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Thursday, May 31, 2012

Catching depositors in your web

What's the best way to stop a bank run? Well, ask Bankia. According to Spanish business daily Cinco Días, The Spanish bank - which is set for a multi-billion state bailout - has launched an initiative called "The amazing Spiderman".

The plan is to convince Bankia's youngest depositors not to pull their money out as things are looking a bit shaky, by providing some impossible-to-resist incentives. First, any customer that can muster an account balance of €300 or more by the end of May will get a Spiderman themed beach towel. As if that wasn't enough, a lucky few winners will also be in line for:
  • A trip to New York;
  • Twelve PlayStation Vita consoles;
  • 1,050 tickets for the new movie, "The amazing Spiderman" - with 50 of the tickets to the very première.
The winners will be announced on 12 June.

And we were just starting to worry about the reported €31.44bn drop in  private Spanish bank deposits last month. This should sort it...

Wednesday, May 30, 2012

Spanish regional profligacy sits as a worrying lesson for the eurozone

In today's City AM, we argue:
Beyond the troubled banking sector, there is another potential problem on the Spanish horizon that could be instrumental in how the euro crisis develops: the central government’s relationship with the 17 Spanish regions, and particularly its ability to keep public spending at the regional level under control.

The 1978 post-Franco constitution designed Spain as a highly decentralised state. Regional statutes are treated as an integral part of Spanish law, and the regions legislate over a wide range of policy areas, from local infrastructure projects to culture and healthcare. As a result, they currently handle over 50 per cent of Spain’s total public spending.

Earlier this year, the new centre-right government, led by Mariano Rajoy, was quick to blame the regions for Spain’s failure to meet EU-mandated deficit targets. He had a point, but, ironically, some of the spendthrift regions – like Comunidad de Madrid and Comunidad Valenciana – have been led by the Prime Minister’s own party, Partido Popular, for years. More worryingly, earlier this month, excessive spending in these regions again forced Rajoy to revise upwards the country’s deficit.

This shows just how difficult it will be for Madrid to control the regions, and therefore Spain’s public spending. Spanish regions have committed to a total of over €18bn (£13.6bn) of savings by the end of 2012 – almost half of Spain’s planned deficit reduction for this year. Given their past record, the regions are unlikely to deliver, meaning that the central government would have to pick up the slack. This would put further strains on Spain’s public finances, which will need much of the ammunition at their disposal to deal with potential future bank bail-outs.

What can Rajoy do? The Spanish parliament has recently passed new legislation giving the government the power to take over the accounts of regions that look set to miss their deficit targets, and the tiny principality of Asturias may become the guinea pig for the new system. But will regions such as Catalonia or the Basque Country – which take their regional identity and independence extremely seriously – accept Madrid coming anywhere near their partial budget autonomy? It looks doubtful. The Basque Country is going to take the government to the Constitutional Court over planned cuts to health and education, while the Catalan governor, Artur Mas, has threatened to break his regional alliance with Partido Popular, unless Catalonia is granted greater tax autonomy.

Spain could be heading for a major political showdown. In theory, Rajoy’s Partido Popular holds a sufficient majority to push through legislation without the support of regional parties. This is precisely what happened with this year’s budget, when the Prime Minister’s party rejected all of the over 3,000 amendments tabled by the opposition. However, the price of consistently taking such an inflexible stance may well be greater discontent in Barcelona and Bilbao.

In general, the feeling is that Rajoy may already have reached the political limit of how much he can encroach on regional autonomy, and any further steps in this direction would require important changes to the Spanish constitution – for which there would be very little support.

So what is the significance of all of this for the future of the Eurozone? First, those that put their hope in the Spanish government being able to deliver far-reaching deficit cuts, via equally far-reaching savings in the regions, are likely to be disappointed. Spain is not going to become France – a highly centralised country where the national capital rules supreme over public spending. Spanish regions will remain a liability, and pushing them too far may trigger a huge political backlash, which would hardly benefit the Eurozone either.

But second, there’s a bigger lesson. If Spain faces difficulties in achieving more fiscal centralisation in its own country, due to political constraints, how much more difficult will it be for the single currency to achieve similar centralisation at the level of all 17 Eurozone members – considering its own number of different parliamentary and economic models, government structures, and cultural preferences? Just a thought.

Tuesday, May 29, 2012

Spain races against time

Things are looking sticky in Spain.

Firstly, the Spanish government announced a bail out of Bankia to the tune of €19bn in addition to the €4.5bn already put in - and is currently looking at the least painful way of getting cash to the bank. The plan is still up in the air. Yesterday there was talk about swopping government bonds for shares in the bank (Bankia could then use the bonds as collateral to get more cash from the ECB). This made a lot of people nervous, not least the Germans, who already worry that the link between states and ECB funding, via banks, is getting a bit too strong. Today's talk has instead focused on issuing bonds from Spain's specific bank bailout fund, FROB, to raise the cash Bankia needs.

Secondly, Catalonia - Spain’s wealthiest region - has asked the central government for financial assistance to repay its €13bn debt; bad news for the central government's debt and deficit. Thirdly, the the spread between Spain and Germany’s ten-year bonds reached its highest level since the introduction of the euro, with Spanish ten year bonds currently at around 6.4%.

There are a huge number of issues on the table here, but these events highlight three things that we pointed to in our April 3 briefing on Spain:
  • Despite Spanish PM Rajoy's remarks to the contrary, it looks increasingly as if Spain is slowly realising that it may not be able to afford to directly fund Bankia or other banks that run out of cash. And the numbers could well go up. This, in combination with talks and leaks over recent days that European money will be needed to backstop the Spanish banking system (Rajoy is very keen on more from the ECB), indicates that Spain is now moving ever closer to bank bailout via the EFSF.
  • A huge battle looms over the finances and economic autonomy of Spanish regions, that remain a massive liability for the central government's attempt to cut its debt and deficits.
  • Spain is racing against the clock. Naturally it will take time for the structural reforms that Spain is pursuing to have an impact - time that markets just won't give it at the moment.
Instead, it looks as though that time may soon have to be bought by eurozone taxpayers.

European bogies under the bed aside, does Ken Clarke have a point?

UK Justice Secretary Ken Clarke has just been on the BBC's Today Programme, taking a major swipe at those calling for an in/out referendum. Asked if he accepted that voters were deeply eurosceptic, he said "The nation is a bit eurosceptic" (no kiddin'). But he went on to say,
"The idea that they are all demanding a referendum on the European Union would be regarded as ridiculous, it would be out of sight as a public priority. It is the demand of a few right-wing journalists and a few extreme nationalist politicians."  
He said a referendum would create "absolute confusion" and that he couldn't "think of anything sillier to do...it would settle nothing. Particularly it would settle nothing with the more frenzied eurosceptics who keep believing that European bogies are under the bed." 

Hmmm. Looks like Ken is continuing arguments from ten years ago - and he comes across as very patronising. But he does have a point though: an in / out referendum would actually settle very little - and probably raise more questions than answers. In the next two weeks, we'll publish a briefing looking at these very issues. In particular, we'll look at the tiny issue of what actually happens on Day 2 if Britain did choose to withdraw (i.e. the in / out debate beyond the 'don't bother me with the details' approach that too often comes with this question).

