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from Breakingviews:

Summit silence on Greece is best option for now

By Pierre Briançon

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

For once euro zone leaders did the right thing, the very thing they have been unable to do throughout the euro crisis: shut up. Their nine-line communiqué to say nothing on the subject was the only sensible option after their informal dinner Wednesday night. The other alternatives would only have made things worse. And whatever the pundits’ or markets’ expectations may be, it’s better for the euro summiteers to keep mum than to pretend having the answer which only the Greeks can provide.

Greece’s euro partners would like the second Parliamentary election, to be held on June 17, to become a de facto referendum on membership of the single currency. But they can’t insist too much without appearing to interfere in the Greek electoral process. The zone’s leaders are most probably ready to offer some concessions on the bailout programme to show that the euro is not just about pain and punishment. But they can’t reveal their hands before the election, because the radical parties rejecting austerity might feel emboldened and demand more concessions ahead of the vote.

Meanwhile, euro zone leaders and the European Central Bank must brace for the worst-case scenario of a Greek chaotic euro exit. But they can’t publicly admit that they’re planning for it, because it could amount to a self-fulfilling prophecy, and because markets turn south every time a European official simply mentions the possibility of Greece leaving the monetary union.

So what’s to do? Keep calm and carry on planning for the day after the Greek election - which, as it happens, will be the first day of the G20 leaders’ summit in Mexico. That may be difficult in a 17-country glass house and a 24-hour news cycle. But euro zone leaders must prepare plans for either dropping Greece, or supporting it with a plan to boost growth in an aggressive way. Strains in Spain, or Italy, might force them to the podium. But silence, in the next three weeks, will be golden.

from Lawrence Summers:

Austerity has brought Europe to the brink again

Once again European efforts to contain crisis have fallen short. It was perhaps reasonable to hope that the European Central Bank’s commitment to provide nearly a trillion dollars in cheap three-year funding to banks would, if not resolve the crisis, contain it for a significant interval. Unfortunately, this has proved little more than a palliative. Weak banks, especially in Spain, have bought more of the debt of their weak sovereigns, while foreigners have sold down their holdings. Markets, seeing banks holding the dubious debt of the sovereigns that stand behind them, grow ever nervous. Again, Europe and the global economy approach the brink.

The architects of current policy and their allies argue that there is insufficient determination to carry on with the existing strategy. Others argue that failure suggests the need for a change in course. The latter view seems to be taking hold among the European electorate.

This is appropriate. Much of what is being urged on and in Europe is likely to be not just ineffective but counterproductive to maintaining the monetary union, restoring normal financial conditions and government access to markets, and re-establishing economic growth.

The premise of European policymaking is that countries are overindebted, and so unable to access markets on reasonable terms, and that the high interest rates associated with excessive debt hurt the financial system and inhibit growth. The strategy is to provide financing while insisting on austerity, in hopes that countries can rein in their excessive spending enough to restore credibility, bring down interest rates and restart economic growth. Models include successful International Monetary Fund programs in emerging markets and Germany’s adjustment after the expense and trauma of reintegrating East Germany.

Unfortunately, Europe has misdiagnosed its problems in important respects and set the wrong strategic course. Outside of Greece, which represents only 2 percent of the euro zone, profligacy is not the root cause of problems. Spain and Ireland stood out for their low ratios of debt to gross domestic product five years ago, with ratios well below Germany’s. Italy had a high debt ratio but a very favorable deficit position. Europe’s problem countries are in trouble because the financial crisis under way since 2008 has damaged their financial systems and led to a collapse in growth. High deficits are much more a symptom than a cause of their problems. And treating symptoms rather than underlying causes is usually a good way to make a patient worse.

The cause of Europe’s financial problems is lack of growth. In any financial situation where interest rates far exceed growth rates, debt problems spiral out of control. The right focus for Europe is on growth; in this dimension, increased austerity is a step in the wrong direction.

