Wednesday, February 29, 2012
The more important figure though, is how much of this is new liquidity. Of the previous €489bn LTRO only around €200bn was new lending, since banks rolled over their previous loans from shorter ECB lending operations. In this instance (since many loans have been rolled over) the new injection of liquidity is likely to be much higher. We expect that the new liquidity totalled between €300bn and €400bn.
Short term loans issued by the ECB earlier this week totalled €134bn, while €150bn of short/medium term lending is also due to expire this week - both can be seen to give an indication of the amount of lending which will be rolled over. Much of the new lending will have come from the loosened collateral requirements (€200bn or so) as well as the decreased ‘stigma’ associated with banks which borrow from the LTRO.
We’re yet to see a full list of who borrowed what (and probably won’t for some time) but there are some details (we’ll update as more come through):
Intesa Sanpaolo (IT) - €24bn
Lloyds (UK) - €11.4bn
Allied Irish (IR) - Unknown
Banco Popolare (ES) - €3.5bn
KBC (BE) - €5bn
Unicredit (IT) - <€12.5bn (not that this helps pin down the figure much)
BBVA - Similar to first LTRO (around €11bn)
Italian banks are reported to have tapped the LTRO for around €100bn in total, while banks such as ING (NL) and ABN Amro (NL) have stated that they did not tap the operation at all. Clearly 'stigma' is not an issue in Italy but alive and well in the Netherlands, presenting an interesting microcosm of the problems facing these countries.
One point we’d note is that the first LTRO was not tapped heavily by banks from the bailed out countries. There is no evidence that banks from Portugal or Greece took any ‘new’ lending from the first LTRO while Irish banks only took an additional €5bn (% of their current borrowing from the ECB and Irish central bank). This could be for one of two reasons: the banks are more or less blocked from taking on massive amounts of extra liquidity since they should be leveraging and meeting stringent capital requirements under the bailout programmes. Or, the banks in these countries had run short of collateral to post with the ECB in exchange for loans. It will be interesting to see if this problem held true in the second LTRO, given the loosened collateral requirements – early indications with the Portuguese borrowing costs jumping suggest it will.
This shows how the LTRO will not solve any of the eurozone problems. In fact it may not even help sentiment or lending in the worst hit countries. The Italian and Spanish banks look likely to increase their purchases of their domestic government debt, further intertwining eurozone states with their banking sectors. The question now is, how many more LTROs will there be?
Given the lack of a credible solution to the problems in Greece and Portugal we fear more may be on the horizon.
Ps. For you German speakers, it's well worth reading this piece from Die Welt's Holger Zschäpitz on why the LTRO is turning the ECB into a lender of first instance rather than one of last resort
But first, something different. Remember, we've long been critical of the ECB's backhanded QE, which has created a range of zombie banks in weaker euro economies (reliant on ECB funding to survive). See here, here, here, here, here and countless other examples of when we're looked at this issue. So it's odd that we're now literally taking the 'oh it's not so bad' view in a discussion about whether the ECB is 'bailing out' banks. Well, at least UK banks.
This after the Left Foot Forward blog claimed, and then re-stated, that "the EU" is bailing out UK banks, after Loyd's (now confirmed) and possibly RBS (unconfirmed) accessed funding from the LTRO 2 (see here for background on this issue). We still do not see how this constitutes a 'bailout'. Again, these UK banks are merely saving cash through avoiding an extra exchange rate charge and borrowing at cheaper rates, rather than relying on more expensive (but still available) sources of funding. While the money will only be used to fund their European operations. This just isn't a 'bailout' in any sense of the word.
The Left Foot Forward provides a politically interesting interpretation, but, we believe, also misunderstands some crucial points:
- If it amounts to a bailout, it's a contender for the smallest one in history. €15bn (if that's the final amount) is equivalent to a tiny amount of the UK's banking sector, the assets of which amount to numerous times the size of UK GDP (around £1.5 trn). €15bn is hardly the difference between life or death for UK banks and surely not enough to signal the need for a complete change in approach.We could go round and round discussing the intricacies of the problems facing banks in Europe but ultimately there are endemic structural problems which cannot be solved by simply throwing more liquidity at the problem - in either the UK or the Eurozone.
- Lower collateral requirements are not directly tied in with the LTRO, as the Left Foot Forward blog suggests. It's a separate policy (just announced at the same time), but was not in place for the first LTRO, so to claim this is the whole motivation for the LTRO is a misnomer. It may allow UK banks to use assets which may not be accepted elsewhere, but is that enough for it to be considered a bailout? The only instance where this association would work is if UK banks had already used all other collateral worthy assets to gain liquidity - this simply is not the case. In fact the main choice for UK banks is whether the reduced cost is enough to offset the negative 'stigma' of using the LTRO.
On the wider point about QE style interventions, the blog is also confused. Does it want a UK LTRO or lower collateral requirements or both and would this be instead of QE or on top of it?
- Here we would say that the BoE already did its (more direct) version of the LTRO with the Special Liquidity Scheme and its ‘Quantitative Easing’ (QE) programme. It's still overshooting its inflation target by some way, throwing more liquidity into the system seems impractical and risky.
- Furthermore, money in the system has increased steadily in both Europe and the UK but lending has not, which is a problem. But increasing liquidity will not solve this. As results from January show, lending in the eurozone still fell despite the December LTRO. It fell by less than the previous month but still not a resounding victory for the theory that the LTRO is a clear cure to all the lending problems in the wider economy.
Tuesday, February 28, 2012
The Irish government had previously said that the chances (or risks if you ask the markets and EU elite) of a referendum were always 50-50, so this was far from a foregone conclusion. And, as Zerohedge put it, markets have reacted badly to the news of democracy, with the euro weakening significantly. But what is the precise significance of this announcement?
