Archive

from Breakingviews:

Now prepare for the next crisis

By Edward Hadas

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

The Tale of Hellenic Foolishness appears to be over. A mix of writedowns and new money, with more of the latter, has come to the rescue. Greece’s chapter in the financial crisis epic reads much the same as the prologue on subprime mortgages – too much foolish lending ends in a sudden stop that threatens to destroy global finance, until finally there’s a political rescue.

The story continues. The financial system remains distorted and dangerous. While banks are better capitalised and perhaps more prudent, policy interest rates are abnormally low and government deficits and commodity prices are abnormally high. The U.S. trade deficit, which fell from 5.1 to 2.7 percent of GDP during the crisis, is back up to 3.6 percent of GDP – adding $560 billion a year to the wild flow of funds around the world’s capital markets.

Where does the saga go from here? Another primarily financial episode, like the subprime debacle, wouldn’t be fantasy. The obvious plotlines are a creditors’ run from the United States or a shortage of buyers of Japanese government debt. “Oil Flameout” – a sudden spike followed by a disastrous fall – is another convincing scenario. Such problems can be solved by the same force which caused them, cheap money. After almost four years of experience, governments know the rescue drill.

Another euro zone-style financial-political crisis would pose greater challenges. Many nations are vulnerable to sharp changes in the prices of commodities and financial assets, or in the availability or cost of credit. The next chapter could be “Russia Topples” or “China Discovers the Downside of Capitalism”. “Euro Redux” is still a risk. “New American Revolution” is less likely, although self-defeating populist economics are appealing in a land where many mortgages remain underwater and unemployment is still high.

It’s not possible to jump to the last page to see how the story ends. But there’s a title for an epilogue about a world that uses finance to solve the problems that finance itself creates: “Inflation Everywhere”.

from Breakingviews:

Euro zone first default gives few reasons to cheer

By Neil Unmack

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

It could have been worse: that’s the best thing to be said about the Greek debt swap. The euro zone’s first restructuring will not be chaotic. But it has done away with the pretence that a euro zone sovereign’s signature is golden. And Greece will still struggle with a heavy debt load.

The good news is that enough bondholders agreed to the Greek plan to allow Athens to force losses on the recalcitrant private creditors through collective action clauses. Some owners of securities subjected to non-Greek law are holding out, but the hit rate will be at least 95.7 percent. That should allow the second Greek bailout in 18 months to proceed. The deal will trigger a payout on credit derivatives. A failure to trigger would have compromised the credibility of other sovereign default swaps, which are important hedging tools for banks.

Still, the restructuring has costs. Arguably, it wasn’t fair. Private creditors have been punished for lending recklessly, but public-sector lenders have got off lightly even as this second bailout was the proof that they had bungled the first one. The European Central Bank’s holdings of Greek bonds have been protected; euro zone governments have not haircut their loans, although they did agree to charge lower interest rates. This unequal treatment will weigh on the prices of bonds sold by other weak states. More broadly, the euro zone must now cope with a world where sovereign creditworthiness has been impaired, affecting borrowing costs across the region.

Even for Greece, the restructuring isn’t particularly good news. Despite wiping about 100 billion euros from its debt pile, Greece will still have debt equivalent to 168 percent of GDP next year – which will only come down to 120 percent by 2020, at least if all goes according to plan. That will weigh on Greece’s growth and its population’s appetite for reform.

The new 30-year bonds issued under the restructuring could be expected to trade at about 28 percent of face value, according to Breakingviews calculations, assuming a discount rate of 12 percent. The current price in the unofficial “grey” market is about 20 percent, suggesting markets expect more losses. After the biggest sovereign restructuring in post-war history, Greece is only at the end of Act 1.

from The Great Debate UK:

A funny sort of Union

The pictures from Athens at the weekend showed a city in turmoil: protests turned violent, buildings were alight and an anti-German feeling was clear for all to see. German flags have been burnt as Greek politicians have agreed to yet more austerity, which means reduced pensions, a 20% cut to the minimum wage and mass layoffs in the public sector.

Added to that the EU has demanded that Greek politicians from both sides of the political aisle sign a pledge to implement cuts regardless of the outcome of the general election scheduled for April. Thus, even if the Greek people vote for an alternative to cuts the troika will insist on them.

But while the Greeks protested at this loss of sovereignty the financial markets have been surprisingly calm. While Greek politicians have been in the throes of austerity, negotiations the bond markets in Italy, Spain and Portugal have continued to recover and apart from a slight blip at the end of last week, euro-based risk assets have continued to rally. Added to this, those calling for the end of the euro have been frustrated by the resilience of the single currency.