And it ain't easy. This is one you don't want to miss...

Monday, May 28, 2012

Euro opinion polls point to more fudge

Some interesting opinion polls from the heart of the eurozone from the last couple of days:

In Greece, a series of polls shows momentum ahead of the country’s re-run election next month shifting slightly from the radical left anti-bailout and austerity SYRIZA party to the pro-bailout and austerity centre-right New Democracy party, though SYRIZA is still set for gains compared with its election result earlier this month. New Democracy, which won the elections with 18.9%, now leads with between 25.6% and 27.7%, a lead of between 0.5% and 5.7% over SYRIZA. That means that together with the establishment socialist PASOK party, which won 13.2% at the elections, a pro-bailout coalition could be formed with a majority of seats in the Greek parliament, something that evaded the parties last time.

The polls also showed support for staying the euro at 65% versus 25% against. While staying in has enjoyed a consistent majority, voters are potentially starting to re-align their party choice accordingly - realizing perhaps that ripping out the bailout package comes with massive risks - albeit this could change again before the elections and remember, SYRIZA remains the joker in the pack.

Meanwhile in Germany, public opinion seems to be shifting in the anti-euro direction, with an opinion poll published on Friday by German state TV ZDF finding that 79% of respondents rejected eurobonds as a solution to the crisis, which is a stark reminder for the rest of Europe how far away we actually are from eurobonds. Interestingly, though, support for euro membership itself was also waning, with 50% (up from 43% in February) saying they believed it carried more disadvantages than advantages for Germany, with 45% taking the opposite view (down from 51% in February).

These opinion polls - together with events of recent weeks - point towards one conclusion: we're looking at yet more fudge. As we've pointed out before, as sceptical as one might be about the future of the euro, there's still considerable scope for negotiations on all sides of the Greek crisis, and therefore, chances that the country can find a settlement and agreement with its creditors after the elections that allows it to stay in the euro remain strong. It would be different if the public were to turn against the euro itself, which it isn't at this time.

The stakes are simply far too high for another round of Russian roulette.

Friday, May 25, 2012

Anti-austerity inside the eurozone: Greek voters stick to their potentially false choice

The key trend in Greek opinion polls holds steady: voters back anti-austerity parties in great numbers but  remain committed to staying in the euro in equally great numbers. The latest Public Issue poll released yesterday put the radical left Syriza as the largest party with 30% of the vote, New Democracy on 26% and Pasok on 15%. The figures suggest a surge in support for Syriza but also a move back towards the larger parties, with smaller parties falling in the polls.

Interestingly, a poll from Ipsos suggests that 70% of Greeks would vote to keep the euro if a referendum on the issue were held today, this compares to 50% of Italians, 62% of French, 51% of Germans and 55% of Spaniards. Interestingly, 38% of Italians would vote to leave the euro if a referendum was held today - that's quite high given the country's traditional support for the single currency.

On a less surprising note, from today's Die Welt we learn that fears over Greece leaving the euro has triggered yet more Greek tax evasion. Greek tax revenues between January and April were €500m lower than anticipated in the 2012 budget, while April’s takings fell by 13% on the previous year.

That is not a good sign.

Thursday, May 24, 2012

Does the SPD really support eurobonds?

Update 1.45: It looks like Trittin has performed one of the fastest and sharpest u-turns of recent times, as he is quoted by Reuters earlier today as saying: "Merkel should stop blocking eurobonds" and suggested it could be a condition for his party's support for the fiscal treaty. This is also a matter of semantics though, as the Greens remain in favour of a limited form of fiscal burden sharing or debt mutualisation. It still illustrates the wider point however: eurobonds are in for a rough ride in Germany.

Update 1.15pm: Die Welt has published a more detailed follow-up on the issue and the Green party has followed the stance of its oft senior coalition partner and also rejected eurobonds at the present time. Green parliamentary co-chairman Jürgen Trittin said that while he agreed with the economic principles behind them, they were the wrong solution at this time, not least because it would require changing the EU Treaties. The paper states that both parties prefer an alternative, only partial, pooling of eurzone debt, possibly via a debt redemption fund.

Original post:

There's a school of thought out there - usually fairly uninformed - which has it that a German government that features the SPD (social democrats), could fairly effortlessly strike a deal with Francois Hollande over further fiscal integration, which would include, for example, eurobonds and greater ECB intervention. People arguing this point notes that SPD supports eurobonds, while doing fairly well in opinion polls. That should cut it right?

Well, this view tends to underestimate the German cross-border consensus on sound money and budget discipline. And from today's Die Welt we learn that the SPD has retreated from its previous support for Eurobonds, thereby distancing themselves from their French counterparts. Thomas Oppermann, the party’s speaker in the Bundestag said:
"We oppose the uncontrolled pooling of debt… There is absolutely no need for general eurobonds". 
Oppermann added that:
“I speak for [Germany] and not for France”.
And there you have it from the horse's mouth...this will be a long, unpredictable debate in Germany.

And the most interesting part of yesterday's EU summit was...

Very little came out of yesterday's informal EU summit, but here's what EU leaders had for dinner (courtesy of La Stampa's Brussels correspondent Marco Zatterin):

Lobster with asparagus
Fillet of John Dory (aka St Peter's Fish) with vegetables
Chocolate mousse
Coffee

It's interesting because we always wondered what EU leaders actually eat at these summits. In April, a menu from the last meal on the Titanic went for £76,000. Maybe one day the menu from the final summit before the eurozone sank (well we're not there quite yet) will fetch a tidy sum…

Germans hit out at the EU's "debt treaty"

Angela Merkel has grounds to be glum
Most recent headlines concerning opposition to Merkel’s eurozone policies have focused on the anti-austerity positions of Hollande and his supporters, and at the more dramatic end, Tsipras and the radical Greek opposition.

However, recent developments on the home front are interesting as well, with domestic opposition to Merkel’s policies gaining focus and momentum, albeit targeting the taxpayer-backed bailout element of the package as opposed to the austerity one. Yesterday saw the launch of a new pressure group called Allianz gegen den ESM (Alliance against the ESM), comprising a coalition ten MPs, business groups and civil society organisations. The group have a (pretty basic) website setting out their five main objections, which are as follows:
  1. The ESM is to be permanent, with member states having no right to leave. 
  2. The ESM Board of Governors, comprised of member states’ Finance Ministers, would wield decision making powers over policy and instruments. 
  3. The Bundestag will have few opportunities for participation and control. The total size of the ESM “mega bank” will be €700bn, more than five times the size of the EU budget. Finance Ministers could agree on an indefinite increase. 
  4.  Member states have to pay €80bn in an-front cash contribution to the ESM, of which Germany’s contribution is around €22bn. Any losses will be borne by taxpayers as the participation of banks and other private creditors is not mandatory. 
  5. The ESM has no mechanism for debt restructuring and can therefore not be considered to be a form of emergency assistance. 
The group have also put out a slightly dystopian video warning of the dangers of a Europe built on debt.

