, there can be no such doubt about a eurobond. The court’s verdict leaves me no alternative but to conclude they are indeed unconstitutional.

Moreover, you cannot get around this unfortunate fact with an ingenious combination of eurocratic trickery and financial engineering. The court, quite cleverly, did not mention eurobonds. It talked about liabilities. The Bundestag is not precluded from giving money to Greece, but it cannot empower a third party, such as the EFSF or ESM, let alone a hypothetical European Debt Agency, from usurping sovereign power. Sovereignty can be delegated in small slices, but not permanently.

A eurobond is, of course, a permanent mechanism. It also involves a permanent loss of control. Its size is very likely to be substantial. There would not be any point in issuing a small eurobond – it would not resolve the crisis. And unless member states were to transfer some of their sovereignty to Brussels, all the inherent risks in the structure would come from non-compliance by national governments or parliaments. In other words, a eurobond perfectly matches the conditions set by the constitutional court for an arrangement that violates the German constitution.

What if the EU decided to create a fiscal union after all? The constitutional court already decided in its ruling on the Lisbon Treaty that this is not possible either. A fiscal union would require a referendum, in which the German electorate would decide to abolish the sovereign German state, and transfer sovereignty from Berlin to Brussels. Suffice to say, that this is not very likely to happen. So we have an impasse. No matter how you organise a future fiscal space in the eurozone, it will either be meaningless, or infringe the German constitution.

Moreover, the political hurdles have also gone up recently. Angela Merkel has ruled it out so forcefully that she cannot turn her back on this promise. Even the leaders of the opposition, who are more sympathetic to the idea, would find themselves constrained by the ruling.

What does this mean? First, the ruling significantly increases the probability of default by one or several member states. This is a simple consequence of the Law of Large Numbers. There are now so many hurdles in place that a systemic accident is very likely to happen at some point.

Do we really think the Bundestag, after having reluctantly accepted the need for a second Greek loan programme, will vote for a third? Or a second Portuguese or second Irish programme? Will they vote Yes once the EFSF starts buying bonds, or recapitalising banks? It takes a single No vote to trigger a default. When that happens, there will be no time left for diplomacy.

The ruling leaves a post-Stark ECB as the sole backstop that could prevent a break-up of the eurozone. Next week I will explain why this option is not going to work either.

Europe Banks Valued at Post-Lehman Lows Show Sovereign Risks Intensifying
by Aaron Kirchfeld and Adam Ewing - Bloomberg

Investors are valuing European banks at levels not seen since the depths of the credit crunch that followed the collapse of Lehman Brothers Holdings Inc. as concern over a Greek default and debt contagion escalates.

A Bloomberg index shows 46 lenders trading at 0.56 times book value, the cheapest since the post-Lehman lows of March 2009, signaling investors estimate their net assets are worth less than the companies claim and are demanding discounts for perceived risks. Valuations reflect the impact of a potential sovereign default for some banks, according to Barclays Capital analysts led by Jeremy Sigee.

Group of Seven finance chiefs meeting in Marseille, France, over the weekend vowed to support banks amid growing concern that the debt crisis is morphing into a banking crisis. As doubts linger about the ability of some European lenders to withstand a Greek default and its ripple effects, the cost of insuring their debt rose to records, while a measure of their reluctance to lend to each other climbed to a 2 1/2-year high.

"Politicians need to get their heads together and deal with the inevitable: a Greek default and recapitalization of some banks," said Peter Thorne, a London-based analyst at Helvea Ltd. "You have to make the banks look financially stable and secure so that people are prepared to deposit money with them for more than 24 hours."

Deutsche Bank AG Chief Executive Officer Josef Ackermann said on Sept. 5 that market conditions remind him of late 2008, and urged lawmakers to act to avoid a repeat of the financial crisis, which spawned the worst global recession since the Great Depression.

Funding Costs Rise
The Markit iTraxx Financial Index of credit-default swaps on 25 banks and insurers increased 26 basis points to 290 on Sept. 9 in London, according to JPMorgan Chase & Co. The difference between the three-month euro interbank offered rate, or Euribor, and the overnight indexed swap rate, a measure of banks’ reluctance to lend to each other, rose to 0.834 percentage point, the widest gap since March 2009.

August was the worst month for long-term debt issuance for the region’s lenders in more than five years, Bank of America Corp. analysts led by Derek De Vries said in a note last week.

The Bloomberg Europe Banks and Financial Services Index of stocks dropped 3.9 percent today to the lowest level in almost 2 1/2 years. The index has slumped 37 percent so far this year, led by financial companies based in peripheral Europe, such as Banco Comercial Portugues SA and National Bank of Greece SA, as well as those with investments there, such as Commerzbank AG of Germany and France’s Societe Generale (GLE) SA.

Implied Writedowns
In the case of some banks, the plunge implies writedowns beyond the current level of sovereign bond prices, according to a note from Sigee on Sept. 7.

BNP Paribas SA, Societe Generale and Credit Agricole, France’s largest banks by market value, are trading at levels that imply a 100 percent loss on Greek, Irish and Portuguese holdings, according to Barclays. In the case of Paris-based Societe Generale, the share price even implies full writedowns on Italian and Spanish debt, according to Barclays.

"The current discounts to book are driven by much broader macro concerns, and attributing all of the discount to a single risk factor like sovereign is too simplistic," Sigee wrote, adding that the French banks’ risks remain manageable. "However, it does give a sense of how severely sovereign risks have been priced into equity valuations."

Credit Ratings
BNP Paribas, Societe Generale and Credit Agricole tumbled in Paris trading on a possible ratings cut by Moody’s Investors Service, extending their more than 40 percent slide in the last three months. France’s three largest banks by market value may have their credit ratings cut as early as this week because of their Greek holdings, two people with knowledge of the matter said.

Societe Generale said today it plans to sell 4 billion euros ($5.4 billion) in assets by 2013 to reassure investors about its finances. The lender said it holds about 900 million euros of Greek bonds and has "no significant" Irish or Portuguese debt.

The 90 banks that underwent European stress tests would face an estimated capital shortfall of 350 billion euros if Greek, Portuguese, Irish, Italian and Spanish government bonds were written down to market values, according to Nomura analysts led by Jon Peace. No "practical" amount of capital can prepare them for a large sovereign debt impairment or default, Nomura said in a note on Sept. 7.

