For any FWers who want to get a good grasp of what is going on in Europe
the following from today's Sunday Telegraph is as good as any. (I've
changed Euros and Pounds into US$ equivalents.)
Keith
----
Haircuts for all as vexed Germany takes a firm grip on the clippers
And so the pain goes on. European bank shares fell sharply last week as
news of an $60bn-70bn bail-out for Ireland sparked fears that senior
creditors of Irish banks could soon be forced to accept losses.
Liam Halligan
Such concerns were particularly acute among investors in the UK and Germany
-- exposed to $85bn and $80bn of Irish bank debt respectively. The
third-most exposed country, incidentally, is the United States.
The centre of the turbulence on Europe's financial markets shifted last
week, though, to Spain and Portugal, causing their governments' borrowing
costs to soar. The reason is that the rescue package being finalised
between Dublin, the European Union and the International Monetary Fund may
impose "haircuts" on all those who lent money to banks in the Republic --
not just the "junior creditors".
That would all but guarantee the same principle being applied elsewhere --
a prospect that sent banking stocks spiralling downward across the
eurozone's "periphery", as well as the UK, piling even more financial
pressure on the governments so desperately standing behind them. The yield
on 10-year Portuguese debt soared to 7%, as unions staged the country's
biggest strike in 20 years, while Spanish yields spiked above 5%.
Over the past 48 hours, in a bid to calm the markets, EU officials have
insisted that the idea of senior bank creditors losing their shirts -- or
at least losing some of their money -- is "stupid". Yet this outcome now
looks inevitable -- not least because it's what Germany ultimately wants.
Chancellor Angela Merkel is having a tough enough time keeping her
electorate onside as it is. Germany's hard-working voters don't take kindly
to foolish banks and their even more foolish creditors (generally other
banks) escaping scot-free while Europe's biggest economy shoulders the bulk
of the bail-out bill. And who can blame them? Especially when the culprits
are more often than not from elsewhere.
"Have politicians got the courage to make those who earn money share in the
risk as well?" Merkel boomed in Berlin on Wednesday -- in a speech that was
disgracefully under-reported by the Western media.
Bondholders and almost all other Western governments don't want to hear it.
But Merkel is completely right. The most galling aspect of this entire
sub-prime debacle is the disgraceful extent to which those who bankrolled
the banks -- as they took on ever more debt, "levering-up" their balance
sheets 20-, 30- and 40-fold -- have been protected from their consequences
of their actions. Powerful vested interests have so far ensured -- amid
much scare-mongering of what would happen if sanity prevailed -- that such
losses have been shoved on to taxpayers instead.
As a result, the balance sheets of most European governments have now been
stretched to the limit and beyond, with some protected merely by the mirage
of printed money. That's why the financial buck looks increasingly likely
to stop with Germany -- Europe's economic powerhouse.
The German economy is now showing its inherent class. The country's mighty
export machine is humming, with expansion spreading beyond manufacturing,
fuelling GDP growth of around 3.5% in 2010 -- a figure beyond the rest of
Western Europe's wildest dreams. Incredibly, despite the madness beyond its
borders, the highly-respected Ifo survey last week put German business
confidence at its highest since 1990.
From this position of strength, Germany can now call the shots. It will
get its way on senior creditor haircuts -- and it must, given the
jaw-dropping moral hazard involved in allowing yet another generation of
bankers and bank creditors to remain off the hook. Market realities and
logistic practicalities mean the day of reckoning may be delayed, with
"mid-2013" currently being floated, sotto voce. That is, of course, unless
the markets wreck the politicians' carefully calibrated timetable by taking
matters into their own hands.
For now, the Western world's all-powerful banking lobby and the political
leaders in its pay or otherwise under its spell -- in other words the
majority -- cling to the deluded hope that rising asset prices and
bucketloads of taxpayer cash will float all boats, allowing UK, European
(and US) banks to carry on without having to endure the shame, related
losses (and law suits) associated with genuine restructuring. This is the
raw politics of it. And it is within the jaws of this almighty battle --
Germany's growing impatience for accountability versus everyone else's
insistence on continued denial --that the tiny Irish economy has lately
been caught.
At the risk of repeating myself, Ireland does not have an inherent fiscal
problem. The country's total government debt is equivalent to 62pc of GDP
-- below the EU average and less than half that of Greece. Ireland faces
none of the demographic challenges of larger European nations -- its
pension system is relatively well funded, and its population is young.
The problem Ireland has is that during the economic boom years before 2008,
Irish banks borrowed cheaply and pumped out loans on homes and construction
projects, helping to fuel a US-style housing bubble. This was a failure of
prudence and regulation on a very large scale -- there can be no denying
it. And now the country's banks are in so deep that their massive
liabilities are threatening to bankrupt the Irish government.
Yet, having made its mistakes, which were considerable but by no means
unique in incidence or scale, Ireland was among the first Western nations
that tried to get real. Almost two years ago Dublin imposed a fiscal
adjustment amounting to 6% of GDP, which makes the UK's austerity measures
look tame. [KH: And which the US has not yet even contemplated, even though
it will have to one day.] The Republic of Ireland has also taken the
courageous step of declaring its banking sector losses, accounting for them
on the government's balance sheet and planning future borrowing so as to
meet those liabilities.
As a result, Ireland's annual budget deficit has soared. But at least the
numbers resemble reality. Most other Western nations, meanwhile, have
allowed their banking losses to remain buried, lurking Japanese-style in
the "shadow" banking system. [KH: And America also. A Japanese-style
deflation is more on the cards that hyperinflation as Benrnake's massive
handouts continue to be absorbed by the banks.]
The big countries felt threatened by Ireland's attempt to impose
transparency and the market applause that originally greeted this effort.
So Ireland's stab at "fessing up and growing" its way out of the crisis,
was effectively crushed by the big Western powers, who sensed an
opportunity, at the same time, to have a go at Ireland's highly-competitive
corporate tax regime.
Amidst such cataclysmic events, it's impossible to forecast the end-game. I
remain of the view that the euro will ultimately break-up -- ike every
other currency union in the history of man, save those (such as the US)
founded after decades of previous political union. Having long predicted
such an outcome, I won't be glad to see it happen. My opposition to
monetary union has always been technical rather than ideological.
More importantly, the "crack-up" will be very messy, involving widespread
"soft-default" as peripheral countries convert euro-denominated sovereign
and commercial debt in terms of re-established (and significantly devalued)
national currencies.
Before all that, though, we must surely be headed for a "Brady Bond"
settlement -- based on the scheme devised by US Treasury Secretary Brady
during the late 1980s to clean-up Latin America's massive debt overhang.
Defaulted loans were converted into bonds with a lower face value (in other
words, after a haircut) that were then traded as market sentiment improved.
Over the coming months and years, the eurozone looks likely to stumble
towards a Brady-style solution, albeit one devised, led and ultimately
collateralised by Germany. That's the "best case" scenario. Which means the
others are even worse.
Keith Hudson, Saltford, England
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