• The vote will essentially determine whether Ireland has access to future bailout funds or not. For a country to access the ESM, the eurozone's permanent bailout fund, it must have ratified and fully adhered to the treaty, according to the terms attached to the deal. The Irish government has already given indications that it will tie its approach closely in with the prospect of further bailout funding, with Deputy PM Eamon Gilmore pointing out the link between emergency funds and the fiscal pact approval. These scare tactics are likely to grow throughout the referendum campaign, with the flip-side of rejecting the treaty being seen as tantamount to a vote for eurozone exit. In other words, the Irish will vote with a gun to their head.In sum, it would have been difficult to avoid this referendum and we're glad the Irish government did not engage in the legal gymnastics that have been going on elsewhere in the eurozone (*cough* Frankfurt). If further fiscal integration is ever going to succeed (leaving aside whether it's desirable), it will have to happen with a clear and strong mandate from the people. This is also a practical point which market players should ponder. Changes built on a clear mandate from the people (particularly when wrapped in pretty heavy austerity) have a far greater chance of standing the test of time.
• It provides yet another illustration of the clash between different parliamentary/constitutional democracies (in this case the German vs the Irish constitutions) that time and again have served as an ‘obstacle’ to perceived crisis solutions.
• Irrespective of the outcome, the vote will not derail the euro fiscal compact as it only requires 12 member state ratifications before entering into force, though it could well limit the impact of the pact.
• Those that thought that the complicated political situation in Europe could be reduced to a simple 26 vs 1 narrative, following Cameron’s ‘veto’ to an EU27 Treaty back in December, have received another reminder as to why that isn't the case.
But the likely approach of tying a Yes vote to access to more bailout funds and greater security and a No vote to a eurozone exit is already worryingly over-simplistic. Finally injecting some democracy into the eurozone crisis should not be watered down by pigeonholing it into tightly defined categories.
That said, as we've noted, the fiscal pact has already been watered down itself and signing up to it would not be the end of the world for Ireland - but only if that's what the people decide after a full discussion of the issue.
‘Selective default’ is essentially a partial default rating (in this case validly applied due to the current restructuring which Greece is undergoing and the fact that some bonds held by the ECB have been exempted). Under the ECB’s rules, when a country (and therefore its debt/bonds) is classified in any form of default its bonds cannot be used as collateral for the ECB’s lending operations. The ECB released a statement confirming as much this morning.
The kicker here is that Greek banks are completely reliant on ECB lending for their liquidity needs – they could not survive without it. Unfortunately, a huge majority of the assets which Greek banks use as collateral with the ECB are tied up with the Greek state (Greek government bonds or bonds backed by a Greek state guarantee). The plan to deal with this issue is for the majority of lending to Greek banks which currently takes place under the ECB to move to the Greek Central Bank’s Emergency Liquidity Assistance (ELA) programme. The ELA has lower collateral requirements and therefore will presumably continue to accept the 'defaulted' Greek bonds as collateral.
This is an unprecedented move and should stop Greek banks collapsing. That said the opacity and secrecy of the ELA means it will be even harder to figure out what is going on within the massive sovereign banking loop in Greece.
As a refresher, we present an article we wrote last September on the ELA for the World Commerce Review. It provides a comprehensive run down of how the ELA works and what implications its use could have for eurozone.
To read the article see here.
Monday, February 27, 2012
Not exactly bed time reading.
As expected, the Bundestag voted to approve the package, by 496 votes in favour compared with 90 against and 5 abstentions. We'll provide a breakdown of the votes alongside some further analysis in due course.
While approving the deal, many MPs were unhappy (Die Linke's Kathrin Vogler specifically raised the issue) about having had only a few days to read through, digest and then analyse a document which came to no less than 726 pages, including hugely complicated issues such as explaining different options for bond swaps, how the swap would work and the impact on Greece's debt sustainability (and therefore the risk to German taxpayers).
The agreement was only reached in the early hours of Tuesday morning, and the Bundestag's budgetary committee only looked into the details on Friday, meaning ordinary MPs only got hold of the documentation over the weekend.
This begs the question, how in the world are MPs supposed to fulfil their role scrutinising the decisions reached by governments. The bailout took eight months to organise, now MPs were expected to approve it with a weekend's notice (at least with respect to the details). Given the number of unanswered questions and heroic assumptions on which the agreement shakily rests, this is a pretty scary situation.
In fact, if this is the future of parliamentary/constitutional democracy in the eurozone, you'd forgive national parliaments for believing that is a price not worth paying for keeping the eurozone intact.
This morning’s FT noted that RBS and Lloyd’s are considering borrowing from the ECB’s long term refinancing operation (LTRO). Remember, the LTRO is the ECB's 'bazooka' response to the eurozone crisis, giving banks across the eurozone access to very cheap long term credit (aimed at avoiding a deep freeze in the banking system, e.g. banks stop lending to each other, which in turn could cause sovereign debt market drying up = Bye Italy).
That banks in Britain - a country that has refused to participate in euro bailouts - now ask for cash from the ECB looks pretty bad on the surface. At least for those not familiar with the ins and outs of central bank financing. And sure enough, the Left Foot Forward blog suggests that the ECB is now “bailing out” UK banks.
Hmmm, not quite.
First, this is actually not new. RBS (€5bn) and possibly HSBC accessed the first LTRO back in December when there was little furore over the process and there has been little fallout since.
But more importantly these banks are providing collateral and borrowing under standard repurchase agreement (repo) terms. Their reason for doing this is not because they cannot borrow this money from the Bank of England or because they could not survive without it - which the Left Foot Forward blog and some others seem to believe - but simply because it is a cheap source of euros. These banks have extensive operations and exposure to the eurozone and therefore it makes practical and economic sense for them to tap the ECB’s lending operations if possible.
All the ECB is doing is taking on the exchange rate risk for these banks (similar to the US dollar swap line – see here for our analysis of this). These banks could obtain this money in pounds and then change it to euros, but then they would have to incur the cost of the transaction and hedge against the risk that the exchange rate could shift significantly over the period of the loan. The UK government or the Bank of England (BoE) could’t really fulfil this role, unless it set up a direct swap line with the ECB (which is redundant since these UK banks can borrow from the ECB directly through their subsidiaries – as they are doing).
In other words, this does not represent any extra risk for the UK or eurozone governments (since collateral is posted) or any failing on the BoE’s part, but simply the subsidiaries of the banks making a practical decision about how to help fund their exposure to the eurozone. Now, there certainly are problems with the LTRO and the risks it poses for Europe's taxpayers in the eurozone long-term. If anything, it would be more concerning if taxpayer-backed banks did not seek to obtain funding at a lower comparative cost and cover their exposure to the eurozone crisis, given that the move is risk-neutral.