ECB Rift
Greek 10-year bonds are trading at a 52 percent discount to face value, according to Bloomberg data. By comparison, some banks agreed in July to write down the value of their Greek securities by an average 21 percent as part of a bond exchange and debt buyback program for Greece.

Reflecting concern that Greece may fail to meet the terms of its aid package and miss its payment obligations, German Chancellor Angela Merkel’s government is preparing plans to shore up its nation’s financial sector, three coalition officials said Sept. 9. The surprise resignation of Juergen Stark from the European Central Bank on the same day exposed the policy rifts aggravating the debt turmoil.

"Stark resigning is another development that suggests Germany isn’t really behind a lot of what the ECB needs to do to shore up the situation," said Jonathan Fayman, a fund manager at BlueBay Asset Management Plc in London. With Merkel preparing banks for the possibility of a default, "the market is scared and it looks like it should be," he said.

Henrik Drusebjerg, senior strategist at Nordea Bank AB in Copenhagen, said the financial turmoil will force policy makers to find a solution that would otherwise have taken decades. "Why?" he said. "Because the alternative is a total breakdown."

ECB's Stark tells Ireland to ramp up austerity
by Carmel Crimmins - Reuters

Ireland's government should cut public sector pay again to get its budget deficit under control, Juergen Stark, the outgoing chief economist at the European Central Bank (ECB), said in an interview published in The Irish Times on Monday.

Speaking hours before his shock resignation on Friday, Stark said Ireland should accelerate efforts to get its budget deficit under control including breaking a pledge to public sector unions to leave wages alone.

"We fully appreciate what the government has already done in correcting public wages," Stark was quoted as saying. "(But) there is scope, further room for adjustment and to be more in line with the wages in the public sector in the euro area as a whole." "The government should be even more ambitious in cutting the public deficit ratio, which is still at double-digit level."

Stark will leave the ECB by the end of the year once a replacement is found. He is resigning amid conflict with the ECB's policy of buying government bonds to combat the euro zone's debt crisis.

Stark shock widens German euro faultline
by Noah Barkin - Reuters

The surprise exit of Germany's top official at the ECB has ripped a hole in Chancellor Angela Merkel's strategy of tackling Europe's debt crisis with closer integration, raising new doubts about the euro project at home and widening divisions in her party and coalition.

Juergen Stark's premature departure from the European Central Bank because of his opposition to its controversial bond-buying program was described by German policymakers and editorial writers as a "wake-up call" for Germany. It comes roughly seven months after Axel Weber, another monetary hawk in the post-war German tradition, abruptly resigned his post as head of the Bundesbank and withdrew his candidacy for the top post at the ECB.

That decision shocked the German policy establishment, but at the time many saw it as a one-off move by an impulsive man who had clashed loudly and publicly with President Jean-Claude Trichet over the extraordinary measures taken by the ECB to safeguard the single currency. The resignation of Stark, a loyal, dedicated central banker who had kept his doubts about ECB policies to himself, tells a very different story, and has unleashed a wave of anxiety across Germany about the direction of 12-year-old single currency bloc.

Taken together, the departures are seen by many as indications of a southern European takeover of the ECB's policy-setting council, a worry sharpened by the looming presidency of Italian Mario Draghi, who takes Trichet's place in November. Former Bundesbanker Edgar Meister called at the weekend for changes to the ECB's one-country, one-vote rule, saying it was "unbelievable" that a country such as Germany that was shouldering the biggest burden in the crisis could be overruled by central bankers from smaller countries that have already been rescued or are at risk of a bailout.

Norbert Barthle, a senior lawmaker from Merkel's Christian Democrats (CDU) who sits on parliament's budget committee, told Reuters that Stark's exit was "a rejection of the policies that the ECB has pursued and a clear signal that the situation in the broader euro zone has reached a really critical point."

"More Europe" Strategy
The implications for Merkel and Berlin's approach to the euro zone crisis are profound. Criticized for focusing too much on domestic politics and failing to provide clear leadership in the bloc, Merkel shifted her approach this summer and began demanding "more Europe" as the solution to the bloc's deepening crisis. She made clear last week in a speech to the Bundestag, the lower house of parliament, that changes to the EU's Lisbon Treaty to bring about closer fiscal integration between the euro zone's 17 member states should no longer be taboo.

After Stark's resignation, the domestic hurdles to that goal have risen substantially. Julian Callow, an economist at Barclays Capital, said the political effect of Stark's resignation "could complicate Germany's involvement in additional bailout programs."

Merkel received a boost last week when the Constitutional Court rejected lawsuits seeking to retroactively block Berlin's participation in bailouts of Greece, Ireland and Portugal, albeit while giving parliament more say in future bailout moves. But after Stark, her drive to secure a conservative majority in parliament for a bigger, bolder euro zone rescue facility on September 29 may have become more difficult again.

Merkel still seems likely to deliver that, but subsequent Bundestag votes on a second aid package for Greece and the launch of a permanent bailout fund -- the European Stability Mechanism (ESM) -- present a huge challenge to her leadership. The Free Democrats (FDP), junior partners in her ruling coalition, are considering asking their 66,000 members whether to support the ESM. If a majority vote against, the leadership will be obliged to adopt that position as FDP policy.

Merkel's other coalition partner, the Bavarian Christian Social Union (CSU), is also agitating -- to boot Greece out of the euro zone. A CSU policy paper obtained by Reuters over the weekend states that countries that do not respect rules on budgetary discipline should "expect to have to leave the currency union."

Default More Likely
A Greek exit from the euro zone still seems remote, and in any case, German officials say in private, such a decision would ultimately be for the government in Athens to take. But a default no longer seems out of the question. The FDP economy minister, Philipp Roesler, said in an article published on Sunday that an orderly bankruptcy of Greece was no longer a taboo and demanded automatic sanctions for heavily indebted countries that did not meet their obligations.

Despite Greek Prime Minister George Papandreou's pledge on Saturday to do all in his power to avert bankruptcy, it is no longer a given that inspectors from the EU, IMF and ECB will sign off on the next aid payment after leaving Greece in a huff over missed deficit targets this month. A German Finance Ministry source told Reuters at the weekend that Berlin's working hypothesis now was that Greece would ultimately default on its 340 billion euro debt mountain.