Systematic comparisons suggest that when economies are demand-constrained and safe short-term interest rates are near zero, policy measures that reduce the deficit by 1 percent have a multiplier of 1 to 1.5 – implying that a 1 percent reduction in a country’s ratio of spending to GDP or an equivalent tax increase reduces its GDP by 1 to 1.5 percent. Essentially, cutting deficits will have a disproportionately adverse effect on GDP because the multiplier is larger than 1 on the growth-reduction side of the equation. This means that austerity measures at the national level are likely to be counterproductive in terms of creditworthiness. Fiscal contraction reduces incomes, limiting the capacity to repay debts. It achieves only limited reductions in deficits once the adverse effects of economic contraction on tax revenue and benefit payments are accounted for. And it casts a shadow over future growth prospects by reducing capital investment and raising unemployment, which inevitably takes a toll on the capacity and willingness of the unemployed to work.

from Breakingviews:

Spain’s banks could use some disaster insurance

By Fiona Maharg-Bravo and Peter Thal Larsen

The authors are Reuters Breakingviews columnists. The opinions expressed are their own.

Spain’s banks are once again in the eye of the storm. Though the sector has undergone consolidation and raised fresh capital, most lenders are still shut out of wholesale markets. Concerns about banking contagion are one reason Spanish bond yields are in the danger zone once more. Disaster insurance, underwritten by the euro zone, could help take the issue off the table.

Banks haven’t been sitting on their hands. They have made bad debt provisions worth 112 billion euros, according to the Bank of Spain, and will set aside a further 29 billion euros against commercial real estate this year. Core capital ratios have been boosted to at least 8 percent. Meanwhile, mergers should help restore profitability: the number of former savings banks has shrunk from 45 to 11.

But investors aren’t convinced. Though banks are prepared for an 87 percent drop in the price of undeveloped land from the peak, the worry is that values will fall even further. Meanwhile, Spain’s shrinking economy could put pressure on mortgages and small business loans, which have held up to date. A one percentage point increase in provisions on loan portfolios - excluding real estate - would force banks to come up with about 16 billion euros in extra provisions, or more than 10 percent of their current tangible equity, according to Exane BNP Paribas.

One way to repair confidence would be to insure Spanish banks against extreme losses. This approach helped to calm fears about Royal Bank of Scotland and Citigroup during the banking crisis. If the Bank of Spain is right about banks’ resilience, the scheme wouldn’t cost taxpayer money. If the worst happens, banks have a backstop.

The key question is how such a scheme would be funded. Spain’s Deposit Guarantee Fund, which is financed by the industry, could provide some financing. Though the DGF has almost run out of money, it can raise funds by borrowing against future contributions, which bring in 2 billion euros a year. The Spanish government could also absorb some losses.

from Breakingviews:

IMF’s euro gloom points to right fiscal path

By Pierre Briançon

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

Euro zone members won’t meet their fiscal targets, but that doesn’t mean they should all force themselves to be even more austere. This is the message that the International Monetary Fund is sending to Europe’s troubled economies. Both disciplinarian central bankers and populist politicians should take note. Austerity remains a must. But too much, too fast will be lethal.

Spain and France illustrate the point the IMF is trying to make. Both should have budget shortfalls next year that will be much higher than forecast, the Fund says. Both countries were supposed to shrink their deficits to 3 percent of GDP in 2013. But according to the IMF, both will miss their targets - Spain’s deficit will reach 5.7 percent of GDP, while France’s will stand at 3.9 percent.

The misses should lead to different conclusions in Madrid and in Paris. Spain’s target was absurdly unrealistic. Since the deficit stood at 8.5 percent in 2011, the target could only be met if country cut spending or raised taxes by a combined 5.5 percent of GDP over two years. Spain needs understanding from its euro zone partners: flexibility is needed to implement painful reforms that need political support.

For France, on the other hand, the IMF report should serve as a wake-up call: more needs to be done. Nicolas Sarkozy and Francois Hollande, the main presidential candidates, seem impervious to the need to seriously shrink the public sector. In a country which hasn’t balanced a budget since 1976, cutting public spending - a euro zone record at more than 56 percent of GDP - is in and by itself a structural reform.