We would note the irony in that some in the UK are calling for ECB style unlimited three year lending to banks, while many in the eurozone are calling for UK style ‘Quantitative Easing’ – we guess the central banking grass is always greener…
With the debate ahead of the Bundestag vote on approving the second bailout package for Greece due to get underway in 30 min or so (as ever we will be covering the event live on our twitter page @openeurope), Germany's biggest selling tabloid, Bild Zeitung, has upped the ante calling on MPs to vote against the package.
Under the brilliantly simple headline "STOP" (see picture above), Bild writes:
"Once again, it's payday in the Bundestag. €130 billion are meant to save Greece from ruin. Bild appeals to all MPs, do not proceed with this folly!"The entire page 2 of the paper then features a range of interviews with economists, such as the German Guru Hans-Werner Sinn, explaining why Greece is a "bottomless pit" and why it "can't stand on its own two feet even with this bailout". The Chief Economist of Deutsche Bank, Thomas Mayer, says that a euro exit should not be "taboo" anymore.
It's pretty strong stuff.
Remember, as we've pointed out before, Bild is a huge paper - by far the best selling paper in Germany (far bigger than the Sun for example) and according to some measures, the paper with the widest circulation outside Japan.
In other words, it has a lot of political clout and serves as an important barometer of public opinion, which you mess with it at your peril. A poll in Bild Am Sonntag also showed that 62% of Germans are against the second Greek bailout (up from 53% in September).
But how many MPs, not including those who were already going to vote against, will be swayed? Given that the opposition SDP and Green party will back the government there is virtually no chance of the bailout being rejected, so the issue is how many coalition MPs will rebel, and whether it will be more than the 15 who voted against the expansion of the EFSF back in September.
If Merkel is unable to rely solely on her MPs to pass through the bailout, it will have serious repercussions for the continued viability of the government...
Open Europe has today published a new report looking at the EU’s farm policy – the Common Agricultural Policy (CAP) – and how it could and should be reformed. As we set out in the report, the UK gets a bad deal from the CAP, contributing £7.1bn more than it gets back over the current EU budget period. At the same time, the subsidies it receives are spent in a way that actively channels resources away from areas and sectors that could generate the most economic or environmental benefits.
Short of entirely liberalising the policy, Open Europe has proposed a radical overhaul, linking subsidies to measurable environmental benefits, while allowing productive farmers to opt in or out of the scheme. At the same time, the overall CAP budget would be rationalised, reducing the UK’s contribution to the EU budget by £7.3bn over seven years.
The full report can be downloaded here, but these are the key points:
- On-going negotiations over the EU’s long-term budget provide an opportunity for the UK to reverse the serious poverty of vision that has characterised British diplomacy and government thinking on CAP reform for decades – but the window for doing so is quickly closing.
- The UK remains a big loser from the CAP. Between 2007 and 2013, the UK will contribute £33.7bn to the CAP and get back £26.6bn; a net contribution of £7.1bn. Per hectare, the UK receives £188, compared to for example France, Germany and the Netherlands which receive £236, £251 and £346 respectively.
- There remains no clear link between the wealth of a country and how much it receives from the CAP. Latvia, for example, gets £115 per hectare from the EU’s Single Payment Scheme – the least out of all member states – despite average farmers’ income being only 35% of the EU average. By contrast, wealthier member states such as Ireland and France continue to do well out of the CAP.
- Despite a series of reforms, the main ‘benefit’ of the CAP is that on the whole, it is less damaging than it used to be. Owing to its arbitrary design and contradictory aims, the CAP fails to meet its own objectives of delivering bio-diversity, boosting farmers’ competitiveness and promoting rural jobs and economic development.
- The share of the CAP spent on explicit environmental aims in the UK is only 13.6%. By failing to differentiate between different types of land, direct CAP subsidies actively channel public resources away from where they could create the biggest environmental gain.
- At the same time, by providing income support irrespective of whether any meaningful economic activity takes place on a farm, direct CAP subsidies often act as an outright disincentive for farmers to modernise, in turn locking in unviable business models and hurting Europe’s competitiveness.
- The cost to consumers and taxpayers across Europe of the EU’s farm subsidies and tariffs now stands at €86.9bn – of this €52.5bn stems from CAP subsidies. If, hypothetically, the CAP and other EU measures to protect farming, such as tariffs, were fully liberalised and the money freed up were re-channelled to more productive areas of the economy, it could be worth a boost in output equivalent to €139bn or 1.1% of EU GDP. Britain would experience a boost in output of €14.2bn or the equivalent of 135,000 full-time and part-time jobs.
- Full liberalisation of the CAP would be economically viable. However, given the widely held belief that that there is still a role for the state to play in delivering objectives such as bio-diversity, land management and R&D, such an option is most likely to gain political support.
- Therefore, we propose a pragmatic mix: a new, radically revamped EU farm policy, allowing for resources to be effectively allocated to both production and environmental benefits while better targeting jobs and growth. This would involve four steps:
1) The current CAP structure would be replaced with a system of agri-environmental allowances. Funding for member states would be allocated according to environmental criteria, such as bio-diversity, but be administered nationally. Payments could then be transferred between farmers depending on where the environmental gain is the greatest.
2) After complying with some minimum environmental standards, farmers would then be free to opt in or out of this scheme, with those farmers wanting to focus exclusively on production being free to do so.
3) EU-level funding for rural economic development should be limited to the poorer member states only, and be migrated over to the EU’s structural funds. Farmers should also be able to qualify for time-limited support from a fund similar to the EU’s Globalisation Adjustment Fund, targeted at making farmers more competitive and able to move into other parts of the economy.
4) A limited pot of money for agriculture related R&D should remain at the EU level.
- By simultaneously streamlining the CAP budget, such a system would reduce the UK’s contribution to the EU budget by £7.3bn over seven years.
Friday, February 24, 2012
Were they about the future of Greece? Or the lack of growth in the eurozone? No.