The group’s 12 o’clock press conference yesterday prompted Handelsblatt to lead with the headline: “High-noon for Merkel’s euro policy”. The paper also very helpfully compiled a ‘rogues gallery’ of the key players. While many of the MPs are long standing critics of the ESM and the bailouts, such as the CDU’s Klaus-Peter Willsch or the FDP’s Frank Schäffler, linking up so clearly with other groups allows their message to be heard more widely beyond the Bundestag. Other participants worthy of note are:

Marie-Christine Ostermann, Federal President of the Association of Young Entrepreneurs, who warned that:
“With ever larger rescue mechanisms, for which the liability is borne by others, Europe is moving ever further down a blind alley.” 
Lutz Goebel, Federal President of the Family Business Association, who in the past has compared the eurozone bailouts to the voyage of the Titanic, and urged the Bundesbank to seize the wheel of rescue before it was too late.

Karlheinz Däke, President of the German Association of Taxpayers, who argued that:
“The subsidising of the distressed eurozone countries, especially by the German taxpayer cannot be the answer to the debt policy of recent decades. The euro has only a future with individual liability and responsibility.” 
John Hüdepohl from Bündnis Bürgerwille (Alliance for Citizens’ will) which campaigns for more input and involvement from ordinary citizens in the eurozone bailouts.

Ultimately, despite Handelsblatt’s dramatic headline, this group and other similar constellations are not in a position to pose a serious threat to Merkel's policies at the moment. However, it shows that German domestic opposition has the potential to be uniting and organising itself, giving it a much better capacity to campaign for alternative policies. If Merkel appears to give in on ‘red-line’ issues such as eurobonds or greater ECB intervention, or if the eurozone is plunged into even deeper crisis – for example if there is no breakthrough in Greece’s re-run elections – expect such campaigns to pick up momentum.

Wednesday, May 23, 2012

The EU's Big Five (& Austria): where are they at ahead of tonight's summit?

The 'growth dinner' of EU leaders is about to start. No big decisions are expected (this is a meeting of EU leaders after all) but here's an overview of where the different big countries are at:

Germany

Berlin  remains fiercely opposed to Eurobonds, but interestingly, EU Energy Commissioner Günther Oettinger - a fellow member of German Chancellor Angela Merkel's CDU party - argues in an interview in today's Handelsblatt:
"Eurobonds are a matter of timing. I advice all participants not to position themselves inherently against them."
Similarly, Rainer Brüderle, the parliamentary leader of the FDP (Merkel's junior coalition partner) told German radio Deutschlandfunk that if structural reforms and budgetary discipline were implemented, Germany should not rule out the introduction of Eurobonds “at a later stage".

It won't touch Merkel for now, but an indication that Germany is set for a long, grinding and existential (in the euro sense of the word at least) debate on this issue.

Austria

It looks like Austrian Chancellor Werner Faymann is on a different wavelength to his Finance Minister Maria Fekter. The latter is opposed to the idea of debt-financed growth à la Hollande, while Faymann told Kleine Zeitung in an interview that he "fully supports" Hollande in wanting to discuss Eurobonds at tonight's meeting. However, the Austrian Chancellor made clear that Eurobonds are "a long-term project that cannot be realised in the next two or three years" while stressing the need to also have strong mechanisms to ensure that budget discipline is "an absolute prerequisite" for the proposal to be implemented.

France

French President François Hollande held a joint press conference with Spanish Prime Minister Mariano Rajoy earlier today. Nothing new came out of it and France's focus at the tonight's summit remains:
  • Fiscal stimulus is necessary to achieve deficit and debt reduction; 
  • Greece must remain in the eurozone, and its partners need to do more to help the country return to growth. However, previous commitments must be respected;
  • No taboos on Eurobonds - they must be discussed. Their main purpose is to cut the financing costs of struggling eurozone countries.
We can't help noting how Hollande of late stropped referring to the fiscal treaty as frequently, instead stressing the 'growth pact' for the eurozone.

Spain

In his joint press conference with Hollande, Rajoy simply reaffirmed Spain's priorities for tonight's meeting (and the near future), saying that "financing" of states and banks was "the most urgent" of all the issues:
  • Immediate action is needed to keep borrowing costs at sustainable levels for Spain and other peripheral eurozone countries. Rajoy stopped short of mentioning the ECB during the press conference, but a new round of ECB bond purchases is clearly on his wish list
  • Eurobonds are not a priority, but could be discussed as part of a broader, long-term debate on  deepening European integration;
  • He also said that the EU need "certainties" including that "the euro will exist for ever and no country will default [on its debt]." The EU institutions should start sending clear messages on these points. Okay, Rajoy...
Italy

Staying true to his style, Italian Prime Minister Mario Monti has kept awfully quiet, although he has warned that trying to isolate Merkel tonight would be "impractical and counterproductive" (no kidding). Monti and his cabinet are presumably doing a lot of work behind the scenes, based on a couple of specific proposals (which we mentioned here and here).

The Italian government yesterday adopted plans to unblock between €20bn and €30bn by the end of the year to make overdue payments to private firms that have supplied goods or services to the public administrations. Could this be a sign that Monti's proposal to temporarily exempt overdue payments to businesses from the EU's deficit and debt rules is gaining ground in Berlin? Possibly...

UK

The UK will continue to voice its opposition to a financial transactions tax (the Commission STILL has not given up on this proposal and will apparently present a massaged impact assessment tonight showing that the negative effect on EU GDP is not bad at all, never mind what it said initially). Cameron will also, rightly, push for various pro single market measures. It will be interesting to see how the UK responds to ideas for 'project bonds' and topping up the European Investment Bank. Cameron will also urge "decisive action" over Greece/the euro and may also provide some (largely irrelevant) advice on how the Greeks should vote in the forthcoming elections and the Germans should respond to proposals for Eurobonds.

In any case, as always, EU leaders will have a lot to talk about.

Pirates of Westfalen

A slightly amusing story in yesterday’s Bild caught our attention this morning concerning a growing row over the seating arrangements in the Nordrhein-Westfalen regional parliament (Landtag) which has to be re-thought following the recent elections. Namely the far-Left Die Linke were wiped out, while the pirate party continued its recent hot streak and won seats in NRW for the very first time with 7.8% of the vote. The other parties want a straight swap with the pirates taking over Die Linke’s old seats on the far left of the chamber, but the Pirates are outraged by this proposal, demanding instead to be sat in the middle, between the governing and remaining opposition parties.

Ostensibly of no great significance, this spat does however illustrate a wider point in German politics: the difficulty for the country's political structure to come to terms with alternatives to the traditional parties. Although, to be fair, classifying and categorising the pirate party, particularly using the traditional left-right labels, isn't easy. For example, polling has shown that it has garnered support from across the political spectrum from the Christian Democrats through to Die Linke. Unsurprisingly, this is reflected in their manifesto, which combines strongly libertarian aspects (e.g. on civil liberties) with more traditionally social-democratic policies (e.g. on universal child care). While there are some interesting parallels with UKIP (e.g. on drug policy), overall the Pirates are pro-EU membership, in particular aspects such as free movement. However, as we have pointed out before, they have been highly critical of the eurozone bailouts, and this could have been a significant factor in their recent rise.