So does this mean that the markets will have a delayed reaction to what is going on in Athens, or does Greece not matter anymore? I tend to lean towards the latter. That doesn’t mean that no one cares about Greece or her citizens – the pictures at the weekend were truly disturbing – it’s just that in terms of the euro zone crisis, what happens in Athens is not such an important part of the equation anymore.

A trader I know put it this way: rather than spook the markets, the current events in Greece may spur Italy, Portugal and Spain to act to meet fiscal targets and implement structural reform. After all, it shows just how harsh the Troika can be if you repeatedly fail to live up to expectations when it comes to fiscal consolidation.

An Italian tax crackdown has already yielded positive results. A recent article in the New York Times reported that Rome’s tax police swooped on a small workshop near the Vatican that sold religious souvenirs but failed to pay the Italian Revenue its share. Other arrests have been made in ski resorts and high profile nightclubs around the country. The warning is clear: if you live in Italy, drive a Ferrari and report earnings that could hardly pay for a Fiat Punto then the tax police are coming to get you.

Fraud in Italy is said to be worth 255-275 billion euros a year by some estimates. Thus, stories of raids on the rich and famous not only catch the public’s imagination, but are also a way for Italy to score brownie points from Germany.

from Breakingviews:

2012: another year of living euro-dangerously

By Ian Campbell The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Fear of euro zone breakup became the world’s leading terror in 2011. That calamity can be avoided in 2012, even if the zone may well shrink later. This year’s global question is whether the world can keep growing while Europe ails. Probably it can, but uneasily.

Evolution of the European crisis will again drive markets in 2012. Italy may provide the year’s first big test. The euro zone’s third-largest economy has over 200 billion euros in debt to refinance and currently faces 7 percent yields despite some European Central Bank bond buying. The risk of a blowout in spreads is high.

The markets fancy the easy option to avoid that: large-scale bond buying by the European Central Bank. Germany, and the ECB, are reluctant. Such purchases are against the ECB’s rules, might encourage debtors to soft-pedal on fiscal and structural reform and could bring future losses to the ECB and its member central banks. The Dutch central bank has put provisions aside for that very purpose.

Germany and the ECB think euro zone governments should support their peers, using funds raised through the EFSF or ESM or obtained from the IMF. But this route has a blatant cost, burdening core economies that are at risk themselves of ratings downgrades – as France currently laments.

The best option is the simplest – Italy, a rich country which has long had excessive debt but also has high private savings, should help itself more. The proposed spending cuts of the new Italian government of Mario Monti amount to only about 2 percent of GDP over three years, less than Ireland is contemplating in one year. It might take a financing emergency in 2012 and a passive ECB to push Italy towards tough but fruitful change.

Even Italian progress would leave Europe with continuing serious problems. In the euro periphery of Portugal, Ireland, Greece and Spain, the problems have different roots: deficits and debts have worsened since formation of the euro. Despite one bailout, Ireland has among the worst public finances in Europe. It will need more help. The other three have large fiscal and trade deficits, look uncompetitive and may need external support for years. Supporting the periphery will test Europe. Years of austerity will test the periphery. Eventually one or more of these economies may leave the zone – and creditors – behind. But the euro itself should survive.

from Breakingviews:

Postponing Greek pain will be costly for taxpayers

By Neil Unmack The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Greece needs a proper debt restructuring. Getting the country’s borrowing under control requires a serious haircut for both private creditors and euro zone governments. If it happened today, private bondholders could bear most of the losses, according to Breakingviews’ latest calculator. But if the euro zone delays, taxpayers will suffer more.

By the end of 2011, Greece’s debt will be 357 billion euros, according to government forecasts -- more than 160 percent of this year’s forecast GDP. To be sustainable, this ratio should probably be halved to about 80 percent. That would give Greece breathing room to recapitalise its banks and finance its budget deficit.

Some debt is protected: the International Monetary Fund is a preferred creditor, while politicians may also exclude Greece’s T-Bills -- short-dated securities the country needs to manage its cash needs -- from any restructuring. That leaves euro zone governments, which have lent Greece 53 billion euros, the European Central Bank, which owns Greek government bonds worth perhaps 45 billion euros, and private creditors who are owed the remaining 223 billion euros to split the pain.

If private bondholders took a 60 percent haircut today, the public sector would have to write down its debt by almost 50 percent, or about 47 billion euros.

Politicians might try to avoid this unpopular move by opting for a voluntary debt swap, such as the deal brokered by the Institute of International Finance. But this will do little to ease Greece’s debt.

Meanwhile, the euro zone’s exposure will increase. By the end of 2012, the euro zone and the IMF will have lent Greece another 32 billion euros to fund its deficit and bond redemptions. And Athens will have borrowed a further 71.4 billion euros to buy back debt and fund the collateral it has promised to private creditors under the debt swap. It will probably also have pumped more capital into its banks.

from Breakingviews:

Euro bonds are not the answer

By Hugo Dixon The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Euro bonds are not the answer to the region's raging financial crisis. The euro countries aren't going to agree to guarantee each others' debts in time to solve it. And, once it is over, neither euro bonds nor fiscal union is desirable. Market discipline is a better way of dealing with the current crisis as well as running monetary union in the long run.

