It has been a common feature of the eurozone’s crisis management that officials begin by denying a problem, act only at the last minute when they are left with no choice, and then end up doing less than they need.
At yesterday’s Ecofin, the Dexia crisis seemed to have persuaded finance ministers to recognise that their banking systems were a problem after all – after those outraged denials a few weeks ago – and that something needed to be done, according to a report in the Financial Times this morning. The report had an immediately positive impact on financial markets, as evidenced by the 4% surge of Wall Street share prices last night, which is likely to be followed up by a strong rebound in Europe this morning.
But we would urge our readers to read the small print behind what is being said. The direction in which Ecofin seems to be moving is towards a coordinated, but still separate approach to bank recapitalisation, similar to the decision in October 2008 after the Lehman crisis, when they agreed their infamous chacun-pour-soi bank recapitalisation strategy – which we consider the original sin of eurozone crisis management.
Olli Rehn is quoted by the FT as saying: “There is an increasingly shared view that we need a concerted, co-ordinated approach in Europe while many of the elements are done in the member states.” While stock markets rebounded, tensions within eurozone bond markets increased, as the crisis was now spreading to France and Belgium, where 10-year spreads jumped to 0.828% and 2.099% respectively.
El Pais has a detail in its covering that Francois Baroin, the French finance minister, left yesterday’s Ecofin to attend crisis meeting in Paris on Dexia. The situation of the Franco-Belgium bank is considered serious, and the authorities are now working on a plan to save the bank.
As for the banking system as a whole, one possibility is that they will increase the capital requirements in the stress tests. Wolfgang Schäuble was quoted as saying that Germany was considering revisiting the SoFFin legislation, Germany’s own bank recap programme, which expired at the end of last year.
In his blog for Le Figaro Cyrille Lachèvre warns that Dexia is becoming a threat to France’s AAA rating. The likely creation of a bad bank with the French state guaranteeing for all potential losses puts renewed pressure on the rating. “I bet that within a few hours we will witness new rumours about a loss of the French ‘AAA’”, he writes. The first sign of investor distrust are already visible, according to the blogger. Yesterday the spread between France and Germany went up by 8 points, “which is enormous”, as Lachèvre points out. “It is a sign that something is happening on the debt market and that the discrimination between Paris and Berlin is growing”.
Moody’s cut Italy’s rating by three notches
S&P led the way, and Moody’s followed by cutting Italy’s rating, by three notches from aa2 to a2. The arguments were similar to those of S&P: long term growth prospects, political uncertainty, a changed global financial environment. In its coverage of the story, Il sole 24 ore writes that Italy is among those countries generally considered solvent, but that the country was facing potential funding problem in the near future. Silvio Berlusconi dismissed the downgrade as something he had expected to happen anyway.
Eurosceptics force referendum on ESM on FDP party leadership
The eurosceptic FDP Bundestag member Frank Schäffler has passed the threshold of 3250 signatures necessary to force the party leadership to hold a referendum on the ESM, Spiegel Online and Süddeutsche Zeitung report. The liberal party will now hold a referendum among its members to determine how the FDP in Bundestag should vote on the establishment of the permanent euro crisis mechanism. The outcome is uncertain but given the mood in Germany, and especially within the FDP, there is a chance the result will be a No vote. The referendum would be non-binding for the party’s members in Bundestag but it seems politically inconceivable that they would ignore the vote. The ESM would probably get enough votes in parliament because the opposition SPD and Greens will vote in favour. But without the FDP, Angela Merkel will not have enough votes to secure a majority with her own coalition which would severely weaken her and perhaps even lead to a break-up of the coalition.
Germany is drawing up a crisis plan to prepare a Greek default
According to the mass circulation daily Bild Germany is preparing a plan to cope with the consequences of a Greek default. Angela Merkel’s government considers it absolutely necessary to have the enhanced EFSF in place to control the ensuing fallout so it puts heavy pressure on Malta, the Netherlands and Slovakia to ratify the rescue scheme as quickly as possible. According to studies of the finance ministry, the German banking system would be able to weather a Greek haircut of up to 50%. To prepare for all eventualities and to be able for the government to take over banks, Wolfgang Schäuble considers reactivating the German bank rescue mechanism Soffin (see also our report on the bank recapitalisations above). In the German budget for 2012 there is a reserve of €12bn to compensate for budgetary shortfalls as a consequence of a default. The government thinks a default could occur around Christmas after the Greek government got one last time €8b from the EU and the IMF in November. So far it is unclear if Greece should remain in the eurozone after a default or if it should leave “voluntarily”.
Greece has enough cash until mid-November
Evangelos Venizelos said Greece has enough cash to pay its bills until mid-November, Kathimerini reports, a month longer than had been anticipated, using €1.5bn from the banking stability funds. The statement came just hours after the eurogroup decided to delay a decision on the next loan tranche, keeping up maximal pressure on the reform implementation process. Venizelos said the budget, which was approved by troika officials, allows for the deficit to slip to 9%, with the difference to be covered in 2012.
A cynical comment in Spiegel online suggests that the eurogroup may as well wait a little longer, for Greece to find another billion in its accounts.
In Greece, meanwhile, a new wave of strikes and protests against the government reforms are starting today.
Slovakia fails to end rift over EFSF extension
Parties in Slovakia’s center-right government failed to overcome a rift over a plan to expand the EFSF on Tuesday but said more talks would be held ahead of a ratification vote in parliament next week, Reuters reports.
Martin Wolf on a minimally sufficient crisis resolution strategy
There is a debating contest out there about what constitutes a minimally sufficient arrangement for the eurozone to end its crisis and to return to a sustainable path. Some say it requires a small fiscal union. Others, like Willem Buiter and now Martin Wolf believe that could get away with a more minimalist structure – which is nevertheless still onerous, and may not necessarily be acceptable to governments. In his latest FT column, Wolf writes that a bare minimum was a mechanism to write down debt of insolvent private and sovereign borrowers, funds to manage bond markets of potentially solvent countries, and enough fund to make the financial system solvent immediately. The cost would still be a multiple of the EFSF/ESM ceiling.
(We agree that this is possible but we should be under no illusion that the Wolf/Buiter approach to crisis resolution is in any way politically more palatable to the creditor nations than an outright fiscal union because it requires massive transfers of a scale that vastly exceeds the ceiling of the agreed resolution mechanisms. As you cannot trivially increase their size, you will probably require a small fiscal union simply to provide those funds. )
Spreads, Forex, and ZC Bonds
Just look at this increase in French and Belgian spreads. The French spreads are still relatively low in absolute terms, but remember this was the level of Belgium until a few months ago.