One to watch is whether the Pirates could see a surge in support by vocally oppose the introduction of eurobonds or greater ECB intervention, particularly if Merkel starts to give ground on those issues. So far she is standing firm, but Merkel does have form for crossing red lines...

Tuesday, May 22, 2012

Euro-bonding

After the G8 summit, French President François Hollande claimed that he would "not be alone" in proposing Eurobonds at tomorrow's informal dinner of EU leaders in Brussels. But, who, exactly, are his bed fellows?

Italian Prime Minister Mario Monti is undoubtedly a supporter of Eurobonds, along with former Economy Minister Giulio Tremonti. However, Monti has also repeatedly stressed that Eurobonds should not be "an excuse to relax budget discipline". From the US, Monti said that, for the moment, he would seek a mere agreement on the "evolution towards Eurobonds." (whatever that means).

Monti is also likely to prioritise his own proposal: exempting public spending on certain "strategic" sectors from the EU's deficit and debt rules - a proposal which no doubt will rub Angela Merkel completely the wrong way. Monti is unlikely add fuel to the fire by also insisting on Eurobonds.

What about Spain, a perceived beneficiary of debt pooling? Well, Prime Minister Mariano Rajoy yesterday told reporters that, at this stage, the priorities for his government are "fiscal discipline, structural reforms and financial stability" - not Eurobonds. He added,
The most important thing is to take decisions that can be enacted in 24 hours. We can't enter debates [about the creation of Eurobonds] that can last for years. 
Quite right Rajoy. The Spanish PM will not want to take on Merkel over the proposal either - his main concern is the future of Spain's banking sector. As speculation mounts that Spain may be forced to tap the eurozone's bailout funds to deal with its banks, Don Mariano wants Germany on side.

Even the European Commission itself is saying that the time is not yet ripe for Eurobonds, instead pushing for the less controversial 'project bonds'. In an interview with the Wall Street Journal over the weekend, Commission President José Manuel Barroso said,
We think that it's only when there is an increased level of convergence and discipline that Eurobonds can appear as something credible. [Eurobonds should not be seen as] an invitation for irresponsible fiscal behavior or having some kind of moral hazard.
So who else? The Austrians, whose Finance Minister Maria Fekter said in an interview,
Growth financed by debt? Those are the recipes from the day before yesterday. The arguments that are put forward by France's new president François Hollande are nonsense and got us into this whole mess in the first place.
Or the prudent Finns? Hardly.

Well, there's one: David Cameron.

At least this time around, Cameron will not have a French President calling him an "obstinate kid" and asking him to stop interfering in eurozone politics.   


Eurobonds are an economic risk and a political dream

In today's City AM we argue,
THE idea of Eurozone countries pooling their sovereign debt in the form of Eurobonds re-emerges every time the euro crisis suffers another turn for the worse. Curiously, the idea’s chief proponent seems to be the UK government, which has made several interventions, stressing the need for the Eurozone to move to “fiscal burden-sharing”. This puts it in the company of European federalists such as Romano Prodi and Jean-Claude Juncker, and socialists such as François Hollande.

However, the UK government, like most other advocates of Eurobonds, tends to gloss over the details. There are at least three economic reasons, and a huge political reason, as to why Eurobonds are no easy fix. 

Firstly, the moral hazard entailed in Eurobonds is huge. Remember, for large parts of the past decade, Greece was treated by markets the same way as Germany, and was able to borrow money at almost the same interest rates. Everyone can see the results.

Secondly, Eurobonds would inevitably take away pressure for radical reform. As painful as it is, at least the Eurozone crisis is forcing Club Med countries to pursue long-overdue reforms of their pension and tax systems, labour markets, and so forth. Piggy-backing on Germany’s credit rating could take away this pressure. And linking back to moral hazard, the focus could again be on growth via debt, rather than through structural reforms.

Thirdly, most of the proposals for Eurobonds would see only part of the Eurozone governments’ debt underwritten jointly, with the rest remaining national. This option would be a major economic gamble. Not only would it be extremely difficult to implement on existing debt stocks, it could also send borrowing costs on the nationally-denominated debt skyrocketing – which would ultimately outweigh the benefits of having Eurobonds in the first place. In addition, a half-way house would mean that a substantial euro rescue fund would still be required, since the Eurozone continues to lack a lender of last resort – putting extra pressure on the credit ratings of Germany and other “core” euro countries.

The first and second problems could be dealt with, in theory, by imposing strong EU budget rules. But the record of Eurozone countries of abiding by such rules – and the lack of credible enforcement mechanisms – does not inspire confidence. The third problem can only be solved by going for “full” Eurobonds, meaning no national debt at all.

However, this is where politics – and a bit of constitutional law – kicks in. German taxpayers are not ready to accept higher national borrowing costs to underwrite Greece, Portugal and Spain. Nor are they willing to accept a euro based on watered-down budget discipline. Going down that road risks a major backlash – which could lead to the Germans pulling the plug. In addition, the German Constitutional Court in Karlsruhe has already expressly forbidden Eurobonds without a change to the German “basic law”.

In any case, Eurobonds would take years to implement. The answer to the current crisis must lie elsewhere.

How to upset three EU leaders in one day - by Francois Hollande

French President François Hollande made his debut on the international stage at the G8 and NATO summits in the US over the weekend. Perhaps a sign of the rocky ride ahead of him, he managed to upset at least three of his fellow leaders.

Germany: Hollande decided to officially add Eurobonds to his wishlist - turning him into the best friend of the British government. Speaking after the G8 summit, he said he will present a package of proposals at the informal meeting of EU leaders tomorrow, adding,
Within this package of proposals there will be Eurobonds, and I will not be alone in proposing them. I had confirmation on this at the G8.
The Germans immediately hit back. German Deputy Finance Minister Steffen Kampeter told German radio Deutschlandfunk,
I believe that prescription [i.e. Eurobonds] comes at the wrong time and carries the wrong side-effects.
Hollande has also expressed strong reservations about German Finance Minister Wolfgang Schaeuble taking over the chairmanship of the Eurogroup. Hollande is reportedly insisting that Schaeuble should resign from his post before taking on the new role (which doesn't make much sense, as the Eurogroup is supposed to be a forum for the finance ministers of eurozone countries).

Spain: Speaking to the press in Washington, Hollande said of Spanish banks,
It would most probably be desirable to have a recapitalisation, and it would most probably be necessary that this recapitalisation takes place through mechanisms of European solidarity.
This is the eurozone's worst-kept secret (as we argued here), but perhaps not the most prudent thing to say. Spanish Prime Minister Mariano Rajoy, who was not at the G8 but joined the NATO summit, swiftly fired back,
If he said that, it must be because Mr Hollande has information that we don't have. Therefore, I don’t think Mr Hollande said that because, logically, he doesn’t know how the Spanish banks are.
The two will have time to settle the issue when they meet in Paris tomorrow.