One can understand why fiscally-challenged governments such as Italy's and Greece's are in favor of euro bonds. If they could issue debt which was guaranteed by all their partners in the euro zone, they wouldn't find it so hard to borrow money. They would then no longer be under such pressure to do unpopular things like tighten their belts and reform their economies. One can also understand why investors are clamoring for the introduction of euro bonds. They would recoup the losses on their investments in fiscally-weak countries' bonds.

But there's precious little chance of these bonds being approved any time soon by fiscally-strong countries -- led by Germany, the Netherlands and Finland. The politicians and public in these nations are worried about being drowned by other countries' debt. Such debt collectivization would also blunt the incentive for governments, which have borrowed too much money and whose economies are uncompetitive, to put their own houses in order.

Germany may be prepared to consider green-lighting euro bonds once current debts are under control. But that, by definition, wouldn't be a solution to the crisis. What's more, Berlin would only agree to the issue of euro bonds if other governments accepted strict rules on how much they could borrow. Mark Rutte, the Dutch prime minister, has even suggested that a budget tsar should be appointed to ensure that countries don't break the rules in future. He or she would have the power to fine miscreants and, in extremis, force them to raise taxes or quit the euro zone. Once the crisis is over, other euro countries may not find such a loss of sovereignty so appealing.

Conventional wisdom, of course, is that fiscal union -– of which euro bonds would be a key element -– is needed to make monetary union a success. Both euro-enthusiasts and euro-skeptics tend to share this view, although the latter group thinks of such union as hell rather than heaven and would prefer the single currency to be dismantled. Both camps often argue that the main reason the euro zone is in crisis is because monetary union was launched without fiscal union.

But this conventional wisdom is flawed. Governments didn’t rack up excessive debts because of the lack of fiscal union. Rather it was because they flouted the rules designed to limit borrowing and bond investors kept lending them money. There was a failure of discipline, both by the bureaucrats and the market.

from The Great Debate UK:

A make-or-break month for the euro zone

By Kathleen Brooks. The opinions expressed are her own.

For over a year now people have been calling for the collapse of the euro zone. Either one of the bailed out nations would leave, or the more fiscally sound northern European states would form their own version of a union. Regardless of what the outcome would be, the harsh reality was that the Eurozone’s massive floor -  allowing countries like Greece to borrow for nearly a decade at German-style interest rates without some limit on spending or enforcement of fiscal rules - meant that it could not survive.

But after 18 months of stop gap solutions, emergency weekend summits and hastily constructed bailout plans it feels more and more like September may be the swan song for the currency bloc.

Event risk is piling up: Greece is due to receive its sixth tranche of bailout funds from the EU and IMF at the end of this month, Germany is scheduled to vote on the legality of the extension of the European Financial Stability Facility (EFSF) and now the region’s banks look like they are being sucked into the crisis. Added to this, various governments are trying to pass austerity budgets and Italy has more than 60 billion euros of debt to finance during the month.

The EU’s response to the crisis so far has been littered with errors, but we are rapidly reaching a point where there is no more margin for error. Already there have been gaffs and we are only at the start of the month.

Firstly, Greece was forced to deny reports that it had hired a US law firm to manage its exit from the Eurozone. Who knows if there is any truth to the story, but it caught my attention as it suggested what a process for exit might look like, something I hadn’t really considered before. If as a member of the currency bloc you decide to leave, then you hire a law firm and they sort out the nitty-gritty for you: how to change back to your original currency, what would happen to any outstanding euro debts, etc.

And that wasn’t all from Athens. The Finance Minister was forced to claim that a report circulating around the Greek Parliament that said Greek debt dynamics were out of control was based on inaccurate information. This is hardly the stuff that engenders confidence in the currency bloc.

from Breakingviews:

Greek rescue: pig in a poke

By Hugo Dixon The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

A deal was better than a disaster. But last week's planned rescue of Greece has the astonishing by-product of increasing its debts. It also lets private creditors off lightly while making taxpayers elsewhere in the euro zone pay through the nose. It doesn't even mark the end of the crisis.

True, the sustainability of the Hellenic Republic’s debt has been improved. Its government will receive 109 billion euros of new 15-30 year loans from the euro zone at an interest rate of only 3.5 percent. Private-sector creditors will also swap or roll over 135 billion euros of existing bonds into new longer-term instruments.