In a possible sign that markets are being prepared for this, French central banker Christian Noyer, speaking on Friday after a G7 finance ministers' meeting in Marseille, said Greek debt did not represent a threat to any bank outside of Greece. Barthle, the budget expert in Merkel's party, told Reuters: "The problems in Greece are not getting smaller, they are getting bigger, and will create significant problems for the bloc ... "I am eager to see what the troika report says. The way things are looking, you can't rule out a restructuring of Greece's debt any more."

Would a default force Greece out of the euro zone? A senior European banker told Reuters that one would have to follow the other, even if there is no legal mechanism for a country to leave the bloc. But senior sources in Berlin and Brussels said all would be done to avoid such a humiliating setback for the currency union. The focus instead appears to be on ensuring national parliaments approve new powers for the bloc's rescue mechanism -- the European Financial Stability Facility (EFSF) -- as soon as possible.

Only after that would the EFSF be really in a position to minimize the damage from a Greek default by providing credits to stricken member states and banks across Europe. Given the time needed to win EFSF approval in all 17 euro states, the chances seem good that EU, IMF and ECB inspectors will nod through the latest Greek aid tranche within weeks.

But Merkel's real test will come in an eventual parliamentary vote on the permanent ESM. The vote is already shaping up as a referendum on her leadership; if she fails to secure a majority from within the ruling coalition, the pressure to call an election from the opposition and parts of her own party will be huge. "The resignation of Juergen Stark is a devastating signal for Angela Merkel," the conservative daily Die Welt said on Sunday. "Life is only going to get more difficult for her."

Germany Readies Surrender Over Greece
by Simon Kennedy and Brian Parkin - Bloomberg

Germany may be getting ready to give up on Greece, as measures in the credit markets signal growing concern about the smaller nation’s ability to repay investors. Yields on Greek two-year notes rose as much as 12 basis points today to a record 57.10 percent as of 8:25 a.m. London time. Credit-default swaps to insure the country’s five-year bonds and to speculate on government securities closed at a record 3,500 basis points on Sept. 9, according to CMA. The contracts are the highest in the world and more than three times the 1,134 basis points on Portugal’s debt.

After almost two years of fighting to contain the region’s debt crisis and providing the biggest share of three European bailouts, German Chancellor Angela Merkel is laying the groundwork for what markets say is almost a sure thing: a Greek default. "It feels like Germany is preparing itself for a debt default," Jacques Cailloux, chief European economist at Royal Bank of Scotland Group Plc in London, said in an interview. "Fatigue is setting in. Germany could be a first mover or other countries could be preparing too."

Officials in Merkel’s government are debating how to shore up German banks in the event that Greece fails to meet the budget-cutting terms of its aid package and is unable to get a bailout-loan payment, three coalition officials said Sept. 9. The move capped a week of escalating German threats that Greece won’t get the money unless it meets fiscal targets, and as investors raised bets on a default.

Geithner Weighs In
Protecting their banks and a hardening of rescue terms risk isolating Germany and unnerving global policy makers already fretting that the region’s political tussles are roiling markets and threatening growth. Underscoring the tone of weekend talks of Group of Seven finance chiefs, U.S. Treasury Secretary Timothy F. Geithner told Bloomberg Television that European authorities must "demonstrate they have enough political will" to end the crisis.

European bank credit risk has surged to an all-time high, according to the Markit iTraxx Financial Index of credit-default swaps on 25 banks and insurers, and the euro fell last week by the most against the dollar in a year. Investors have doubts about whether Greece will implement austerity moves fast enough to get a sixth payment from last year’s 110 billion-euro ($150 billion) bailout. The euro declined as much as 1.2 percent today to $1.3495, the weakest level since Feb. 16, and traded at $1.3572 at 8:20 a.m. London time.

Stark Resign
The Greek government’s top priority is "to save the country from bankruptcy," Prime Minister George Papandreou said in a Sept. 10 speech in the northern Greek city of Thessaloniki. "We will remain in the euro" and this "means difficult decisions," he said. More evidence of rifts at the heart of policy making was exposed with the unexpected Sept. 9 announcement that Juergen Stark, a German, will quit the European Central Bank’s executive board over his opposition to the ECB’s purchases of bonds from debt-laden countries.

"Stark’s departure could be seen by financial markets as another indication of growing disenchantment in Germany towards the euro," said Julian Callow, chief European economist at Barclays Capital in London. "This could complicate Germany’s involvement in additional bailout programs."

French Banks
At the G-7 gathering in the French port of Marseille, ECB President Jean-Claude Trichet and European Union Economic and Monetary Affairs Commissioner Olli Rehn said they knew nothing about the talk in Germany of the so-called Plan B to protect banks. French officials said they weren’t working on a parallel proposal and Bank of France Governor Christian Noyer said his country’s banks have the capital to withstand a Greek default.

BNP Paribas, Societe Generale and Credit Agricole, France’s largest banks by market value, may have their credit ratings cut by Moody’s Investors Service as soon as this week because of their Greek holdings, two people with knowledge of the matter said on Sept. 10. Moody’s said in June that the three banks were placed on review to examine "the potential for inconsistency between the impact of a possible Greek default or restructuring," and the companies’ current rating levels.

Bond Losses
German banks were the biggest holders of Greek government bonds at the end of 2010 with $22.7 billion, according to data from the Bank for International Settlements. As of June 30, Deutsche Bank AG, Germany’s largest bank, had 1.15 billion euros of net sovereign risk to Greece, down from 1.6 billion euros at the end of 2010. The aim of the contingency plan is to shield German banks from losses from a possible Greek default, which has a more-than 90 percent chance of happening within five years, prices for insurance against default show.

The plan involves measures to help banks and insurers that face a possible 50 percent loss on their Greek bonds if the next portion of Greece’s bailout is withheld, said the three officials, who declined to be identified because the deliberations are being held in private. The successor to the government’s bank-rescue fund introduced in 2008 might be enrolled to help recapitalize the banks, one of the people said.

The discussions aren’t intended to shove Athens out of the euro, said Klaus-Peter Flosbach, budget-policy spokesman of Merkel’s Christian Democratic Union and the Christian Social Union in parliament. "It would be of central importance to keep the possibility of contagion in the euro zone as low as possible," Flosbach said in an e-mail. "In any case, we’re not looking into pushing Greece out of the euro zone."

