It has been our experience that one should never bet on a European summit to fail to reach agreement, even when such agreement appears elusive 24 hours before the event. The FT reports this morning that this time there may really not be a conclusive deal after all on one of the most important issues to be decided –the Greek haircut. Talks have (unsurprisingly) not proceeded well on the issue persuading banks to increase their voluntary participation to over 50%. The problem here is simple. The EU does not want an involuntary haircut, but unfortunately this is now the only possibility if you want to go down the default route. The banks have no interest in a voluntary one beyond the token gesture they agreed back in July. On the EFSF, Polish finance minister Jacek Rostkowski, who is now chairman of the Ecofin, said the full package may not be ready by Wednesday, with further technical work to be carried by finance ministers, who next meet November 7. (Again, not surprising, complex financial products are by definition complex. The issue is not the contractual small print, but the overriding principle of the leverage deal. If the summit can agree on those, it will have done its work. In our view, the more troubling issue is that neither scheme is going to work.)

 

Haircut on Greek bonds to include cash payback

 

 

Finance Minister Evangelos Venizelos presented to the managers of Greek banks the latest haircut plans, according to Kathimerini. The plan foresees that for every €100 of Greek debt that private investors own, they will get €15 in cash and €35 in 30-year bonds with a 6% voucher, although the ratio of cash and bonds could change.

 

Haircut to cover two-third of Greek debt, half of this in Greek hands

 

 

Nick Malkoutzis in Kathimerini points out that the haircut will only apply to two-thirds of the country’s debt, and almost half of that is in Greek hands. “According to calculations by UBS, Greece’s total public debt is just under €350bn. Of that, €55bn (16%) is with the ECB, €17.9bn (5%) with the IMF and €47.7bn (14%) has been borrowed through bilateral loans. This debt will not be written down. Instead, the haircut will apply to the remainder, which is €125.9bn (36%) held in the international markets, €73.9bn (21%) sitting with Greek and Cypriot banks, and €26bn owned by other Greek institutions, mostly social security funds…. A 50% writedown means Greek banks will have to be recapitalized and pension funds, already strapped for cash, will take a hit of some €12bn. When added to the losses from the haircut, the deal … could cost Greece and its banks some €40bn.”

 

A setback for European financial engineering from Brazil

 

 

This is not the most important headline grapping story of the story, but the kind of story we may be ready more often in the near future. Brazil yesterday said it will not participate in any European debt scheme. Guido Mantega, the Brazilian finance minister, said the Europeans did not any funds from Brazil, but Brazil would participate in any IMF scheme. Reuters reports that the eurozone wants the IMF to participate in this special purpose vehicle currently drawn up by eurozone technocrats.

 

High drama in Rome – culminating in a 15-page letter of reform promises

 

 

There was high drama within the Italian government yesterday, ending in a hasty compromise put together in a 15-page letter of reform proposals, which Silvio Berlusconi will present to tonight’s EU summit, Corriere della Sera reports. This is the quid pro quo for the EU offering continued support to Italy. Berlusconi’s government looked on the brink, as no agreement seemed possible with the Lega Nord, which opposed most of the changes, including an increase in the pension age to 67. Reuters quotes Umberto Bossi as saying that it remains to be seen whether the government could survive, and whether the compromise is acceptable to the EU. (We fear not. The pension age is not the most important issue from an economic point of view. The make-or-break issues are reforms in labour and product markets, and in public administration.)

 

Wrangling about the wording on the ECB in the council conclusions

 

 

The German press is relatively certain that Angela Merkel will get the necessary majority in today’s plenary vote to have a mandate for the EU summit and the EFSF guidelines. But yesterday there seemed to be a lot of wrangling about the council conclusion’s wording on the continued role for the ECB in the crisis management once the EFSF is up and running. Süddeutsche Zeitung quotes from a draft which says the heads give the ECB their “full support” for securing the euro with the continuation of its nonstandard measures (SMP, unlimited liquidity for banks, etc). Angela Merkel yesterday let it be known that Germany did not agree with anything that looked like applying pressure on the ECB. The commission yesterday said a formula could be to underline that the ECB “continues to be responsible for financial stability in the euro area”. The Frankfurter Allgemeine Zeitung quotes Merkel that the heads wanted to know at the summit what exactly the ECB intended to do in order to comment that in the debates.

  

For Handelsblatt today is the “the day of the broken promises”

 

 

The front page of Handelsblatt reads “Euro-summit: the day of the broken promises”. The paper goes on to say: “The debt cut will come just as the leverage for the rescue fund. The heads of state and government meet today in order to break all promises that have given voters, investors and banks in the past months.” Handelsblatt then quotes FDP vice chancellor Philipp Rösler, Wolfgang Schäuble, Christine Lagarde, Olli Rehn, Jean-Claude Trichet, Angela Merkel and Jürgen Stark promising things about the EFSF, Greece, the role of the ECB, etc. that are contradicted by today’s summit decisions.

 

Will Germany be liable for EFSF debt with its gold?