But this private-sector involvement comes at a huge cost. Because the European Central Bank put the fear of God into politicians about the consequences of a Greek default, private creditors have been handled with kid gloves. Sure, they are going to suffer 21 percent losses compared to the face value of their bonds (assuming a 9 percent discount rate). But that's much less than the 50 percent haircut that is needed to put Greece's finances onto a stable footing.

What's more, the financial fiddling used to corral the creditors actually means Greece's debt will rise. This is mainly because Athens will need to borrow 35 billion euros to buy collateral to partially guarantee the new bonds it will give its creditors.

The deal also envisages Greece borrowing 20 billion euros to buy back debt with a face value of 32.6 billion euros. The price, equivalent to 61.4 percent of face value, is another sweetheart deal for the creditors. A more muscular approach would have cut them to half face value.

Taxpayers in other euro zone countries, by contrast, are digging deep. Imagine they applied the same 9 percent discount rate that private creditors think is appropriate. Their new 109 billion euros of loans would be worth only 54 billion euros, according to a Breakingviews analysis. In other words, they are the ones taking a 50 percent haircut.

from Breakingviews:

Greek rescue bizarrely increases its debts

By Hugo Dixon The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Listen to the politicians and one might think that Greece’s debts will fall as a result of last week’s provisional rescue by euro zone leaders and private-sector creditors. In fact, they go up. Athens’ borrowings will increase by 31 billion euros under the rescue scheme, according to an analysis by Reuters Breakingviews. This increase, equivalent to 14 percent of GDP, will push the country’s estimated peak debt/GDP ratio next year to 179 percent.

This bizarre result comes because of the way the different elements of the fearfully complex rescue plan interact. Greece will need to borrow extra funds to enhance the creditworthiness of the new bonds it will provide the private sector. It will also need to inject capital into its own banks. These extra borrowings amount to 55 billion euros and will more than outweigh the reduction in Greece’s debts that comes as a result of haircuts to be agreed by private-sector creditors and a planned buyback of debt at a discount to its face value.

The Breakingviews analysis is at variance with comments made by Nicolas Sarkozy, France’s president. He said after the July 21 summit of euro zone leaders that Greece’s debts would fall by 24 percentage points of GDP.  This was because he ignored the costs of "credit enhancement" and bank recapitalisation. He also included in the debt reduction 12 percentage points of GDP coming from the fact that Athens will be paying low interest rates on its official loans. While this will definitely improve the country's debt sustainability, the benefit (under Sarkozy's maths) will be spread over 10 years.

FINE PRINT

The euro zone leaders agreed to provide 109 billion euros in extra funds to Greece. This money will be supplied by the European Financial Stability Facility (EFSF), the euro zone’s bailout fund.

At the same time, private-sector creditors, under the auspices of the Institute of International Finance (IIF), plan to contribute a gross 54 billion euros to Greece’s funding needs by mid-2014 and a further 81 billion euros between mid-2014 and end-2020 –- or 135 billion in total. This contribution will come by swapping old bonds for new Greek bonds, or by rolling over old bonds into new bonds when they mature.

from Breakingviews:

Three questions the Greek debt summit must answer

By Pierre Briançon The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

The best signal that the euro zone may be nearing a Greek debt deal is that its leaders have decided to hold a summit. With investors questioning Europe's determination to tackle its debt problems, ending the high-profile meeting on an inconclusive note would be unconscionable. But how should success be gauged? That depends on the answer to three key questions.

First, does Greece get some relief? The goal is to come up with a package that lightens the country's debt burden and provides it with funding for the next three to four years. A bond buyback programme could allow Athens to take advantage of its distressed debt status by buying back some bonds. This could be done by the European Financial Stability Facility, or by the European Central Bank, supported by a euro zone government guarantee. At the same time, the interest rate on the existing bailout should be lowered, and the maturity of the loans extended.

Second, is there an agreement on private sector participation? Germany insists that banks and others private creditors must share the pain. But governments must spell out what form this will take. A levy on the banking sector has gained ground in recent days. The idea is fraught with risks, could be counter-productive and shouldn’t even be on the agenda.  Adopting it would send the ominous signal that governments can’t agree on anything more substantial.

Third, is the European Central Bank on board? The ECB so far has played its cards well, forcing governments to step in and take responsibility for the Greek mess. It will only agree to cooperate in a new bailout -- compromising at last on its rigid opposition to any form of default -- if it believes governments are tackling other issues such as recapitalizing weak lenders. Any indication that the ECB is refusing to play ball means the plan won’t fly.

The summit doesn’t necessarily have to come up with a detailed plan. Greece doesn’t have short-term funding problems, and a few technical issues can be explored for another month or two. But investors will want a signal that the euro zone is getting to grips with the problem. Anything short of a strong consensus on the plan’s main points would send markets into another debt panic attack -- with repercussions far beyond Greece.