The briefing was supposed to remain secret, but it soon became common knowledge in the crowded press room. A German journalist asked Rehn whether he was planning to extend such "confidential briefings" to female reporters at some point. Clearly embarrassed, Rehn managed to put together an answer,
I've regular contacts with journalists, in various contexts, on and off the record. I take note that there's an interest with regard to these meetings.
Some things are best kept under wraps Olli...
Thursday, February 23, 2012
As usual, we would like to start with Germany. The front page of Die Welt ran with an unequivocal headline,
Europe: Welcome to the Transfer Union
Prices must fall if Greece wants to compete with its neighbours in agricultural products or tourism. Such an adjustment usually works via the exchange rate with the devaluation of the own currency. But members of the monetary union have relinquished this instrument. In Greece wages and prices would have to fall by half in order to become as successful as Ireland. That is too much – there is a lack of will and force. Therefore, a third credit package is coming – or the farewell to the euro.
In Die Welt, political commentator Günther Lachmann warned,
Europe is being radically changed. With regulations in a Socialist-style language the EU is trying to govern nation-states...The kind of consequences this has can now be seen in Greece. There, the government is actually thinking of changing the constitution, at the request of the EU, to give absolute priority to debt repayment.
[Greece] is de facto being completely put under custody...This has nothing to do any longer with the normal democratic order of a sovereign state.
The euro has condemned European citizens to deal with each other more than they may really want to. Can Europe go on this way?
Greece must choose between money and democracy.
Are being floated without any serious protest coming from the European Commission, the European Council or even the European Parliament.
In Italy's main business daily Il Sole 24 Ore, editorialist Carlo Bastasin noted that, with the second Greek bailout,
Europe enters into the heart of the state’s supreme authority, showing that monetary and fiscal policies are now detached from the sphere of the nation’s exclusive prerogatives.
This European way out of the crisis in which national institutions democratically elected by citizens are gradually losing the effective ability to rule their countries…to the advantage of European institutions chosen by states will do nothing but distance even more the citizens from the so-called European project.
Greece’s temporary suspension from the euro and the circulation of the new drachma in parallel would allow for the effective devaluation of Greek prices and costs, once and for all and without so much social discontent.
Marathon can refer to one of two things: one of the most decisive battles in history, in which the ancient Greeks repelled the threat of the Persians and a disastrous future, or the long-distance race which marks the lung-busting effort of messenger Pheidippides to inform the Athenians of victory over the invading army...Where these two allegories might cross paths in the case of modern Greece in the wake of the Eurogroup’s bailout decision is that the country might escape the clutches of disaster but its people, like the ancient messenger, might collapse from exhaustion.
Two years ago, European leaders concealed the gravity of the situation of the sickest economy of the eurozone, and pretended to believe that, with some tens of billions of aid, [Greece] would be put back on its feet and miraculously regain the markets’ confidence. Not only was this a complete failure, but such a denial of reality also undermined the credibility of the eurozone as a whole and contributed to make the crisis worse. So that nowadays it’s frankly paradoxical that the more cautious, those who warn against the risks, those who don’t rule out a Greek default in the coming months, are relegated with disdain into the ‘anti-European’ camp.
Over the coming years, Greece will be watched over by an impressive number of EU and IMF observers. It must commit, in its constitution, to prioritising the reimbursement of its foreign creditors. Can this stand up to the exasperation of [Greece’s] public opinion and part of the political class? For the first time in the history of the European construction, a member state is deprived of part of its budgetary policy prerogatives.
In Swedish daily Dagens Nyheter, columnist Annika Ström Melin argued,
The crisis is not only about the survival of the euro. A rescue package for democracy will be required as well. Even more secret meetings and ingenuous but incomprehensible agreements between the representatives of the political elite are not enough to save the European project.
Trading sovereignty in exchange for financial assistance could be acceptable if it were a temporary measure, until Athens is ready to stand on its own feet again. However, this is not going to happen – the agreement reached in Brussels contains…utopian macroeconomic assumptions regarding Greece’s debt, deficit and growth prospects which could only be achieved if Greece were to completely overturn its economic, administrative and political system and replaced its pathology with a healthy state and economy…Let it be a warning to others.
New debt issued by the Greek government in 2014/2015 will essentially be junior to existing debt. This raises the question why private creditors would want to purchase Greek debt at all in three years' time, given that they would be first in line for any losses if Greece’s economy goes down the tubes. Taken together with the tough austerity targets which could choke of any chance of recovery, as the [debt sustainability analysis] admitted, this may force Greece to seek another €50bn bailout after 2014 [as investors will have little incentive to hold Greek bonds].
This is enough reaction for one day, but if you want to stay on top of the latest developments in the eurozone crisis, follow us on Twitter @OpenEurope.
Wednesday, February 22, 2012
However, his nomination was far from a smooth process, with the junior coalition party, the FDP, pulling off an extraordinary coup by instating Gauck ahead of more 'establishment' candidates preferred by Merkel. The FDP has had a tough time of late; derided for its lack of effectiveness and credibility (its promised tax cuts not deliverable in the current climate), riven by internal infighting (not least over the eurozone bailouts) while opinion polls consistently put them under the 5% required to win Bundestag seats. The party therefore saw the 'Presidential poker' - as the German media dubbed the nomination process - as an opportunity to hit back and outmaneuver Merkel by working with opposition parties to install Gauck - the people's choice - as opposed to another of her political allies, like Wulff had been.
“In the darkest days of the cold war, trust between the Soviet Union and the USA was better than trust [between the parties] in this coalition.”While a break-up of the coalition and early elections look very unlikely, not least because of the FDP's dire polling figures, there has been much speculation that the party's actions during the 'President poker' should be interpreted as positioning for a potential future 'traffic lights' coalition (SDP + FDP + Greens). Following last weekend's success, it could well be the case that the FDP will adopt further attempts at 'differentiation', putting a strain on the unity of the coalition. This could have potentially serious consequences given that the eurozone crisis could well take another turn for the worse, for example if Portugal is found to require further assistance, or if the agreement on Greece's restructuring and 2nd bailout started to unravel.