This government-heavy economy sets the country apart from other euro zone members. The IMF forecast shows that Paris can’t simply wait for better days, especially with the weak GDP growth expected this year (0.5 percent) and next (1 percent).

from MacroScope:

The Law of Diminishing Greeks

The Law of Diminishing Returns  states that a continuing push towards a given goal tends to  decline in effectiveness after a certain amount of effort has been expended. If this weren't the case, Usain Bolt would be able to run the mile in  less than 2-1/2 minutes.

From an economic standpoint, this law now seems to be fully in force in Greece. The latest jobs figures from the twice-bailed out euro zone country paint a bleak numerical picture of the impact of unrelenting austerity in ordinary Greeks, regardless of whether it was self-inflicted or not. To wit:

More than one in five Greeks is unemployed.

There are more young people without a job than with one.

The record 1.08 million people  without work in January was a  47 percent tumble  in a year.

Putting aside for the moment the question of what such a condition means for political dissent, there is now the issue of whether any of this austerity-fueled pain is actually helping the Greek economy.

Austerity mixed with the inability of euro-tied Greece to devalue its currency  means  Greece is now in its fifth year of recession. As for job-creating small and medium -sized businesses, the latest projections are that more than a net 130,000 of them will have shut down over two years by the time 2012 is over.

The biggest example of the Law of Diminishing returns, however, is the impact all this is having on what ails Greece in the first place -- its budget.

Unemployed people offer no revenue to the government in terms of income tax and far less in sales tax than they would if they were working.

from Breakingviews:

Spain reveals holes in Europe’s crisis plan

By Neil Unmack

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

Rising Spanish yields have thrust Europe back into crisis mode. Policymakers thought the European Central Bank’s three-year loans had bought the euro zone some time, but markets are catching up fast.

The flashpoint is Spain. The country’s apparent inability to control its fiscal deficit - which was 2.5 percentage points higher than its target last year - and its decision to raise this year’s target shortfall to 5.3 percent, from 4.4 percent, has spooked investors. Bond-buying by Spanish banks helped to keep yields in check for a while. But the ECB-funded stimulus is wearing off. Yields on the country’s 10-year bonds are back above 5.8 percent.

The government’s decision to relax fiscal targets has placed it at loggerheads with the European Commission. However, the obsession with austerity may be self-defeating. The government is struggling to rein in spending by the autonomous regions, which were largely responsible for the budget spillover. Meanwhile, markets fret about growth; youth unemployment is shockingly high at over 50 percent, and the banking system is still weighed down by real estate exposures. Banks could face losses of 203 billion euros under a stressed scenario, according to Citigroup.

There are few easy solutions. The ECB could throw more money at banks to help them buy government debt. But Spanish lenders are overloaded with government debt having increased holdings by 52 billion euros in the two months to January, according to Citigroup. A full-scale bailout also looks difficult, as it would exhaust the euro zone’s recently-expanded bailout fund.

One option is a targeted bailout for Spanish banks, perhaps in conjunction with an external audit, as has already happened in Ireland. That would at least ease persistent concerns about property exposures, which in turn might lift some of the pressure on the government finances. In the end, however, Spain will have to fix itself. Investors would probably tolerate a loosening of fiscal targets, provided there was evidence that over-spending regions were under control. Spain also needs to press ahead with reforms to boost growth. That means labour reform, and reducing the burden on employers by lowering social security contributions.

from Breakingviews:

Greece faces new taboo: not defaulting

By Neil Unmack

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

Greece’s debt restructuring has been a total success - almost. A small number of bondholders have rejected the debt swap. The holdouts could drag Athens through international courts. But paying them off would be difficult too.

Greece has so far forced investors holding 177 billion euros of bonds issued under domestic law into accepting a restructuring, as well as some foreign-law bonds. All in all, it has roped in about 96 percent of the private sector bonds targeted in the swap, enough to secure a second bailout from euro zone partners and the International Monetary Fund.