German Lawmakers
Fredrik Erixon, head of the European Centre for International Political Economy in Brussels, said Germany’s concern is broader than Greece, which is in its third year of a deepening recession, and centers on how its banks and economy would cope if the debt crisis spreads. "Germany is preparing for the worst, which is that the crisis in the euro zone is going to be much bigger for everyone," Erixon said.

German lawmakers, who are scheduled to vote Sept. 29 on a second Greek aid package and revamped rescue fund, stepped up their criticism of Greece after an international mission to Athens suspended its report on the country’s progress two weeks ago. "There can be no doubt" that Greece must fulfill the terms of aid to receive it, German Finance Minister Wolfgang Schaeuble said in Marseille. "Everybody must stand by the agreements."

Opposing Aid
With a loss in her home state of Mecklenburg-Western Pomerania, Merkel’s coalition has been defeated or lost votes in all six state elections this year as voters reject putting more taxpayer money on the line for bailouts. Merkel has also antagonized markets and fellow leaders by initially holding out against aid for Greece and demanding investors pay a share of the assistance.

Fifty-three percent of Germans oppose further aid for Greece and wouldn’t save the country from default unless it fulfills terms of the rescue agreement, Bild am Sonntag reported, citing an Emnid poll of 503 respondents conducted Sept. 8. French Budget Minister Valerie Pecresse said her nation would halt its loans to Greece if the country doesn’t keep to its bail-out pledges, the Wall Street Journal reported, citing a television interview on French channel M6.

'Unequivocal’ Support'
After European markets closed last week, Greek Finance Minister Evangelos Venizelos dismissed "rumors" of a default and said his nation is committed to "full implementation" of the terms of the July accord for a second aid package. Budget measures including a special levy on real estate will be enough to meet targets set for 2011, Venizelos told reporters in Thessaloniki yesterday.

The market fallout served as the backdrop for the G-7 talks at which Canadian Finance Minister Jim Flaherty said Europe’s woes were the "number one" topic and that Greece may even need to quit the euro if it can’t consolidate its budget. Geithner said authorities "need to do whatever they can do to calm these pressures" and that rich European nations need to provide "unequivocal" support for their weak neighbors.

G-7 officials vowed to "take all necessary actions to ensure the resilience of banking systems and financial markets," and to make a "concerted effort" to support a flagging world economy. They detailed no new policies.

Germany and Greece flirt with mutual assured destruction
by Ambrose Evans-Pritchard - Telegraph

Bild Zeitung populism has prevailed. Germany is pushing Greece towards a hard default, risking the uncontrollable chain reaction so long feared by markets.

First we learn from planted leaks that Germany is activating "Plan B", telling banks and insurance companies to prepare for 50pc haircuts on Greek debt; then that Germany is "studying" options that include Greece's return to the drachma. German finance minister Wolfgang Schauble has chosen to do this at a moment when the global economy is already flirting with double-dip recession, bank shares are crashing, and global credit strains are testing Lehman levels. The recklessness is breath-taking.

If it is a pressure tactic to force Greece to submit to EU-IMF demands of yet further austerity, it may instead bring mutual assured destruction. "Whoever thinks that Greece is an easy scapegoat, will find that this eventually turns against them, against the hard core of the eurozone," said Greek finance minister Evangelos Venizelos. Greece can, if provoked, pull the pin on the European banking system and inflict huge damage on Germany itself, and Greece has certainly been provoked.

Germany’s EU commissioner Günther Oettinger said Europe should send blue helmets to take control of Greek tax collection and liquidate state assets. They had better be well armed. The headlines in the Greek press have been "Unconditional Capitulation", and "Terrorization of Greeks", and even "Fourth Reich". Mr Schauble said there would be no more money for Athens under the EU-IMF rescue package until the Greeks "do what they agreed to do" and comply with every demand of `Troika' inspectors.

Yet to push Greece over the edge risks instant contagion to Portugal, which has higher levels of total debt, and an equally bad current account deficit near 9pc of GDP, and is just as unable to comply with Germany's austerity dictates in the long run. From there the chain-reaction into EMU's soft-core would be fast and furious.

Let us be clear, the chief reason why Greece cannot meet its deficit targets is because the EU has imposed the most violent fiscal deflation ever inflicted on a modern developed economy - 16pc of GDP of net tightening in three years - without offsetting monetary stimulus, debt relief, or devaluation. This has sent the economy into a self-feeding downward spiral, crushing tax revenues. The policy is obscurantist, a replay of the Gold Standard in 1931. It has self-evidently failed. As the Greek parliament said, the debt dynamic is "out of control".

We all know that Greece behaved badly for a decade. The time for tough love was long ago, when the mistakes were made and all sides were seduced by the allure of EMU. Even if the Papandreou government met every Troika demand at this point, it would not make any material difference. Greek citizens already understand this, and they understand that EU loan packages are merely being recycled to northern banks. Instead of recognizing the collective EU failure at every stage of this debacle, the creditor powers are taking out their fury on what is now a victim.

We have never been so close to EMU rupture. Friday's resignation of Jurgen Stark at the European Central Bank is literally a kataklysmos, a German vote of no confidence in EMU management. Dr Stark is not just an ECB board member. He is the keeper of the Bundesbank's monetary flame. The vehemence of his protest against ECB bond purchases confirm what markets suspect: that the ECB cannot shore up Italian and Spanish debt markets for long without losing Germany.

"I look at what is happening in EMU and the words that spring to mind are total and utter disaster", said Andrew Roberts, credit chief at RBS. He thinks German Bund yields could break below 1pc in the flight to safety. Citigroup and UBS both issued reports last week on the mechanics of EMU break-up, both concluding with touching faith that EU leaders cannot and will not allow it to happen.

"The euro should not exist," said Stephane Deo from UBS. It creates more costs than benefits for the weak. Its "dysfunctional nature" was disguised by a credit bubble. The error is now "painfully obvious". Yet Mr Deo warns that EMU exit would not be as painless as departing the ERM in 1992. Monetary unions do not break up lightly. The denouement usually entails civil disorder, even war.

If a debtor such as Greece left, the new drachma would crash by 60pc. Its banks would collapse. Switching sovereign debt into drachma would be a default, shutting the country out of capital markets. Exit would cost 50pc of GDP in the first year.