The second way in which Gauck's nomination could be significant is the potential for him to challenge Merkel's handling of the crisis, if he feels that too many constitutional rules and democratic principles are being circumvented. While the position is largely ceremonial, it does also carry some political clout, with the public looking to the President for leadership beyond the realm of party politics, particularly in such a time of crisis. As a leader in yesterday's Welt argued:
"[Gauck] will be a strong president. His word will carry weight next to that of Angela Merkel. It may well be that Merkel is not really comfortable with that prospect."Another comment piece in the same paper added that:
“Gauck is a real trumpeter for civil society... praising the ordinary, everyday variant of democracy, including its slow pace and its unsightly political machinery... he will always have something to say.”Given the ongoing debate in Germany about constitutionality, democracy and transparency in the context of the crisis, it will be interesting to observe how Gauck, a committed pro-democracy activist who is certainly not afraid to speak his mind, will respond if the demands of crisis management continue to put these under pressure. As an independent figure, Guack will be free to act in a way that Wulff, who owed his position to Merkel, was not. This is certainly an area worth keeping an eye on, not least on March 18th, when the new President heads on a state visit to Greece...
Tuesday, February 21, 2012
Unfortunately, it is once again hopelessly optimistic and contains numerous gaps and unanswered questions which could still bring down the whole deal. This is nowhere outlined better than the damning leaked debt sustainability analysis (see here for full doc).
Below we outline a few key issues (not exhaustive by any means, there are many more) and give our take on how they could play out.
Greater losses for private sector bondholders: Reports suggest the Greek government was sent back to the negotiating table with bondholders at least four times during last night’s meeting. Nominal write downs for bond holders now top 53.5% (or around 74% net present value). The leaked Greek debt sustainability analysis (DSA) assumes a participation rate of 95%.
Open Europe take: 95%, really? We weren’t convinced the previous threshold of 90% with a lower write down would be reached and that was while potential ECB participation was still on the table. Although this target may have been agreed with the lead negotiators for the private sector, it is far from a cohesive group, diminishing the value of the agreement. It will be interesting to see how bondholders respond to the plan but we think that hold outs could well be more than 5%.
Greek ‘prior actions’: The deal includes a list of requirements which Greece must meet in the next week to get final approval for the bailout. These include: passing a supplementary budget with €3.3bn in cuts this year, cuts to minimum wage, increase labour market flexibility and reforms opening up numerous professions to greater competition.
Open Europe take: The now infamous €325m in cuts still needs to be specified. The huge adjustments to labour markets and protected professions mark a cultural shift in Greece – pushing these through will not be painless and could result in further riots.
Fundamental tensions in objectives of the programme: The DSA notes that the prospect achieving a return to competitiveness while also reducing debt is very small – the massive austerity could induce a further recession.
Open Europe take: As we have noted all along the assumption that Greece can impose massive levels of austerity and then return to growth in the next two years is a big leap and almost inherently contradictory. We’d also note that the cuts in expenditure in Greece are larger than have been attempted anywhere in recent memory (successful or failed). Likely to be substantial slippages in the austerity programme while the growth programme remains almost non-existent, essentially closing the book on Greek debt sustainability.
Further favourable treatment for the ECB: ECB and national central banks avoid taking losses on their holdings of Greek bonds but promise to redistribute ‘profits’ from these holdings so that they can be used in Greece.
Open Europe take: See our previous post for a full discussion of this issue. Markets still don’t seem too worried by suddenly being subordinated by central banks in Europe – they should be. This raises questions of the basic premise that all bonds are treated the same, based on who issued them not who holds them. As we’ve noted before, the whole concept of ‘profits’ is misleading, while any distribution would happen anyway – this is not a commitment from central banks but a further fiscal commitment by the eurozone (should really be included in total bailout funding).
Greece may not be able to return to the market even after three years: The DSA points out that any new debt issue will essentially be junior to existing debt, hampering the chances of Greece issuing new debt in 2014/2015.
Open Europe take: This point isn’t too clear but given that the eurozone, IMF and ECB will own such a larger percentage of Greek debt in 2014 any new private sector debt will be massively subordinated and at risk of taking losses if anything goes wrong with the Greek programme. Additionally after the restructuring the remaining private sector debt will be governed under English law and will have the EFSF sweetener – further subordinating any new debt issued to the market. Why would anyone want to purchase Greek debt in this situation (especially given the other concerns above)?
EFSF funding requirements: The EFSF will have to raise €70.5bn ahead of the bond swap – €30bn in sweeteners for the private sector, €5.5bn to pay off interest and €35bn to provide Greek banks with assets to use to gain liquidity from the ECB.
Open Europe take: We’ve already questioned whether raising these funds so quickly can be done and whether the approval from national parliaments will be forthcoming. Even if it is the €35bn is said to fall outside of the €130bn meaning it is expected to be returned swiftly – given the uncertainty over how long banks will need these assets (as long as Greece as declared as in selective default by the rating agencies) this may be a generous assumption.
There is also no talk of the money to recapitalise banks. This is a risky strategy given that Greek banks’ main source of capital (government bonds) will have just been wiped out significantly. The needs were previously specified at €23bn, although reports now suggest they could top €50bn. It’s not clear where this money will come from or when it will be raised. The bond restructuring will be like dancing through a minefield for Greek banks.
We’re still trawling through the responses, analysis and documents to come out of the meeting – meaning there are likely to be plenty more questions and uncertainties to come.
The one thing that is clear is that even if this bailout is ‘successful’, it will set Greece up for a decade of painful austerity and low growth leading to social unrest, while the eurozone will have to provide on-going transfers to help it keep its head above water.
Sorry to be killjoys but as Dutch Finance Minister Jan Kees de Jager put it, the deal isn’t “something to cheer about”.
Monday, February 20, 2012
A potentially telling picture from inside today's meeting of finance ministers...?
Unlikely, but still an unfortunate snapshot. In other shocking news, reports suggest that the meeting is moving along slowly with little progress on issues such as getting the Greek debt to 120% of GDP in 2020, the escrow account or how big a presence the EU/IMF/ECB troika should have on the ground in Greece.
It's going to be a long night...