UK: As we've noted, David Cameron and Hollande have more in common than what one might think, but on some issues the two are still poles apart, for example an EU financial transaction tax which Hollande continues to push for. Before the bilateral meeting at the UK Ambassador's residence in Washington, Cameron told reporters,
On the financial transactions tax, I'm very clear, we are not going to get growth in Europe or Britain by introducing a new tax that would actually hit people as well as financial institutions. I don't think it is a sensible measure. I will not support it. 
Do these rows come down to lack of experience for the new Président or are they simply examples of classic French negotiation tactics? We're still not sure...

Monday, May 21, 2012

UK government to Merkel: move to fiscal union or else...


Regular readers know what we think of the UK government's peculiar habit of lecturing the eurozone on the need to move to a full fiscal union (meaning eurozone governments completely running over their own electorates). Well, over the weekend, the Coalition moved from dropping hints to - it seems - issuing outright instructions.

Here's Nick Clegg in an interview with Der Spiegel (at least qualifying his remarks):
"You have to have something which creates a fiscal accompaniment to monetary union. Whilst I have a huge amount of sympathy with German taxpayers and German politicians who are reluctant, understandably because Germany is the paymaster of the European Union, to entertain these ideas, I fear that they are unavoidable. It is not sustainable to believe that the eurozone can thrive through fiscal discipline alone - it also has to, at some level, include an ability to either share debt or to deal with shocks in one part of the system or the other through fiscal transfers."
And here's George Osborne, writing in the Sunday Times,
"The eurozone needs to follow what I described a year ago as the 'remorseless logic' of monetary union towards greater fiscal integration and burden-sharing. I mentioned eurobonds as one possible mechanism, and there are others."
Meanwhile, David Cameron followed up last week's comments that the eurozone need to increase the bailout funds, move to"fiscal burden sharing" and the ECB starting to act as lender of last resort (quite a wish list), by saying that the forthcoming Greek elections have to become "a moment of clarity and decisiveness for the eurozone" noting that,
"We now have to send a very clear message to (the Greek) people - There is a choice, you can either vote to stay in the euro with all the commitments you have made, or, if you vote another way, you are effectively voting to leave."
To be fair, Shadow Chancellor Ed Balls was quick on the lecturing too. While telling the BBC Today Programme that:
"I don't think David Cameron's posturing helps at all, I think it just makes it worse"
He did some posturing of is own, telling Sky News' Murnaghan Show, however:
"In the end... somebody has got to persuade Germany that this is a catastrophe for Britain, Europe and the world and that Germany has got to change course...The problem is, the German people went into the eurozone 10 years ago on the clear promise that they weren't going to bail out Italy and the central bank wasn't going to play this role. Both things have got to change." 
So how did the German commentators and politicians respond to his unusual show of cross-party consensus in the UK (minus London Mayor Boris Johnson, calling the UK government's stance on eurozone fiscal union "unbelievable"), in favour of more European integration? Barely a whimper. There were a lot of talk of Hollande, and one mention of Clegg's interview, but apart from that, the German press was deadly silent on this issue, although hinting at a Cameron U-turn, Süddeutsche's Nikolous Piper has this to say:
"Two years ago, at the summit of the G-20 leaders in Toronto, Merkel was able to enforce the requirement that developed countries should cut their budget deficits by 2013. She was supported by the then newly elected British Prime Minister David Cameron. In the meantime, Cameron’s austerity policies led Britain into a recession, with a corresponding loss of credibility."
We get it. British euro lecturing is for domestic consumption, but is this really where Cameron wants to be in Europe (the perception isn't exactly helpful)?


Friday, May 18, 2012

Letting the cat out of the bag

Update 2.15pm:  At least two more European Commission spokespersons have denied Commissioner de Gucht's claim. After Mina Andreeva (see below), Olivier Bailly tweeted,
The European Commission denies firmly being working on exit scenario for Greece. The Commission wants Greece to remain in the euro area.
Then Simon O'Connor tweeted,
We're not working on the basis of a scenario of Greek exit.
So it's settled then...

Here's our original blog post:

It's Ascension Day today, and the EU institutions are closed. Still, someone at the European Commission felt the need to say something on Greece.

In an interview with Belgian daily De Standaard, EU Trade Commissioner, Belgium's Karel de Gucht, said,

"A year and a half ago maybe there was a risk of a domino effect. But today, there are [people] in the European Central Bank, as well as in the Commission,  working on emergency scenarios if Greece shouldn't make it."
He also added,
"A Greek exit does not mean the end of the euro, as some claim."
De Gucht's comments were not appreciated by his colleagues at the Commission, however. Within hours, European Commission spokeswoman Mina Andreeva moved to deny the existence of any such plans, saying,
"[The European Commission] is working on scenarios to keep Greece within the eurozone, not to make it leave."
According to the spokeswoman, Commissioner de Gucht was speaking "in his personal capacity". This isn't the first time Karel has annoyed colleagues by letting the cat out of the bag (well, on a potential Greek exit, the cat wasn't exactly in the bag). He was the first one to admit
"We knew that Greece was cheating [on its public accounts]."
That was in May 2010.


What do a British Conservative PM and a French Socialist President have in common?

Over on the Telegraph blog, we note:
David Cameron will have his first face-to-face meeting with newly elected French President Francois Hollande today, at a G8 summit in the US. There has been some fuss about Cameron and Hollande not getting along. Cameron snubbed Hollande during a visit to London. And, most importantly, one is a French Socialist, the other a British Conservative. They must be each other’s diametrical opposite, surely?
Well, judging from some of their remarks and actions over the last year, if one didn’t know any better one would think they actually have quite a bit in common:

Both are trying to cut deficits: Yes, despite all the anti-austerity rhetoric, Hollande is trying cut spending too (as we’ve noted, the difference between the economic plans of Hollande and the ousted Sarkozy was paper thin). As his new economy minister Pierre Moscovici put it, “Hollande has always said that we should tackle state debt and reduce deficits”. Hollande wants to achieve a ‘balanced budget’ by 2017, Cameron wants to eliminate the UK’s spending deficit by 2015, albeit both are likely to fail.

Both have threatened to veto an EU treaty: In December, Cameron vetoed an EU Treaty change to impose greater fiscal discipline in the Eurozone. Equally, Hollande has implicitly threatened to veto the free standing ‘fiscal treaty’ (itself a result of Cameron’s veto), unless a clause on various fiscal stimulus measures is added. The rationale in each case is of course different but both have clashed with Germany’s view of the solution to the crisis.

Both have called for the ECB to become the euro’s lender of last resort: Causing half the German population to choke on their morning pretzels, Cameron and Hollande have both called on the ECB to do far more to “share the burden” of the Eurozone crisis through monetary activism, which probably means the ECB buying hundreds of billions of government bonds (which Cameron has endorsed implicitly, Hollande explicitly).

Both have toyed with the idea of eurobonds: In the past, both have called for a discussion on the eurozone moving to full debt pooling via eurobonds. Cameron called for it again yesterday, while Hollande hasn’t mentioned the idea since August last year and seems to have backtracked somewhat (his ‘project bonds’ are something different).