If creditors such as Germany left, the new mark would jump 40pc to 50pc against the rump euro. Banks would face big haircuts on euro debt, and would need recapitalization. Trade would shrink by a fifth. Exit would cost 20pc to 25pc of GDP. UBS concludes that the only course is a "fiscal confederation", a la Suisse.

Well, perhaps, but Germany's top court chilled such hopes when it ruled that the Bundestag's budgetary powers may not be alienated to "supra-national bodies". Nor do I believe that German society is willing to undertake such a burden for Greco-Latins in regions equal to six times East Germany.

Citigroup's Willem Buiter disputes the "federalism or bust" dichotomy, saying Anglo-Saxon commentators are trapped in the mental world of the Peace of Westaphalia in 1648, which established the sovereign state as pillar of international order. "There is no recent, close analogue to the EU," he says. As a blend of national and supra-national, the EU resembles the Holy Roman Empire, which united central Europe from the 10th Century until Luther (technically until 1806).

Dr Buiter says the two "canonical models" for EMU break-up - that debtors walk out, or the German-led core walks out - are both are fraught with perils. The weak would sell their souls for a mess of potage, discovering that devaluation can be an "uncontrollable process" with little lasting gain for exports. If the German bloc left to create a "Thaler", the costs would be less. However, the rump euro would fall apart, with massive dislocations. "It would not be pretty," he says.

Ultimately, political investment in the EU project is by now too great to entertain such thoughts. The eurozone will muddle through along a third way, with spasms of debt restructuring kept within the euro-family. It will fall short of a transfer union or a debt pool, he said. Each of these reports is a terrific read, but as an unreconstructed Westpahlian - and having covered a lot of NO votes to EU referendums - I don't accept that Europe has a teleological destiny towards closer union. It has already pushed its ambitions beyond the tolerance of Europe's historic states and cannot be made democratically accountable.

The new fact of recent months is that German society has begun to discern a clash between its own democracy and the fiscal drift of EMU. The two are seen to be in conflict for the first time. Germans may be forced to choose. The outcome to that is far from clear. Nor do I accept the headline figures of UBS. Every Treasury official and every voice of orthodoxy warned in 1931 that British exit from the Gold Standard would unleash the seven plagues. It proved a liberation. The UK, the Empire, and allied states broke free from a system that had become an engine of deflationary Hell. It cleared the way for monetary stimulus and recovery.

There is a close parallel between 1930s Gold and EMU, both in destructive effect and totemic sanctity. The Gold Standard was more than a currency system. It was the anchor of an international order and way of life. My solution - like that of Hans-Olaf Henkel, the ex-head of Germany's industry federation (BDI) - is to split EMU into two blocs, with France leading a Latin Union that keeps the euro. This bloc would devalue but not by 60pc, yet uphold its euro debts intact. The risk of default and banking crises would decrease, not increase.

The German bloc could launch their Thaler, recapitalizing banks to cover losses from rump euro debt. Disruptions could be contained by capital controls at first. None of this is beyond the wit of man. My bet is that aggregate losses would be lower than the status quo, and the long term outcome much healthier. The EU might even carry on, unruffled.

The status quo, however, is not acceptable. EMU's debt-deflation strategy has trapped half of Europe in depression, with youth unemployment reaching 46pc in Spain and no way out for years. Perhaps a global coalition of the G20, IMF, China, and the oil powers will combine to rescue Euroland, as some now hope. But how would that bridge the gap between EMU’s North and South? It solves nothing.

Europe May Need to Bail Out, Nationalize Some Banks
by Jason Scott - Bloomberg

European officials may have to bail out and nationalize some private banks to avoid another global recession, said Russell Jones, global head of fixed-income strategy at Australia’s second-biggest lender.

"The last thing really the global economy needs now is a major banking crisis in the euro zone," Jones, of Sydney-based Westpac Banking Corp., said in an interview yesterday on the Australian Broadcasting Corp.’s "Inside Business" program. "The governments are going to have to put their hands in their pockets."

Group of Seven finance chiefs and central bankers vowed in recent days to support banks and buoy slowing economic growth. "We will take all necessary actions to ensure the resilience of banking systems and financial markets," they said in a statement released during weekend talks in Marseille, France.

A European banking collapse is "the sort of shock to the system when things are very fragile, as they are at the moment, that could really push us back into the sort of downturn we experienced in 2008 and 2009," Jones said, according to a transcript of the interview. Nationalization is possible, "at least temporarily so," he said.

Emergency steps such as unlimited loans from the European Central Bank are keeping many banks in Greece, Portugal, Italy and Spain solvent and easing the lending of others, while low interest rates and debt buying are containing borrowing costs. Such aid is needed to counter concerns about slowing economic growth and sovereign debt that are prompting banks to curb lending, stockpile dollars and hoard cash.

Market Turmoil
Stocks sank and the euro slid to a six-month low against the dollar on Sept. 9 as three German officials said that Chancellor Angela Merkel’s government is preparing plans to shore up banks should Greece default.

European bank credit risk surged to an all-time high on Sept. 9 and stocks fell worldwide on concern that the debt crisis is escalating. German two-year yields declined to a record as investors sought a haven and Greek two-year note yields added as much as 86 basis points to 55.91 percent, a euro-era record.

There’s little sign of a rebound in Europe. France’s economy stalled in the second quarter, Germany’s expanded 0.1 percent and the U.K.’s gross domestic product grew 0.2 percent "A lot of the European banks had a lot of the government bonds which have been issued by some of the more, shall we say, struggling economies around the periphery of the euro zone," Jones said. "They are not going to get all of the money back" should those nations default on their debts, he said.

Australia’s Slowdown
Australian households are saving more as assets including stocks and houses decline in value as the Reserve Bank of Australia maintains the benchmark lending rate at a developed- world high of 4.75 percent. A 13.5 percent increase in the Australia dollar in the past year, spurred by a boom in mining investment to meet demand from India and China, is hurting the nation’s manufacturing and tourism industries.

On top of the high currency, "the lingering effects of the global financial crisis and continuing international uncertainty have resulted in Australian consumers being a lot more cautious in their spending," Australian Treasurer Wayne Swan said yesterday in a weekly economic note. "This is making life harder for sectors like manufacturing, tourism and retailing."