Other captions welcome in the comments (h/t FT live blog)
- There remains at least a €6bn gap in the Greek funding plan and Germany, the Netherlands and Finland have set a ceiling of €130bn on the size of the second Greek bailout. The meeting must find a way to fill this gap – reports suggest it will be done through a combination of a write down on the Greek debt held by national central banks and a reduction in the interest rates charged on the initial Greek bailout, while discussions are on-going over the redistribution of profits from the ECB’s holdings of Greek debt (which as we point out here is nearly impossible).As we outlined in a recent briefing, eurozone leaders will struggle to find an agreement on these issues (along with many others).
- Currently the debt sustainability analysis shows Greek debt at 129% of GDP in 2020, above the target of 120%. This may be in addition to the funding gap mentioned above (although this isn’t clear).
- Will the eurozone accept and approve the lower IMF contribution? Reported to be only 10% this time around, compared to 30% in previous bailouts (also raises questions over the IMF’s support for the programme more generally).
- Following the Greek restructuring, Greece will be declared as in ‘selective default’ by the rating agencies. Any Greek bonds will not be eligible as collateral to gain loans at the ECB. This essentially means Greek banks will be stripped of assets which they use to gain the ECB funding upon which they are completely reliant. The plan suggests providing them with €35bn in assets, although outside of the bailout funding. Where will this money come from? Likely to take the form of EFSF bonds, although the creation of these bonds will still need to be approved by the eurozone in the same manner as if it were lending cash directly.
We’ll update this blog with any big news throughout the day.
Friday, February 17, 2012
There are basically three options for Greece: a debt write-down that creditors agree to voluntarily, coercive restructuring (where Athens uses contract-based provisions to not pay back its creditors) or disorderly default (all hell breaks loose). Today’s deal has reduced the risk of the latter while increasing the chance/risk of the first two. However, it still hasn’t answered the question whether the ECB will actually itself take losses – or participate in some form – in a Greek restructuring.
Why is the ECB swapping its current holdings of Greek bonds for new ones?
Under this arrangement, the new bonds will be distinguished from the old ones in some way (possibly through different serial numbers) allowing Greece to pass legislation which retroactively imposes collective action clauses (CACs) on the rest of Greek debt held outside of the ECB. (This is sort of like the government hiking the tax rate today and then trying to claim 10 years of back tax at this higher rate). While a number of bondholders could agree to take write downs voluntarily, the remaining ones could be forced to do under these CACs. But the ECB is now safe. This matters tremendously since, if Greece went for a coercive restructuring without any special protection for the ECB, the institution could be faced with major losses and huge dents to its credibility – since it continually denied that it was taking too much risk since it saw a Greek default as impossible. The Eurozone and Germany in particular is keen to avoid this (see here for a whole range of political reasons why).
Open Europe take: While we have sympathy with the ECB for trying to avoid losses, this is a rather strange move (and a result of their flawed policy approach we might add). The preferential treatment it now has on Greek debt, suggests that the ECB’s wider holdings of eurozone debt from its bond purchase programme (around €220bn) are senior to eurozone debt held elsewhere. This could create uncertainty in the bond markets of the southern eurozone states, as bonds held by private creditors are much more likely to be next in line for a write down. More importantly, it also opens the ECB up to legal challenges, since some bond contracts will have clauses protecting them against subordination (negative pledge clauses). Importantly this worrying precedence is reported to be the reason why Bundesbank President Jens Weidmann objected to the move, further highlighting the fundamental disagreements within the ECB itself.
Doesn’t this increase the prospect of a voluntary restructuring?
The swap seems to have gone down well with markets. The perception is that private creditors – those that still hold out – will be much more likely to now accept voluntary losses, which – finally – can bring a conclusion to what has seemed like endless talks between creditors and the Greek government.
Open Europe take: The risk of a disorderly default on the 20 March has radically decreased, which must be considered a good thing. The Greek threat of forcing a coercive default using CACs is now much more credible (it can be done with fewer legal complications) which should force private sector bondholders to pull their finger out since they could face far greater losses under a coercive restructuring. At the same time, Greece now actually has the tools to push through a coercive restructuring (via the CACs) and a larger write-down, meaning that this option is still very much a possibility. So perhaps the markets are getting ahead of themselves.
Does this provide any additional debt relief for Greece?
No. There has been some confusion over this point. Currently the swap is 1:1 meaning the ECB will not take any losses or provide any monetary benefit to Greece. The ECB does seem to have agreed to distribute its ‘profits’ (revenues from the interest payments) on the new holdings so that they can be used to aid Greece.
Open Europe take: As we have noted before, the official sector will take losses in Greece, now or in the future (better now). The ECB should not take direct losses but forgoing the difference between the purchase and nominal price of its holdings of Greek debt would be beneficial. On a side note this episode highlights the lack of transparency surrounding the ECB's actions in the eurozone crisis. Despite purchasing the bonds at a discount the ECB holds the bonds at nominal value on its balance sheet, therefore selling them at purchase price means the ECB would still book a loss on paper. This is not an argument against the ECB providing some debt relief to Greece in of itself (by selling the bonds at purchase price), but more that the ECB does not correctly display risk on its balance sheet and did not create enough safeguards against such an event when it first decided to purchase eurozone government debt.
Furthermore, the concept of redistributing ECB ‘profits’ is flawed. The ECB already pays out any profits it makes to eurozone member states. It is then up to them to use the money how they see fit – it is a political decision, meaning the ECB’s comments about profits being used to aid Greece in this sense are more or less irrelevant.
Is this the end of the discussion with the ECB and Greece then?
Not quite. Once the switch to the new bonds has occurred there could still be scope for the ECB to offload them and sacrifice the difference between the purchase price and nominal value of their Greek holdings. The voluntary restructuring will move ahead and if it does not provide enough debt relief the pressure on the ECB to provide some additional relief will increase again.
Open Europe take: As we note above, Greece will probably need help from the ECB at some point. The Greek negotiating position is now significantly weakened since the ECB has greater protection. The ball is firmly in the ECB’s court – not exactly desirable given the opacity and stubbornness which it has presented so far in the eurozone crisis.