Both leaders have cabinets with ministers who opposed the flagship Lisbon Treaty/European Constitution: Laurent Fabius, new Foreign Minister, campaigned successfully for a “no” vote to the European Constitution in in 2005, while his UK counterpart William Hague, and most of Cameron’s cabinet (Ken Clarke excepted) opposed both the European Constitution and its successor the Lisbon Treaty.

So what’s my point? Of course, there are a whole range of disagreements between the two leaders. But two observations: first, the ‘austerity vs. growth’ debate is fundamentally false – even the proclaimed anti-austerity champion realises that public spending needs to be cut (at least in theory), while everyone is in favour of ‘growth’. The debate is on how to get there. Secondly, the line between the alleged ‘Eurosceptic’ and the alleged ‘pro-European’ suddenly becomes awfully blurred (who’s who again?) as both, obviously to different degrees, have problems with the status quo in the EU/Eurozone.

Bends assumptions doesn’t it?

Thursday, May 17, 2012

In case anyone wondered about the state of the euro

In a speech to business leaders in the North West today, Cameron will say:
"The eurozone is at a crossroads. It either has to make up or it is looking at a potential break-up....Either Europe has a committed, stable, successful eurozone with an effective firewall, well-capitalised and regulated banks, a system of fiscal burden-sharing and supportive monetary policy across the eurozone...Or we are in uncharted territory which carries huge risks for everybody." 
Alongside remarks from Bank of England chief Mervyn King that the euro is "tearing itself apart", this has triggered a lot of excitement amongst the UK media (montage: Tim Montgomerie):

This, of course, was just in case anyone was still uncertain as to what shape the euro was in (and needed Cameron to remind them)...

Wednesday, May 16, 2012

Is the ECB trying to push Greece out of the euro? We’re not so sure…

A story seems to have taken hold today that suggests the ECB may be indirectly trying to push Greece out of the euro by reducing its liquidity support to its banks which, the theory goes, would threaten a banking collapse and cause Greece to leave the euro in order to use its own central bank to support its banks. This seems par for the course with many of the headlines doing the round at the moment, but after some further inspection we're not certain that any decrease can really be seen as the ECB trying to force Greece out. 

The story started from an overnight report from Dutch daily Het Financieele Dagblad which claimed that, according to unnamed central bank sources, the ECB is winding down its lending to Greek banks due to concerns over their capital levels. According to the article the liquidity provision from the ECB to Greek banks has dropped by almost half since they last publicly recorded level of €73bn in January.

Now, the report could be accurate but there are some caveats here which need to be noted.

First, ECB lending to Greece was always going to fall post restructuring.

Most of the €73bn borrowing by Greek banks from the ECB uses Greek bonds as collateral, when these were written down by over half, the banks were always going to have much fewer assets to post as collateral. This problem has also been exacerbated by the fall in the value of the new Greek bonds, which would have ensured that they were subject to huge haircuts in value at the ECB’s liquidity operations.

So, the Greek banks would probably have always had to cut their borrowing from the ECB simple due to collateral constraints.

The slack will naturally be taken up by the ‘Emergency Liquidity Assistance’ ( ELA, provided by the Greek Central bank under less stringent capital requirements, see here for a full discussion) resulting in a decrease in the level of lending by the ECB directly to Greek banks. Some lending would have been maintained by the €35bn in guarantees which the EFSF provided to help insulate the ECB against additional risk. However, these fall far short of covering the entire €73bn borrowing by Greek banks from the ECB (against which they would have needed to post around €100bn in collateral due to the large haircuts which the ECB applies).

One of the motivations for the ECB's supposed reduction in lending is the slow progress in the bank recapitalisation. This could well be true, however, the fact is that without this new capital the banks will continue to be short of collateral to use at the ECB, meaning lending must take place under the ELA in the interim.

Lastly, the size of the balance sheets which Greek banks need to service would also have been reduced by the restructuring meaning they may need less liquidity than before.

In summary, a fairly large decrease in ECB lending to Greek banks would have been expected in the aftermath of the restructuring, even if it were just moved onto the ELA. It could in fact have been motivated by constraints on the banks themselves rather than the ECB.

Now, that’s not to say that the ECB is not annoyed by the lack of progress in the Greek bank recapitalisation but we all know that the correlation of these events does not mean causation. Things will be clearer when the full figures are released, but until then we’d be very wary of suggestions that the ECB is trying to force Greece out the euro, it’s not like the eurozone is short of dramatic headlines anyway.

Lightning didn't strike twice

After being hit by lightning and left soaked by a rain shower during his first day as French President, you'd forgive Francois Hollande for thinking that something would go seriously wrong at his first meeting with German Chancellor Angela Merkel. However, as expected, yesterday's meeting wasn't overly exciting.

After the mandatory comments about the importance of the Franco-German relations, a German journalist asked Hollande whether France would ratify the fiscal treaty as it stands (the question on everyone's mind), to which Hollande answered:
"Our method will be to put all the ideas on the table and then see what legal implications they can have."
Sufficiently vague enough to allow for a compromise, i.e. fiscal treaty remaining intact but with some sort of add-on. Merkel was also stressed that "the fiscal treaty was signed by 25 [EU] countries last March", adding,
"We have different approaches to achieve growth, but we will share our ideas and see what the different paths to stimulate growth are."
The upcoming meeting of EU leaders on 23 May could be the first real test. For the moment, a new poll shows that half of French think their new President will not be able to twist Merkel's arm on the fiscal treaty.

The second big issue was Greece (what else?). Both leaders said that France and Germany want Greece to remain in the eurozone, and made some interesting remarks. In particular, Merkel said,
"We’re ready to do everything we can…to help Greece structurally."
Hollande said that Greece must respect its previous commitments, but added,
"People in Greece need to know that we will help them – through growth-enhancing measures, through support to [Greece’s] economic activity – to ensure their presence in the eurozone."
Is this a signal that Germany could be willing to give Greece more time to meet its deficit targets? Too early to tell. German Finance Minister Wolfgang Schäuble also ruled out re-negotiating the conditions attached to the EU-IMF Greek bailouts in an interview with German radio Deutschlandfunk this morning.

The most important outcome of the meeting was always going to be the tone it struck. Clearly, it was conciliatory, the focus was always on compromise. It will be interesting to see if this holds throughout the upcoming negotiations on Greece. Those expecting a clash between an irresistible force and an immovable object (the much maligned growth vs. austerity debate) may yet be disappointed.

Tuesday, May 15, 2012

Omen alert: Hollande and Merkel set for a bumpy ride...

On an extremely busy day in the eurozone, French President François Hollande has reportedly had a curious - and somewhat scary - accident on his way to Berlin. His plane was hit by a bolt of lightning, and had to return to the military airport of Villacoublay - where it had taken off some 40 minutes earlier.

Therefore, Hollande had to jump on another plane. He's now flying to Berlin, but will be late to his first meeting with German Chancellor Angela Merkel.

We're glad Hollande ans his team are sound and safe, but the new 'Merkhollande' couple is really off to a rocky start...

P.S.: We're pretty sure that the Chancellor will forgive Hollande's tardiness, given that he just appointed Jean-Marc Ayrault - who speaks good German and is widely seen as a 'Germanophile' - as the new French Prime Minister.