Swan also said a tax forum he’s convening next month will focus on ways to keep Australia’s government debt under control. "We’ve seen how important it is to maintain a strong budget position in recent months as the United States and Europe have struggled to get their public finances on a sustainable footing," he said. "The government will not be in the cart for any measures that compromise our strict fiscal discipline."

Watching Rates
RBA Governor Glenn Stevens has signaled a willingness to keep rates on hold while the nation’s consumers retrench and global financial markets create instability for the "foreseeable future." Last week he held rates for a ninth straight meeting, citing "unsettled" international markets. Westpac’s Jones said the RBA may need to cut rates as signs emerge the economy is slowing, such as the jobless rate in August climbing to 5.3 percent from 5.1 percent, the highest since October.

The Australian economy "is not performing quite the way that the authorities thought it would or would like it to," Jones said. "Irrespective of what is going to go on in the global economy, there are growing reasons for the Reserve Bank to embrace a more accommodative approach to monetary policy."

Cyprus Downgrade Likely After Russia Loan
by Stelios Orphanides - Bloomberg

A cut-rate loan that Cyprus is negotiating with Russia’s government to avoid surging borrowing costs may delay austerity plans and prompt another credit-rating cut, Piraeus Bank Ltd. fund manager Marios Demetriades said.

Labor unions may "become reluctant to accept the necessary measures as they might take an approach of pushing the problem forward," Nicosia-based Demetriades said in an e-mailed note today. "If the government does not take the necessary measures as promised, this lending will lead to greater problems in the medium term as the government deficit is structural and rating agencies will continue to downgrade the country."

Russia is in talks about extending a loan to the euro area’s third-smallest economy, Finance Minister Alexei Kudrin told reporters in St. Petersburg on Sept. 10. Finance Minister Kikis Kazamias has neither confirmed nor denied a report in Phileleftheros newspaper that Cyprus is set to get a five-year loan from Russia worth 2.5 billion euros ($3.4 billion) at an annual rate of 4.5 percent, more than 10 percentage points below the market rate. "A possible deal will not alter the government’s fiscal- consolidation plans," Kazamias told reporters in Nicosia on Sept. 9.

The eastern Mediterranean island, rocked by a July 11 explosion that destroyed its largest power station and knocked out more than half of its electricity-generating capacity, is struggling to avoid becoming the latest victim of Europe’s debt crisis. Moody’s Investors Service, Standard & Poor’s Rating Services and Fitch Ratings have all downgraded Cyprus’s credit rating since the blast amid concern it may become the fourth European Union nation to require a bailout.

Cyprus is seeking to trim its budget deficit to 5.5 percent of gross domestic product this year and 2 percent in 2012 in an attempt to avert further rating cuts. It also has to refinance maturing debt worth 1.7 billion euros in 2011 and 2012. The yield on Cyprus’s five-year bond expiring in Oct. 2015 was 14.7 percent at 4:14 p.m. in Nicosia. It peaked at 21.58 percent on Aug. 29, compared with 7.17 percent three months ago.

If the government fails to further curb public payrolls, an outflow of deposits from Cyprus’s banking system may not be ruled out, as further sovereign-rating cuts will follow, economist Spyros Episkopou, chief executive officer of Nicosia- based Epicentral Consultancy Ltd, said today. "This could lead to a shrinking of the contribution of the business services sector and the banks to the economy," he said, adding that the loan won’t "avert any rating cuts."

Labor Unions
Cyprus’s OHO-SEK union, which counts 72 percent of all employees in state-owned companies and municipalities, threatened to take action against a government proposal to cut by a quarter the 13th salary its members receive as a Christmas gift and freeze inflation compensation for two years, the union’s general secretary, Nicos Tampas, said by phone today. Glafkos Hadjipetrou, leader of PASYDY, the civil servants union, also threatened strike action, according to the website of Politis newspaper.

Mainly Russian non-residents hold one of every two euros deposited at Cypriot banks, directly or indirectly, according to Theo Parperis, chairman of the Institute of Certified Public Accountants of Cyprus. Foreign companies that use Cyprus as a base or vehicle for offshore operations contribute approximately 15 percent of the island’s economy, said Parperis, who is also a partner in PricewaterhouseCoopers Cyprus.

U.K. Banks Face Costly Overhaul
by Margot Patrick - Wall Street Journal

The U.K.'s major banks Monday were hit with the prospect of an annual bill of up to £7 billion ($11.12 billion) to implement new reforms proposed by the government-appointed Independent Commission on Banking. The commission said the changes could have a further social cost of £1 billion to £3 billion, touching off the latest round of a debate between banks, the government and business and consumer groups on the potential effects of the measures on the country's weak economy.

The U.K. bank heavyweights fell sharply after the announcement, with Barclays PLC dropping 4.3% and Royal Bank of Scotland Group PLC slipping 3.8%. The ICB as expected called for banks to segregate, or "ring-fence," their retail activities, and for retail institutions to hold at least 10% core equity against their assets, far more than required at global peers, but it left open the possibility of delaying the implementation period to as late as 2019.

The ICB said ring-fenced entities would operate independently with separate boards and all transactions with other parts of the group would be done at arm's length. Ring-fence proponents say the plan will make banking safer and keep the economy ticking if a bank nears collapse, while critics fear it will undermine the ICB and government's objective of avoiding state bailouts of failing banks by creating an implied guarantee around the banks' retail arms.

Chancellor of the Exchequer George Osborne, who set up the panel last year to study ways to make U.K. banking safer and more competitive for consumers and taxpayers, on Monday said the report marked an important step toward a new banking system and that the government will look to make the reforms law in the current parliament sitting until 2015. The ICB recommended banks put in place operational changes as soon as possible but said the changes could be made by as late as 2019 to give banks time to adapt.

The U.K. continues to hold a major share of the banking sector. It holds a 41% stake in Lloyds Banking Group PLC and an 83% stake in RBS. The global financial crisis sparked a deep recession at home and constrained growth, leading to a series of new regulations that included higher liquidity requirements at banks, a clampdown on bonuses and an annual levy on large banks' balance sheets.

The debate about the size of the U.K.'s banks in relation to gross domestic product and the banks' "social usefulness" has continued to rage, though. The ICB reforms are designed to draw a line under concerns about future taxpayer bailouts.