Swedish Finance Minister Anders Borg – top of the pile in Europe according to the FT – today gave the EU committee of the Swedish Riksdag the lowdown ahead of Monday’s meeting of EU finance ministers (in some countries, lo and behold, ministers are actually accountable to their parliaments for what they say and do at EU summits). Amid all the gloom and doom, Borg outlined seven reasons to now be more optimistic about the state of the European economy:
1. The risk posed by Greece to European banks has been substantially reduced
2. The ECB has taken strong actions
3. The talks with private creditors over a Greek debt write-down are about to be concluded
4. The Italian government is pushing ahead with reforms
5. The Spanish government is pushing ahead with reforms
6. A solid recovery in the US
7. The Chinese government believes that its growth will remain relatively strong in 2012
Enough to believe that the worst is behind us? You decide.
Ps. For some Friday 'entertainment', you may wish to check this out - a rather odd sample of Swedish humour....
As Welt journalist Florian Eder pointed out on twitter, with German President Christian Wulff's resignation this morning over the long-standing property scandal, Bild has claimed a significant victory (the paper played a key role in uncovering the scandal and called on Wulff to step down).
Will it also get its way on Greece?
- A new poll published by Greek magazine Epikaira confirmed that the Greek electorate is moving towards the extremes of the political spectrum. New Democracy - the centre-right party led by Antonis Samaras - is credited with 27.5% of votes, while former Greek Prime Minister George Papandreou's PASOK lags well behind with 11%. In total, the two 'mainstream' parties would therefore get 38.5% of votes. The Greek Communist Party, Democratic Left and the Radical Left Coalition (SYRIZA) are credited with a combined 43.5% of votes, but the first has ruled out entering a coalition with the other two hard-left parties. These results are clearly very significant, not least because they will give Germany, Finland and the Netherlands fresh impetus to argue that Greece's smaller parties should also provide written commitments to austerity. Unfortunately, as we point out in our latest briefing, at the moment it's quite hard to see any of these parties agreeing to such a request;
- PASOK's Michalis Chrysochoidis, Greek Minister for growth and competitiveness (definitely an unenviable post), told reporters in Frankfurt that his party is "in favour of an extension of the life of [Greek Prime Minister Lucas] Papademos’s government...Elections should take place by the end of the constitutional term in 2013." Incidentally, Germany, Finland and the Netherlands reportedly brought up the possibility of postponing the Greek elections during Wednesday's conference call of eurozone finance ministers;
- Greek President Carolos Papoulias' anti-Schäuble invective didn't go unnoticed in Germany. CDU MP Christian von Stetten yesterday said that, without the German Finance Minister, Greece would already have been bankrupt a long time ago. The Greek President's intervention, he went on, was "unthinkable" and "absurd". Most significantly, Mr von Stetten said that Papoulias' words would "certainly impact" on the Bundestag vote on whether to approve the second Greek bailout, due on 27 February;
- According to Die Welt, the ECB has started the announced swap of its €50 billion Greek government bond holdings for new Greek bonds. The ECB is swapping the bonds at their nominal value, meaning that it is making profits out of them. These profits will then be distributed via national central banks to eurozone governments, which will have to decide whether they want to return the money to Greece as part of the second Greek bailout. The swap will be reportedly completed by 20 February. We will expand on this specific point later;
- Separately, Schäuble is also said to have rejected the idea of providing Greece with a bridge loan to avoid the country defaulting on 20 March - when Greece needs to redeem €14.5 billion worth of its debt - and uphold the rest of the second Greek bailout until after the elections as a means to maintain pressure on Athens.
Thursday, February 16, 2012
The briefing argues that, realistically, only a few of these issues are likely to be fully resolved before the deadline meaning that Greece’s future in the euro will come down to one question: whether Germany and other Triple A countries will deem this to be enough political cover to approve the second Greek bailout package.
In particular, the briefing argues that recent analyses of Greece’s woes have underplayed the importance of the problems posed by the large amount of funding which needs to be released to ensure the voluntary Greek restructuring can work – almost €94bn – as well as the massive time constraints presented by issues such as getting parliamentary approval for the bailout deal in Germany and Finland. While the eurozone also continues to ignore or side-line questions over the whether a 120% debt-to-GDP ratio in 2020 would be sustainable and if, given the recent riots, Greece has come close to the social and political level of austerity which it can credibly enforce.
The briefing concludes that, ultimately, there’s no way Greece can actually ever fully meet the conditions laid down by the EU and IMF – particularly if they keep piling on new demands. The scale of the cuts goes far beyond any fiscal consolidation – successful or failed – that any country has gone through in living memory. The question is instead one of how long the eurozone’s charade of unrealistic conditions in return for more bailout cash can continue. Specifically, will Germany and other Triple-A countries accept half-baked solutions to the big unanswered questions that still haunt the efforts to save Greece?
To read the full briefing click here.
What are his chances?
Rivals for the Elysee dismissed the event. Le Pen called it a “non-event…of no political importance” and centrist candidate Francois Bayrou slammed Sarkozy’s time in office “his record speaks so much louder that anything he can say”, mocking the incumbent’s analogy of a captain refusing to abandon his ship, “when a captain has steered his ship onto rocks, it’s time for change”.
But historical precedents need not necessarily apply. In 2007 Sarkozy proved himself to be an expert campaigner, able to inject dynamism into the Elysee race, and capable of appealing to wide sections of the electorate. Recent positive figures on French growth (0.2% in the last quarter of 2011, compared to recession in the rest of the eurozone) could bolster the incumbent’s argument that he has the experience to lead an embattled France through the economic crisis.
On the whole though, this looks unlikely. Sarkozy has led an erratic unofficial campaign since January. The proposal to introduce reforms to the sclerotic French labour market last month was widely perceived as an electoral mistake. It is unpopular with the French, and is ill-timed, if necessary. Angela Merkel’s endorsement of his re-election was awkward, as it came weeks ahead of Sarkozy’s official announcement, and jars with his recent decision to appeal to Le Pen’s anti-euro, anti-German supporters. In addition, his pledge last night to “put work at the heart of everything” was too similar to his undelivered 2007 campaign promises.