No Good News From Greece

Today's negotiations in Greece on the creation of a government of technocrats have broken down. Talks will resume tomorrow morning, but only in order to appoint a caretaker cabinet which will remain in office until new elections take place - in all likelihood as early as mid-June.

Although widely expected, the outcome of today's meeting is going to create further political and economic uncertainty over the future of Greece in the eurozone. So what could happen now?

First off, it's by no means certain that a stable government will come out of the next elections. The latest polls indicate that left-wing SYRIZA could be the biggest party, but it would still have to form a coalition government. However, following the latest tough round of talks, the outspoken leader of SYRIZA Alexis Tsipras (in the picture with Greek President Karolos Papoulias) doesn't seem to have many friends - the Communist Party has ruled out a left-wing coalition since the very beginning of the electoral campaign, and Democratic Left leader Fotis Kouvelis said yesterday that he would no longer cooperate with Tsipras, even after new elections. On the other hand, Tsipras has repeatedly said that he doesn't want to become a 'complicit' of New Democracy and PASOK - the only two Greek parties that insist on the need for Greece to stick to the EU-IMF bailout programmes.

Needless to say, this would complicate Greece's position vis-à-vis its eurozone partners. As Eurogroup Chairman Jean-Claude Juncker told reporters in Brussels yesterday, there could be some room for Greece to negotiate a relaxation of its deficit targets if a serious new government can be formed. As we pointed out here, Greece may well be heading towards a series of inconclusive elections. This would make it very difficult indeed for Germany and the others to justify the disbursement of future tranches of bailout money.

Greece's euro exit is becoming increasingly likely - not just because it's being talked about by a growing number of top European politicians - although we still think that Greece's anti-bailout parties may ultimately soften their stance, potentially paving the way for a compromise. What's most interesting is the fact that figures are being put on the impact of a Greek euro exit (and consequent default). A couple of hours ahead of Francois Hollande's inauguration ceremony, outgoing French Economy Minister Francois Baroin told Europe 1 that Greece's euro exit and default "would have a net cost of €50bn" for France, "plus the debt held by banks and insurance firms in their portfolios." Le Figaro did its own estimates, and put the cost at up to €58.5bn - that is, €895 per Frenchman.

Quite a busy eurozone day. As usual, you can follow our live updates on Twitter @OpenEurope, and continue to check out our blog for updated analysis. 

Monday, May 14, 2012

Four out of five Greek voters still committed to the euro: Will the Greek anti-austerity parties blink first?

Over on the Telegraph blog, we argue: 
There’s a paradox at the heart of the Greek euro debate: voters have comprehensively rejected EU-mandated austerity – parties that are (more or less) in favour of ripping up the bailout conditions mustered 68pc of the votes. And yet, according to a new poll, 78pc of Greeks are still in favour of the new government doing “whatever it takes” for the country to stay inside the Eurozone.

On one level, this phenomenon is an extreme case of having your cake and eating it. Clearly, Greece needs root-and-branch reform if it’s going to have any hope of remaining inside the euro, and naturally, Germans and other creditors will want guarantees in return for putting up cash.

But this paradox may also hold three clues to Greece’s future inside the eurozone.

First, it illustrates the conflicting view inside Greece of "Europe". The country has been an EU member for 31 out of 38 years as a democracy (at least in modern times). EU membership is still associated with stability, prosperity and democracy, which explains why four out of five Greeks remain committed to the euro. Therefore, when German ministers, central bankers and others dare Greece to tear up the bailout deal and face an imminent euro exit, they also dare Athens to risk all which marks the break from its chequered past of colonels and instability. Rhetoric aside, are Greek parties really willing to pull the trigger?
 At the same time, though, on the current austerity path there must be a tipping point for Greece, when the euro and/or the EU becomes predominantly associated with a whole range of negatives, including undermining democracy, meaning Greece will almost certainly decide to leave. Though we’re not there yet, there are plenty of signs already.
Secondly, the Greek population is in some ways rational in its opposition to a euro exit. Yes, the country is stuck with a hopelessly overvalued currency. Yes, it was a mistake to allow it in and the rest of it. But whether staying or going, Greece is in for a very rough ride. Just to illustrate: the Greek banking sector is completely reliant on the eurozone for recapitalisation and liquidity (via the EFSF and ECB). If Greece exited, the newly independent Greek Central Bank would be forced to fill this void by essentially printing huge amounts of money, perhaps equal to half of Greek GDP. Hyperinflation would be a real threat as would the collapse of the banking sector. Would SYRIZA and others dare to risk it?

Thirdly, the Greek population isn’t entirely irrational in its opposition to the EU/ECB/IMF programme either. This programme is based on unrealistic assumptions and is choking off any chance of growth. This is not an endorsement of debt-funded growth à la Hollande – which is what put Greece in this mess in the first place – but of giving Greece some flexibility to enact structural reforms, for example via a full restructuring (which is now much harder due to the ‘private sector involvement’ in the second bailout). If the Troika could loosen the reins slightly, and a new Greek government use that to boost chances for growth while also and saving face at home, perhaps there’s a compromise to be had between Greece, Germany and the IMF – and Greece can live another day inside the euro. Though the euro still would have plenty of issues, at least, this could give Greece time to recapitalise its banking sector and achieve a primary surplus, both of which would make managing an exit easier.

In any case, in the ongoing game of chicken between Germany and the Greek anti-austerity parties, given the huge stakes, it may well be the Greek parties that blink first.

Last Call For Greek Parties?

Negotiations to form a coalition government carried on over the weekend in Greece, and are due to continue this evening - in parallel with the meeting of eurozone finance ministers in Brussels.

Here is a quick update of where the situation is at:
  • On Sunday, the leader of left-wing Syriza, Alexis Tsipras, announced that New Democracy, Pasok and Democratic Left had reached an agreement to form an emergency cabinet due to last for two years - i.e. until the end of the second EU-IMF bailout programme;
  • Democratic Left leader, Fotis Kouvelis (in the picture), denied Tsipras' claims as "defamatory lies". He made clear that no national unity government is possible without Syriza's participation;
  • In a last-ditch attempt at striking a deal, Greek President Karolos Papoulias has convened the leaders of New Democracy, Pasok, Syriza and Democratic Left for this evening (at 7.30pm in Athens, 5.30pm in London);
  • Tsipras has said he will not attend a meeting with "selected" political leaders. Instead, he challenged President Papoulias to hold talks with the leaders of all parties that won seats in the Greek parliament - with the exception of Neo-Nazis Golden Dawn party;
  • Syriza leader Alexis Tsipras' recalcitrant stance has not gone down well with Democratic Left leader Fotis Kouvelis. He just told Greek Real FM radio that he has no intention of cooperating with Syriza, even after new elections.
The move by Syriza to call for cross party talks tonight could very well be little more than political posturing. Following the break-down of talks over the weekend Tsipras didn't come off too well, with all the other parties blaming him for the lack of progress. The recent polls showing that 78% of Greeks want to see a coalition which supports the euro could have played a role in convincing him to come back to the table - if only to save face and look to be participating constructively ahead of the new elections.