The ICB said it wants the country's largest banks—including those deemed "too big to fail" by global authorities—to hold additional capital amounting to at least 17% of risk-weighted assets, plus a further 3% of assets at banks that are of special concern to supervisors. That ratio compares with a 7.5% core Tier 1 ratio required under the coming international regulations known as Basel III, raising concerns from the industry that it will struggle to compete against global peers.

The British Bankers' Association representing the country's major banks on Monday said the reforms still need careful analysis and comparison with international rules. The ICB said competition in U.K. banking could be increased by making it easier for customers to switch accounts, by loosening requirements for new banking entrants, and by potentially enhancing a planned disposal of 632 branches by Lloyds Banking that is being made as a condition of its earlier bail-out.

The ICB stopped short of its earlier plan to have Lloyds required to sell more assets, instead saying the government should reach an agreement with Lloyds to make sure the disposed entity has sufficient funding and at least a 6% market share of checking accounts. Lloyds on Monday said it is assessing the report and may comment later.

The £300m cable that will save traders milliseconds
by Christopher Williams - Telegraph

In the high-speed world of automated financial trading, milliseconds matter. So much so, in fact, that a saving of just six milliseconds in transmission time is all that is required to justify the laying of the first transatlantic communications cable for 10 years at a cost of more than £300m.

Seabed survey work for the Hibernian Express, as the 6,021km (3,741 mile) fibre-optic link will be known, is already under way off the east coast of America. The last cables laid under the Atlantic were funded by the dotcom boom in the 1990s when telecoms infrastructure firms rushed to criss-cross the ocean.

The laying of the new transatlantic communications cable is a viable proposition because Hibernia Atlantic, the company behind it, is planning to sell a special superfast bandwidth that will have hyper-competitive trading firms and banks in the City of London and New York queuing to use it. In fact it is predicted they will pay about 50 times as much to link up via the Hibernian Express than they do via existing transatlantic cables.

The current leader, Global Crossing's AC-1 cable, offers transatlantic connection in 65 milliseconds. The Hibernian Express will shave six milliseconds off that time. mOf course, verifiable figures are elusive and estimates vary wildly, but it is claimed that a one millisecond advantage could be worth up to $100m (£63m) a year to the bottom line of a large hedge fund.

Some City experts have criticised the growth in vast volumes of electronic trading, where computers automatically buy and sell stocks with no human input. The British firm laying the cable, Global Marine Systems, is plotting a new route that is shorter than any previously taken by a transatlantic cable. As closely as possible, it will follow "the great circle" flight path followed by London-to-New York flights.

"We spent 18 months planning the route," says Mike Saunders, Hibernia Atlantic's vice-president of business development. "If it ever gets beaten for speed we end up giving our customers their money back, basically, so my boss would kill me if we got it wrong." And, he says, customers from hedge funds, currency dealers and exotic proprietary trading firms are queuing up for the switch-on in 2013.

"That's the way these guys think," Mr Saunders says. "If one of them is on a faster route, they all have to get on it."

The Incinerator That Kept Burning Cash
by Michael Corkery - Wall Street Journal

Years of Borrowing Have Harrisburg, Pa., Dodging Default

Like homeowners who used their houses as piggy banks by refinancing over and over before the real-estate market crashed, Harrisburg, Pa., now is desperate to avoid financial collapse. In 1969, officials in the state's capital city raised $12.5 million to build a trash incinerator that generates electricity. Since then, officials have borrowed at least 11 more times, according to the city controller and bond documents, swelling the facility's debt to $310 million.

Investment banks, lawyers and advisers collected fees for assembling the deals, and Harrisburg guaranteed most of the debt in return for its own share of the money. Much of the proceeds from bond sales that sank the incinerator deeper into debt went to refinance old bonds and for a retrofit that went awry. "No one knew how to say no. They just knew how to do deals," says William Cluck, who was appointed last year to the Harrisburg Authority, the public entity that owns the incinerator. "The mayor said, 'I want to do this.' And the financial advisers said, 'Here is how you do it. Now, please pay me my fees.' "

Incinerator revenue now exceeds operating expenses, and it has been praised as one of the nation's most successful waste-to-energy facilities. But business isn't good enough—and might never be—to cover debt payments. The city of about 47,000 residents also faces a cash crunch from a budget deficit.

Scrambling to avert a default, officials might sink Harrisburg even deeper into debt. The city council is scheduled to vote Tuesday night on a plan to borrow as much as $11 million. Some of the cash would be used to pay $3.3 million to bondholders by a Thursday deadline. The deal carries an interest rate that could reach 10%, according to the mayor's office.

Harrisburg's plight is an example of how easy money flowed into municipal governments for decades as government officials sought financing for ambitious projects and Wall Street firms obliged by selling the bonds to investors. Some of the deals were failures. In Birmingham, Ala., county commissioners are expected to vote Friday on whether to declare what would be the largest municipal bankruptcy in U.S. history, largely because of a soured debt deal tied to the county's sewer system.

Some Harrisburg residents are worried they will have to clean up the incinerator's mess by paying higher taxes. "Taxes are already high enough in the city," says Greg Rothman, a local real-estate broker and investor in Harrisburg's minor-league baseball team. "It's hard to get developers to look at the city because of all the uncertainty."

The trash-burning facility "was a loser from the start," says Bruce Barnes, a managing director at Milt Lopus Associates, a Harrisburg firm that advised the Harrisburg Authority on some of its bond deals. Technology glitches led to pollution problems and costly repairs. For years, the incinerator struggled to boost revenue. But because Harrisburg guaranteed the facility's debt, the incinerator's owner kept borrowing to cover operations and refund debt that came due. Bonds also were sold to pay for upgrades, including a major retrofit in 2003. When that construction project ran into problems, the Harrisburg Authority had to borrow even more money.

Mr. Barnes said it would have been difficult for the city to shut down the facility because that would have left it more than $100 million in debt. Bond documents show that the Harrisburg Authority borrowed about $300 million between 1998 and 2003, paying about $12 million in financing costs. Those expenses include payments to lawyers, bankers and advisers. The city collected $6.9 million, according to the documents. Harrisburg's investment bankers included Merrill Lynch & Co., now part of Bank of America Corp., and Mesirow Financial Inc. Representatives at both firms declined to comment. Mr. Barnes says he couldn't estimate how much his advisory firm made in incinerator-related fees, but it wasn't a bonanza. "I drive a five-year-old Chevy," he says.