 

 

Bild tells its readers that Germany may well be liable for EFSF debt with its gold stock, the second largest in the world after the US. The reason is a sentence in the German version of the guidelines for leveraging the EFSF that talks of “assets” with which guarantees to investors can be paid in case the EFSF bonds go under. The paper quotes Norbert Brackmann, a parliamentarian and budget expert from Angela Merkel’s CDU, who says: “If you think that through that means Germany is liable with all its assets – which means beyond its shareholding, with the Bundesbank’s gold reserves.” He insists that it must be clear that Germany’s limit is guaranteed to be its official share of €211bn. The paper also quotes deputies from the liberal FDP and the Bavarian CSU saying the same. Bild even runs an editorial by Einar Koch who says the Germany’s gold must absolutely remain off limits.

 

Wolfgang Münchau says Bundestag should reject EFSF leveraging

 

 

In his column in FT Deutschland, Wolfgang Münchau writes that the Bundestag will almost certainly approve the latest twist in the EFSF debate at a special vote today. But he says this would be mistake. There are at least three reasons why leveraging is a mistake. The first is that it gives countries a possible incentive to leave the eurozone through defaulting on its debts. Through their insurance, the other member states would effectively subsidise an exit. Second, leveraging could destabilise the EFSF, especially in the case of a downgrade of France, which Münchau considers a high-probability event. And finally, the cross country transfer payments will end up very high, and the political reaction will be extreme (considering that there have been no cross country transfers so far, it is already bordering on the hysterical).

 

Has Germany taken over the leadership in Europe, Les Echos asks

 

 

According to Les Echos, Germany has all it takes to be the uncontested leader of Europe: good public finances, economic health, the confidence of the market. France on the other hand is in bad shape. Debt and deficit are not under control, a stagnating economy and question marks behind its AAA rating. “Nicolas Sarkozy has become the junior partner of Angela Merkel”, the paper quotes the former Socialist Europe minister Pierre Moscovici. “He is not the motor in the relationship. He does not have the necessary means.” However Thomas Klau of the ECFR cautions that Merkel’s leadership capacities are strongly limited by the complicated decision-taking procedures on European issues in Germany and by the huge internal resistance against the euro rescue policy.

 

France will slash its growth prospects after the summit

 

 

France will wait for the summit’s result to announce the downward revision of its totally unrealistic growth expectations of 1.75% for 2012, Le Figaro reports. Germany has already lowered its expectations to 1% and a more realistic approach for France seems to be between 0.8% and 1.0%, according to the paper. The consequences for the French budget will be dire. In order to bring the deficit to 3.0% in 2013 the government will have to announce additional austerity measures in the magnitude of roughly €7bn on top of the €10bn already announced earlier. That will be no easy task 6 months ahead of the presidential and the parliamentary elections.

 

Portugal’s 2012 budget prepares for layoffs

 

 

Portugal’s state budget for next year has at least one characteristic never seen: €350m for civil servant salaries set aside and classified as an exceptional expense, Jornal de Negocios reports. Unexplained by the finance ministry, several experts are now suggesting that this option could be used to finance severance payments in case of layoffs.

 

Central bank loans used to pay bondholders

 

 

The former Anglo Irish Bank will repay €718m due to senior unguaranteed bondholders next week, using among others emergency loans from the Central Bank, the Irish Times reports. The bank no longer holds customer deposits to fund the repayment so will have to rely on further drawings under the Central Bank’s exceptional liquidity assistance (ELA) facility to repay the debt. Meanwhile, Bank of Ireland and Irish Life and Permanent have raised €5.3bn by issuing bonds to themselves under the Government guarantee and using them as collateral to borrow discounted funding from the ECB.

 

Martin Wolf’s letter to Mario Draghi

 

 

In his FT column, Martin Wolf writes an open letter to Mario Draghi, telling him that he faced a straight choice between preserving the prevailing policy consensus, or preserving the eurozone. The main task would be to turn the ECB into a lender of last resort, which according to Wolf is the only short-term solution to this crisis.

 

Spreads, Forex, and ZC Bonds

 

 

 

Spreads ease up a little on France, but get worse for Italy and Spain. Euro stable at $1.39.

 

10-year spreads
	Previous day	Yesterday	This Morning
France	1.200	1.138	1.124
Italy	3.845	3.904	3.907
Spain	3.437	3.488	3.558
Portugal	11.753	11.933	11.760
Greece	22.698	22.793	22.54
Ireland	6.350	6.376	6.495
Belgium	2.342	2.269	2.298
Bund Yield	2.117	2.063	2.06
Euro Bilateral Exchange Rate
	Previous	This morning
Dollar	1.391	1.3917
Yen	105.830	105.78
Pound	0.870	0.8678
Swiss Franc	1.227	1.2224
ZC Inflation Swaps
	previous	last close
1 yr	1.88	1.88
2 yr	1.84	1.85
5 yr	1.82	1.83
10 yr	1.92	1.94
Source: Reuters