But some holders of bonds issued under foreign law, and by state-owned enterprises, aren’t playing ball. These bonds have similar collective action clauses (CACs) to the Greek-law bonds that Athens used to force losses on creditors. But because the CACs must be activated for each of the 36 different bonds, it is easier for investors to resist. So far, investors in 11 of the bonds have rejected the restructuring, and votes for another nine have been adjourned. Greece has already said it cannot pay holdouts more than they would get under the swap. If they don’t agree, a default will follow.

The threat to Greece is that bondholders then pursue their claim in the English courts, undermining the country’s revival. Argentina is still locked out of markets despite restructuring its debt years ago. The matter will come to a head in May, when a 450 million euro bond matures. The bonds are currently trading at about 70 percent of par, suggesting investors believe they will get a much better deal than the debt swap, which imposed losses of 75 percent. However, Greece has already crossed the default rubicon by forcing losses on bondholders and triggering credit default swaps linked to its debt. Paying the bonds would anger Greek voters, euro zone governments, and creditors who have already been strong-armed into the swap.

Perversely, the choice becomes tougher as more bondholders fall into line. If it is left with just a very small number of holdouts, it might be easier for Greece to offer a better deal, or even repay bonds at par. But for now, it can play hardball.

from Edward Hadas:

What’s really wrong with Europe?

The euro zone debt crisis shows that something is seriously wrong with Europe. But what is it?

Most financial professionals think the problem is economic. They have long considered continental Europe something of a mess – slow GDP growth, inept governments, smothering regulation and a culture that doesn’t “get” markets. European residents seem equally gloomy, especially about the economy. In the most recent Eurobarometer survey, 71 percent of respondents did not expect the crisis to be over two years hence.

The economic worries of both financiers and citizens are misplaced. Even if the slow patch does last a few more years, the European economy will continue to do what a modern economy is supposed to do. European consumers are basically as well off as Americans after adjusting for longer European holidays and different lifestyle choices. There is probably greater justice in the distribution of incomes and consumer goods in Europe than in the United States. The euro zone’s low trade deficits – less in total since 1990 than the United States ran in the last six months – suggest that Europe is globally competitive. Europe probably has a worse unemployment problem than the United States, but national governments are belatedly trying to remedy that.

Where Europe is really weak is not in economics but politics. A lack of political cohesion turned relatively minor financial problems – one small reprobate government (Greece) and two small careless ones (Portugal and Ireland) – into a disproportionately large struggle to avoid a devastating financial meltdown. Despite the risk, politicians and bureaucrats spent years bickering. They may have finally found the necessary toughness and solidarity, but there are enough unanswered questions to suggest that further crises are a lively possibility.

The indecision and discord needs to be kept in proportion. Politically, Europe is far more stable than it was a century ago, when a much smaller trigger set off the First World War. It is more unified – fiscally and financially – than it was in that war’s aftermath, when the anti-solidarity policy of reparations and the anti-flexibility of the gold standard wreaked havoc.

Still, Europe could do better. I suggest a three-pronged effort to make the region stronger.

The first is supposedly underway: balanced national budgets in normal economic times. An earlier effort to mandate this, the Stability and Growth Pact, failed, but the intervening crisis may have concentrated minds and strengthened resolve. If it hasn’t, then the euro project is liable to topple over as soon as economic challenges arrive.

from The Great Debate UK:

Germany should be happy to let Greece go

When the Greek crisis began, there was much talk of contagion as the greatest short-term risk. In my view, this worry is almost irrelevant because bondholders are in any case facing a haircut of over 70%, so the question of default or bailout is now merely a technical detail.

From a longer term perspective, there is also little reason for the Germans to panic over a Greek default, even if it ultimately leads to the disintegration of the euro zone. The line peddled by a number of commentators and politicians that Germany has “done very well out of the euro zone” begs the question of how well it would have done without the euro zone, a question to which I do not know the answer – but nor does anyone else.

The implicit or explicit claim is that, with floating exchange rates, German trade would have suffered as the DM appreciated against the currencies of its neighbours. This is nonsense, a case of how, in the world of popular economics – what one colleague famously called D-I-Y economics – exchange rates occupy a position of exaggerated importance (If those who study the subject were given the same importance, I’d have had a peerage by now).

