Europe, cooperation and train wrecks

August 30, 2011

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

HUNTSVILLE, Ala., Aug 30 – In an unintended irony for a continent with a great public transport infrastructure Europe’s debt rescue plans are turning into a train wreck. Consider that as Greek two-year interest rates stood at 45 percent on Monday, officials and interests in the euro zone descended into an unseemly mix of squabbling over assets, denying the undeniable and disagreeing about first principles. Even as weak as recent U.S. economic data has been, these fractures, which imply heightened risk of a bank-centered market crisis, are surely the main source of the recent extreme financial volatility.

Most interesting was the intervention by newly minted International Monetary Fund Managing Director Christine Lagarde on Saturday who warned “developments this summer have indicated we are in a dangerous new phase.”

Lagarde went on to say that Europe’s banks need “urgent recapitalization,” using public funds if necessary, and advised that one option would be to use the European Financial Stability Fund (EFSF), or some other vehicle, to inject capital into banks directly.

Here we have the head of the IMF, a woman who was until recently the finance minister of France, more or less asserting that the bank stress tests are best disregarded and that people should have real doubts about the banks they do business with, invest in and lend to.

This is nothing that cannot be seen in market prices, of course, but it’s a bit as if U.S. Treasury Secretary Tim Geithner were to leave government service, set up as an equity analyst and come out with a “sell” rating on Bank of America.

Not helpful, even if perhaps true.

Lagarde said that Europe risks a liquidity crisis, though surely any crisis that comes as a result of people withdrawing credit from banks because they have not got enough capital has to be classed as a crisis of solvency.

Euro zone officials were quick to stamp on the idea, pointing out there were well known remedial steps being taken as a result of the stress tests, and that new banking regulations offered further protection. It is good that euro zone officials can agree that they’ve solved the bank capital problem, because very few others seem to agree.

On other issues, European officialdom is showing comical, if destructive, disagreement. Take Finland’s demand for collateral as part of its participation in the rescue of Greece. This demand immediately sparked a round of “me too” demands from other smaller euro zone players, states whose share of the package is about 10 percent. To an outsider, this looks suspiciously like a lack of faith in Greece and in their European partners. It has the feel not of a rescue of a sovereign state and euro zone partner, but of in-fighting among the creditors in a bankruptcy.

While Finland appears to have backed off from some of its demands, the situation hardly inspires confidence.


And of course even within countries there are deep political divisions over the right path. Germany is an excellent case in point; Chancellor Angela Merkel last week came out against Finland’s bilateral deal and euro zone common bonds, while maintaining that she would be able to push through approval by parliament of the expansion of the EFSF. Reports in German media indicate substantial opposition within Merkel’s somewhat shaky coalition, meaning she may be forced to seek votes from the opposition. Merkel has canceled a long-planned visit to Russia on Sept. 7, the day of the vote.

The ECB’s decision to buy Spanish and Italian debt on the open market, a thus far successful effort to cap interest rates for the two vulnerable states, has left it subject to strong criticism that it has overstepped its bounds and compromised its independence.

German President Christian Wulff last week inveighed against the ECB’s action and against the last-minute nature of recent policy-making.

“I regard the massive acquisition of the bonds of individual states via the European Central Bank as legally questionable,” he said, speaking at an economics conference in Lindau, Germany.

Wulff cited an article in the European Union’s fundamental treaty, which he said prohibits the ECB from buying bonds directly from governments.

“Decisions have to be made in parliament in a liberal democracy. That is where legitimacy lies,” he said. This is an interesting echo of the less well tempered criticism of Ben Bernanke by presidential hopeful Rick Perry, who said that further radical easing by the central bank would be “treacherous, almost treasonous.”

The truth, perhaps, is that Europe is a group in an impossible situation, just as the Fed is an institution in an untenable position. Groups of people in impossible situations tend only to act when forced, and only rarely are able to act in concert.

Expect an active and unsettling September.

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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Yep – it promises to be an interesting September, to say the least.

But the markets in the U.S. are expecting QE3 ‘Goose the Market’ from the Fed, and are rising on this expectation. It seems to me, however, that when QE3 finally does arrive, it’ll be like that B mystery movie that spent way too much time hinting at a murder so that when it finally does come people just ignore it or even laugh it off, very derisively.

Dangerous – because as Mr. Saft points out many very toxic factors keep pressing ever harder against the pillars of the entire Western financial order. The Fed can ill afford to disappoint in such an environment where investor panic is crouching just off stage. A disappointment in such an environment could lead to a massive panic and a crisis far worse than 2008.

Looks to me like investors are right now being set up for the big fall.

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