In 2007, the incinerator borrowed about $20 million from Covanta Energy Corp., which now operates the facility, to finish upgrades. Covanta's chairman is well-known investor Sam Zell. The loan hasn't been paid since April 2010. Despite its debt problems, the incinerator is now running smoothly. "We think of this as a pretty good turnaround story," says James Regan, a Covanta spokesman. The Solid Waste Management Authority in nearby Lancaster County, Pa. has offered to purchase the incinerator for about $124 million.

Harrisburg Mayor Linda Thompson, who took office in 2010, says the borrowing binge "was the way of municipal financing in America. … You borrow money and then leverage the future." Ms. Thompson says she wants to "eliminate all incinerator debt and scale back our general debt in the future," possibly by selling or leasing certain city assets.

For now, though, the mayor sees little alternative to borrowing even more. In the deal being voted on Tuesday, Harrisburg is seeking to extend a lease on city parking facilities in exchange for an upfront payment of $7.4 million from the authority that runs the properties. The authority would borrow as much as $11 million and make a lump-sum payment to the city, making it possible for the city to pay bondholders Thursday.

Officials have also discussed selling public assets or a possible state takeover to deal with the incinerator debt. The investor who has offered the loan to Harrisburg won't be disclosed until the "legal paperwork" is finalized, according to the mayor's office. "This is not a pie-in-the-sky thing," says Corky Goldstein, a member of Harrisburg's parking authority. "Everything is in place." Last year, Pennsylvania came to the rescue by advancing Harrisburg funds due later in 2010. A spokeswoman for Gov. Tom Corbett, who took office in January, says he isn't inclined to make a similar advance this year.


Ilargi said...

Apologies to all, our comments section remains closed for the time being.


Ilargi said...

We'll open the comments section for a limited time later today.


Ilargi said...

Comments are open for an hour or so.


Biologique Earl said...

Harry Dent predicts 3000 Dow by 2013. He also says to get of out of gold at 2000USD/oz as it is going to crash as will silver.


jal said...

I kinda missed bouncing ideas at TAE. I hope that the comment sections will continue.


These will all take the form of repurchase operations against eligible collateral and will be carried out as fixed rate tender procedures with full allotment. Further information on tender procedures can be found on the ECB’s website.
Re.: A touch of reality will make the medicine go down
If the rules and laws of yesterday, are an impediment, then change the rules and the laws.
Yesterday is gone.

Printing, leverage, forgiveness of debts, by the “CLOUDS”, (virtual entities), will be the new reality.

Expect fluidity.

Expect volatile.
Gamblers place your bets! The reaper awaits you!

The only one that has any cash is China. It is in China’s interest to step in and delay the catastrophe to its time table.


Stoneleigh said...

All good for all,

You put up a duplicate post. I deleted the duplicate, and you seem to have deleted the original. There was nothing wrong with your comment if you'd like to repost it.

Stoneleigh said...

The comment section is still open. I will post a notification when I close it again.

Ashvin said...

These Fed-sponsored dollar swaps for Euro banks are nothing new or unexpected. Right now, it seems to be a game of buying time (maybe a week or two) before the inevitable Greek default and insulating the global financial system from "contagion" as best as possible (which is not very well). The problem for them is that these weak preparations and propaganda only make investors that much more certain that they are not only willing to live with default, but are fully expecting it. I've noticed that the equity markets are eerily timid right now, even with the existence of disappointing economic news (which investors have traditionally taken as a justification for QE or stimulus), a lack of horrendous Euro news (at least since earler this week), an ongoing capitulation of "weak shorts", and relatively large currency moves in favor of the "risk trade" in response to supposedly big news of "coordinated intervention". All in all, the premise of diminishing returns to market manipulation seems to be taking a solid hold for equities, as they cannot ignore the rapidly deteriorating credit markets much longer and 2008-style tactics are no longer feasible or effective.

AllGood4All said...

On a different subject:

My understanding (and my gut intuition) is that for most people, survival (and increased quality of survival) during challenging times is more likely if one is connected with others in a cooperative fashion. I know this is also the view of TAE.

I'm curious if anyone knows of studies that show this.

Why? It would be nice to present as evidence to counter the strong tendency - at least as i've observed in going-it-alone societies - to "bunker down" and fortify in isolation.

I think going it alone in a fort or distant place may work for some people. But for so many more, especially so many in urban and sub-urban environments, trying to fortify ones apartment against invaders and hording supplies or hiding guns and ammunition, will generally not produce more favorable outcomes.

Much of the vibe in the US is individual survivalist, and people here would be served to learn about the practical survival wisdom of cooperation and community.

AllGood4All said...

here's the post i accidentally deleted:

First, thank you all so much for the clarification and the "heads up", which i have also been sharing with friends and family.

My question:

I've noticed that generally you recommend USD and US Treasuries as relatively safe places - at least in the short and medium term - to put our money.

I'm curious your view on ETFs. Specifically, what your view of pros/cons investing some of our savings in USD and US Treasury bullish / Stock bearish ETFs.

Thank you!

Anonymous said...

Further to AllGood4All's comment, what does TAE recommend in terms of storing wealth outside of the banks?

I believe it is said in one TAE primer that keeping wealth within the bank may be problematic during periods of extreme deflation, but I'm not entirely comfortable with stuffing $1,000's of dollars under my mattress!

Hopefully you can provide some guidance Stoneleigh :)

Stoneleigh said...


I would be careful about ETFs. Shorting is likely to be banned at some point, so trying to profit from your correct view that the long term trend is down could become problematic. It's not enough to be right, you may have to be lucky or well connected as well.

I think being dollar bullish and putting savings into short term treasuries is a better bet.

Stoneleigh said...


I would suggest keeping perhaps a year's worth of cash under your own control, but beyond that I'd consider short term US treasuries. They're a cash equivalent because they're highly liquid. That doesn't mean a long term bet, but they should be a good short term bet (ie a couple of years or so).

Stoneleigh said...

It's getting late, so I am going to close the comments section for tonight. We'll see what we can do tomorrow.

Stoneleigh said...

Don't be fooled by the supposed coordinated central bank support for Europe. It's just more smoke and mirrors, and won't make any difference at all. Watch for some more choppy volatility, followed by further lows. The larger trend is down, and will be for a long time, despite counter trend rallies from time to time.

Ilargi said...

New post up.

Global Imperatives of a Chinese Exporter