If exchange rate appreciation were so damaging and depreciation so beneficial to a country’s trade, the Swiss would by now be the poorest country in Europe and the Italians the richest. The reality is that, while there may be short term dislocations, the effect of changes in the value of a currency are ephemeral. Devaluations are self-defeating because they push up costs until the country’s terms of trade are back where they started, and the opposite for appreciations: a rise in the value of a country’s currency makes its imports cheaper, reducing its inflation rate and restoring its competitiveness as time passes. The process of adjustment seems to take some six or seven years, which might seem a window of opportunity worth seizing for opportunistic devaluation. The fly in the ointment, however, is that the more rapidly a currency depreciates, the more agents in the economy wise up and start anticipating the next depreciation, speeding up the adjustment and thereby narrowing the window of opportunity for exporters.

In other words, exchange rate flexibility smoothes the road, but does nothing whatever to change the destination. Moreover, the effect of exchange rate changes is smallest for countries with the most efficient labour markets, which includes Germany ever since its reforms of ten years ago, so there is every reason to suppose that it would adjust quickly anyway, just as it did in the 1970’s and 1980’s when the DM rose in value almost continually without seriously damaging the country’s competitiveness.

As far as Greece is concerned, making it competitive inside the euro zone will require a so-called internal devaluation – mainly a reduction in wages – whereas outside the euro zone a relaunched drachma could be allowed to float downward. The only difference is that in the former case, Greek workers will have to get by on fewer Euros than they have been used to, whereas outside the euro zone they would be paid in devalued drachmas, which would mean a cut in their living standards of the same order of size (is there such a thing as a Hobson’s Choice between Scylla and Charybdis?).

For Germany (and for the rest of Europe, including Britain), the real danger is that euro zone disintegration might be followed by the collapse of the single market, the only truly valuable component of the EU edifice. As a nation very reliant on its external trade, Germany needs market access – no reasonable person wants to go back to a world of protectionism, quotas and  non-tariff  barriers to trade, but it is an ever-present threat as populist politics take hold in Europe. But even then, the German carmakers have demonstrated in the last couple of years how capable they are of compensating for sales lost in Europe by higher volume in the emerging markets of Asia and Latin America, and there is every reason to suppose that the formidable German capital goods sector will prove just as adaptable.

from Breakingviews:

EU needs contingency plan to handle Greek blow-up

By Hugo Dixon

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

The euro zone needs a contingency plan to handle a potential Greek blow-up. The latest game of brinkmanship being played in Athens will probably end in a fudge – that’s how such games normally resolve themselves. But if it doesn’t, Greece’s banks will go bust and the rest of the euro zone will need a plan to prevent a panic in its own banking industry.

The hardliners in Europe, led by Germany, have virtually lost patience because of the Greek government’s inability to deliver on its promises. The fact that the next tranche of bailout cash is supposed to be a super-sized 80-90 billion euros seems to have made the lenders even more determined to secure reforms to make the economy more competitive. This is serious money, after all. The Greek politicians, meanwhile, are reluctant to force the voters to drink any more unpleasant medicine - especially given that there could be a general election in April.

But is the rest of Europe really prepared to pull the plug? Doing so wouldn’t just mean that the Greek government would go bust, as it would be unable to pay a bond that comes due in March. It would also mean that the country’s banks, which are stuffed with their government’s debt, would go belly up.

If the Greeks were the only ones who would suffer from such a catastrophic bankruptcy, their partners could afford to hang tough.But such a scenario would probably provoke runs on banks in the rest of the euro zone - especially weak economies such as Portugal, Ireland, Spain and Italy. The European Central Bank would, again, have to ride to the rescue by flooding the system with liquidity.

Helping banks deal with an all-out panic wouldn’t be easy. After all, the ECB is only supposed to provide liquidity in return for adequate collateral. And, in some cases, banks have run out of such eligible assets. This is why the ECB has already authorised national central banks to provide so-called emergency liquidity assistance to their country’s banks in return for lower quality collateral.