It's argued that Sarkozy's real chance in re-election lies with Le Pen. If the FN candidate fails to secure the 500 mayoral nominations needed to present herself at the ballot, Sarkozy will benefit from a boost in support. Despite his pro-Euoprean stance, it is likely that far-right supporters will be wooed by promises of referendums on the rights of immigrants and the unemployed. This is something Sarkozy is aware of: tellingly, he refused to back Bayrou’s plea for a reform of the nomination system. A poll published earlier this month found that Sarkozy and Hollande would equalise in the first round if Le Pen did not run in the election. However, although this would provide Sarkozy with a boost in the first round, it wouldn't make a difference to his second round chances, where he continues to trail behind Hollande with 43% compared to the Socialist candidate's 57%. In all likelihood, Le Pen will not make it to the second round, so her inability to run on the ballot won't change Sarkozy's chances. Looks like Nicolas needs to try harder to win over the electorate.
Wednesday, February 15, 2012
However, he has finally bowed to pressure. Here is a link to the letter Samaras sent to the European Commission, the ECB and the IMF to reassure them that he will stick to the latest round of austerity measures adopted by the Greek parliament on Sunday if he wins the next general elections in April.
Predictably, media reports are focusing on the following part of the letter,
If New Democracy wins the next election in Greece, we will remain committed to the [Greek Stabilisation] Programme’s objectives, targets and key policies.Given that former Greek Prime Minister George Papandreou has already sent over to Brussels a similar commitment on behalf of his Socialist PASOK party, on the surface Greece seems to have made another crucial step towards its second bailout.
However, doubts remain over the strength and the actual relevance of the commitment sought by Greece's public lenders. Firstly, as Samaras specifies in his letter,
Prioritising recovery along with the other objectives, will only make the [Greek Stabilisation] Programme more effective and the adjustment effort more successful. Therefore...policy modifications might be required to guarantee the Programme’s full implementation. And, once again, we intend to bring these issues to discussion along with viable policy alternatives.Indeed, this is supposed to happen "strictly within the framework outlined by the Program, so that the achievement of its objectives will not be put at risk." Still, this reads like a clear hint that, at some point, Samaras may want to give a boost to Greece's public spending in the name of economic recovery.
Secondly, and most importantly, are the Commission, ECB and others really liaising with the right people in Greece? In other words, is a written commitment from only PASOK and New Democracy enough to ensure that Greece will keep doing its homework regardless of who wins the next elections? According to the latest opinion polls, the answer seems to be a 'no'.
In fact, Samaras' party is currently polling at 31% - definitely not enough to secure an absolute majority in the Greek parliament. The problem is that New Democracy's 'natural' ally in a hypothetical coalition, the far-right LAOS party, recently withdrew its support for Lucas Papademos' technocratic government precisely because it didn't want to back the latest round of austerity imposed on Greece.
Crucially, the polls show that not even a German-style (unlikely) Große Koalition between New Democracy and Papandreou's PASOK would be enough. With PASOK credited with only 8% of votes, the two parties would put together less than 40% of votes - still not an absolute majority.
In other words, Athens' public creditors seem to have lost touch with the political reality in Greece. And the reality is that, as the two 'mainstream' parties are increasingly seen as mere executors of the requests coming from the EU, Germany, France and others, the Greek electorate is moving towards the extremes of the political spectrum. As the FT's Gideon Rachman points out, three far-left parties account for 42.5% of the votes - so potentially more than New Democracy and PASOK together.
Perhaps the European Commission should try and pick up its interlocutors a bit better. Or, perhaps, people in Brussels think that Greek voters will feel 'encouraged' to vote for either New Democracy or PASOK as they are the only two parties which can make sure that Greece gets its second bailout...
However the poll also had a number of other interesting findings which are worth highlighting:
- 42% support Poland’s accession to the intergovernmental ‘fiscal treaty’ vs. 35% against
- 57% are opposed to Poland lending an additional €6.3bn to the IMF to possibly support vulnerable eurozone members vs. 32% in favour
- 62% believe that further European integration would be beneficial for Poland vs. 26% who believe otherwise
- 81% believe EU membership is beneficial for Poland vs. 12% who believe otherwise
The poll result could serve as another reminder to those who argue that the euro is an integral and necessary component of the EU and further integration, and that rejecting the euro would signal the death knell for the European project as a whole. Ultimately this poll and other like it are good news for supporters of a more flexible EU arrangement, where countries can integrate more closely together if they wish, but can also remain outside of some common structures – such as the single currency.
As reported by the FT and the WSJ in the past day or two, a draft of the latest bailout agreement has been circulating, however we believe that some of the issues which the drafts raises have been underplayed - particularly those that impact the chance of delaying or breaking up the bailout.
The draft lays out how some of the bailout funds will be used:
Bond sweeteners - €30bnThis is money needed to make the PSI successful and allow the voluntary restructuring to be completed. Firstly, this highlights that the claims by the eurozone that they could simply push ahead with the PSI without fully approving the second bailout seem to be incredibly misleading. Without this money in place there would be a huge amount of uncertainty on the part of bondholders, particularly Greek banks who would need new capital injections to survive. However, to disperse this substantial amount of money would need full approval from the eurozone and some national parliaments. Given that it is widely accepted that the PSI needs to be put into motion this week if Greece is to avoid a disorderly default on 20 March getting this money released could be a huge stumbling block.
Funds to buy back bonds from the Eurosystem - €35bn
Funds to pay off interest - €5.7bn
Bank recapitalisation - €23bn
Total - €93.7bn (out of the €130bn bailout)
Secondly, where would this money come from? The draft stipulates that the EFSF will issue debt to raise these funds (since it currently only has guarantees), however, it is has not pre-funded any of these commitments and suddenly flooding a subdued market with over €90bn in (possibly non-triple-A) EFSF bonds is not an effective funding strategy. There is no telling how the market will react or at what cost the EFSF will be able to borrow. The urgency of the situation feeds the uncertainty here and could be catastrophic for Greece.
Lastly, with new provisions such as €35bn for bond buy backs, will €130bn be enough to fund Greece for three years? We questioned whether this was even enough originally, now it seems even more unlikely.
The chance of getting approval for and raising this amount of funds in the time necessary (a week or two max) seems unrealistic. But it is also unlikely that eurozone finance ministers will delay the PSI further, simply because they cannot afford to. The eurozone has once again backed itself into a corner and things are likely to get worse before they get better.