The situation remains very uncertain, but the general feeling is that tonight's round of talks with President Papoulias could really be the last chance to avoid new elections. Essentially, for this to happen, Kouvelis has to U-turn on his electoral promises and accept to enter a coalition with New Democracy and Pasok. However, the latest developments seem to suggest that new elections could, at this stage, be inevitable.

Quote of last week

“The EU can’t increase its budget, but has to use its resources better than it has done so far… We need to re-think of the use of EU funds. Calculating what share of each country’s contribution comes back in the form of European subsidies is no longer fit for purpose. This ultimately leads to aberrations such as EU subsidies going to day-spas or romantic hotels. We are all familiar with absurd examples of this type of subsidies in our own country. With European taxpayers’ money, we must achieve better efficiency quotas and demand better results.”
- German Foreign Minister Guido Westerwelle speaking in the Bundestag on Friday.

Hear hear! As we have flagged up repeatedly, because of its flawed design, the EU budget is particularly prone to mis-allocation of resources and poor project selection.

Seriously, for how much longer can Europe afford having such an economically irrational policy at the heart of its common project?

Incidentally, if you're around Brussels tomorrow, we're organising an event on this very question, i.e. on how the EU budget should be reformed.

Friday, May 11, 2012

Spanish banks...Mañana, Mañana...?

The Spanish government held a press conference this afternoon finally laying out its plans for dealing with its significantly troubled banking sector. As usual Spanish Prime Minister Mariano Rajoy dodged the limelight and left the unenviable task of presenting the proposals to his Deputy, Soraya Sáenz de Santamaría, and Finance Minister Luis de Guindos – despite this being par for the course with the new government we still can’t help but feel that it fails to inspire confidence.

That fact aside, the plan did include a few concrete details on how Spain plans to deal with the Spanish banking sector, below we outline the key points and give our take:

·         Two independent auditors will carry out an evaluation of all the real estate assets held by Spanish banks – the Deputy PM termed this “an exercise in transparency”.

Open Europe take: We have been calling for this for some time, so believe it is a positive step. However, we have seen that similar tests have been fudged in the eurozone and Spain before, so it is very much wait and see. Taking an adverse scenario and ensuring these assets are written down to their real values is key – if they start posting falls in the future it will reignite the uncertainty surrounding the banking sector. The Spanish government also failed to mention that, at least according to the Spanish press, de Guindos was going to be asked to hire independent auditors by his eurozone counterparts at the meeting of eurozone finance ministers next week.

·         By the end of 2012, provisions to cover against losses on real estate loans considered as ‘non problematic’ will have to increase from 7% to 30%.

Open Europe take: This seems far too low. Given comparisons to Ireland we expect real estate prices could fall by another 35% in Spain. Additionally, this move seems to be skipping a step – Spanish banks already have €136bn in ‘doubtful’ loans against only €54bn in provisions, surely provisions against these very risky assets should be increased first or at least in tandem.

·         In absolute terms, this means an increase of around €30bn.

Open Europe take: Again, far too little. We predict that Spanish banks would need to at least double their provisions, taking them up to around €100bn. Similar estimates abound, with RBS calling for an additional €100bn and Roubini Global Economics suggesting it could go as high as €250bn over the next few years. Meeting the Basel III capital requirements will put further strain on the sector.

·         Banks will be allowed to get money from the FROB, but will have to pay 10% interest on it – Spanish Economy Minister Luis de Guindos stressed that this money cannot therefore be seen as state aid. Suggested maximum use of public funds would be €15bn. Heavy use of ‘contingent convertible capital’.

Open Europe take: This seems to be poorly thought out and based on an ideological reaction. Clearly the government is keen to avoid being seen to bail out banks, and rightly so. However, the banks tapping these funds will be those locked out of the interbank funding market (due to high rates), punishing them with 10% interest will make this recourse worthless. Any use of public funds should come with strong conditions but better to focus on letting some banks fail and be wound down in an orderly fashion, while forcing those that take funds to produce ‘living wills’ and give the state equity warrants. Contingent convertible capital can be useful but does not fundamentally solve the problems facing the banks, again it simply delays dealing with the problems and kicks in as a last resort safety mechanism – will do little if provisions are shown to be woefully small or valuations far too high.

·         Spanish banks will be obliged to transfer real estate assets into ad hoc societies tasked to sell them on the markets – i.e. the ‘bad bank’ that dare not speak its name.

Open Europe take: Potentially a large burden for the state, but given the breadth and depth of the problems across the sector some form of ‘bad bank’ scheme looked hard to avoid. The key here will be transferring the assets at realistic values so that they are sellable or can be written off. The Irish experience with NAMA makes this point clear – a bad bank stuck with uncertain assets can be a huge burden to the state. Furthermore, it could also distort the recovery of the sector as a whole, if the overvalued assets pile up on state books it will be hard for the remaining market to adjust – something which is necessary if the Spanish economy is to rebalance and recover.

The market response to the proposals has been lukewarm at best with Spanish borrowing costs rising slightly and the shares of many Spanish banks falling sharply.

There are some positive steps in the proposals and we will reserve full judgement until the complete package is announced and the stress tests have been detailed, however, it again seems to be a step short of what is needed. The key to tackling these banking sector problems is doing so decisively and in one swoop, rather than pushing the problems to tomorrow. Incremental adjustments increase uncertainty and expose the state to a longer and more volatile burden than needed - given the size of the Spanish economy, that is something which the eurozone cannot afford now or in the future. 

German inflation backlash alert (it took about 12 hours)

Well, it didn't take long. You may have thought that yesterday's comments from people allegedly close to Bundesbank President Jens Weidmann to the effect that Germany could live with the shocking inflation rate of 2-3% were in any way a sign that Germany was about to cave in on its resistance to anything that resembles high inflation. Well the front page of Bild Zeitung - the gold standard of European tabloids (pun intended) - says it all:


The “Bundesbank is going soft on the euro”, adding that:
“Over the next few years prices in Germany will rise much faster than before. Our venerable Bundesbank, the sacred guardian of price stability, will do nothing about this since it considers it to be ‘manageable’”.
And in case the 13 million or so Bild readers didn't get the message, page 2 features a giant picture of a one trillion DM banknote from the Weimar era:



An op-ed by the paper's chief editor Nikolas Blome argues that:
“[inflation] will above all hit workers, employees and pensioners. Precisely those who kept a cool head and ploughed on through the crisis. This is unfair. It gnaws at our trust in money and our major institutions, in politics and central banks… since Germans have bitterly experienced it themselves they know that high inflation ultimately breaks down every society”. 
It wasn't only Bild though. The man himself, Weidmann, moved swiftly to deny the reports, claiming in an interview with Süddeutsche that this was an “absurd discussion”. He clarified that keeping inflation below 2% in the eurozone as a whole meant that “in some cases” German inflation would be higher, but that “we will ensure [in the ECB’s governing council] that inflation in Germany will not run out of control. Citizens can rely on the vigilance of the Bundesbank”.

This is one national core belief you don't mess with.