COLUMN-Europe’s Speculator Full Employment Act: James Saft

May 11, 2010

(James Saft is a Reuters columnist. The opinions expressed are his own)

By Jim Saft

HUNTSVILLE, Ala., May 11 (Reuters) – Far from setting a trap for the “wolfpack,” Europe’s $1 trillion bailout package amounts to a full employment act for speculators, or should that be the reality-based community, for the foreseeable future.

Hoping to tame markets it accused of “wolfpack behavior,” the European Union on Monday unveiled a 750 billion euro package intended to avert a rolling sovereign debt crisis that has engulfed Greece and threatens to spread widely among the weaker euro zone countries.

The package can’t be blamed for being too simple: it contains loans from the International Monetary Fund, an EU emergency fund and euro zone governments, as well as an interesting undertaking by the European Central Bank to buy bonds in order to restore liquidity to supposedly poorly functioning parts of the bond market. In a move straight out of a Russian fairy tale, Spain and Italy, to name just two, are pledging money towards a package that may well be used to bail themselves out. Maybe they should have put up even more money.

Once again, those in power look at a solvency issue and pronounce gravely that is a matter of mere liquidity.

Well, it isn’t.

That move worked, at least for the time being, when the United States bailed out its banks, but the U.S. was able to create easy conditions in which its banks could earn their way out of the hole. Rather than create easy conditions, this bailout imposes tougher ones. Greece, Spain and Portugal will face even greater austerity as a result of budget cuts, austerity that will make it even tougher for them to earn their way out.

The plan was greeted with joy on financial markets, with bonds and stocks rallying sharply, but the rally had the feel not of speculators heading for the hills but of children learning how to push their parents’ buttons more effectively.

“Markets have learned that bailouts will happen under pressure,” Gabriel Stein of Lombard Street Research wrote in a note to clients.

“This is a lesson they will not forget. Getting to that bailout will take substantial pressure (obviously) and much delay, offering plenty of opportunity to profit along the way.”


The funds involved are huge and are ample to cover borrowing needs for the next couple of years, but the issue of how exactly the countries involved can meet their new pledges and generate growth is not answered. Portugal is going to undertake fiscal tightening of another 1 percent of gross domestic product this year, while Italy will have fiscal measures of about 0.7 percent of GDP both this year and next. Greece has already committed to very severe cuts as it tries to bring down a ruinous deficit with only very blunt tools.

It is possible that global growth takes off and lifts Europe out of its morass, but it is also possible that an extended European recession dampens growth globally. Greece has been in default for 90 of the past 180 years and is now being asked to undergo an almost unprecedented adjustment without help of a currency it can devalue. Europe surely has bought some time to think something up, but in the end the issue of rescheduling debts, if not default, will likely rise again. That’s not speculation, that is just logic.

Another key point to understand is that the new money in the package is senior to loans to existing creditors. As you would expect, the IMF will get its money back before Credit Hapless of France. What that means is that as the issue of rescheduling or default comes back on the agenda, European banking solvency questions will begin to drive markets. Lenders to Greece, and Spain and others, will still be wondering where the money to pay them back will come from.

It is very interesting to note that while bank shares soared, the interbank lending market did not really recover with the same vigor. The three-month dollar London interbank offered rate, the rate banks charge each other, fell only slightly and actually rose relative to government interest rates.

That means that banks are still afraid of lending to each other. Remember European banks have been slow to raise capital and are still very heavily reliant on unpredictable short-term funding.

This brings us back to why the European authorities continue to, perhaps deliberately, confuse solvency and liquidity. Rescheduling sovereign debt would not just prompt a crisis of existence for the euro zone, it would very likely prompt a run on some banks, leaving policy makers with some very unpleasant decisions.

Expect massive capital-raisings starting this summer by European banks. Don’t be surprised too if the yields on Greek, Italian, Spanish, Portuguese and Irish debt begins to move outward again to reflect the continued risk of eventual loss, package or not.

Speculators will find plenty of work. (Editing by James Dalgleish)

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.

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