A quieter day, but with some interesting political and financial stories, though none from Germany where there are no newspapers because of a national holiday.

The FT has seen a draft of Herman van Rompuy’s designs of a fiscal union, which include the most far reaching changes to economic governance in the eurozone yet. The story says the most critical element was the creation of a central eurozone budget, which could be used to insure the eurozone against asymmetric shocks. The article says the Germans see such a central budget as an alternative to mutualising debt, while Pierre Moscovici has proposed the use of the central bank for unemployment benefits. The article said there was growing agreement in principle among the large member states on the idea of a central budget, but no common view on how it would be funded, or used. The FT quotes unnamed officials involved in the drafting as saying that it should be seen as an attempt to stimulate discussion among leaders, though the draft was based on a series of consultations. It also links to the separate work on the banking union, and calls on leaders to accelerate the process to establish a single banking supervisor “as a matter of priority by the end of the year”, which the FT says constituted a direct rebuke to the German government, which is seeking to delay the process to 2013.

Rajoy says No bailout

One gets the sense that he is enjoying himself by keeping everyone guessing about whether and when Spain is going to apply for the rescue. Maybe this is part of a “who blinks first” kind of game, which his mentor and predecessor Jose Maria Aznar understood to play so well. It is a dangerous strategy, however, in the middle of a debt crisis.

In any case, he issued what must rank as one of the funniest denials we have heard during the crisis, relating to the Reuters’ scoop yesterday, according to which Spain would seek a bailout as early as this weekend. This is what he had to say:

“If there is some agency, or someone, who says that this weekend we are going to ask for a bailout, as they say, there are two possibilities: that this agency is right and has better information than I do, which is possible, or that is not the case, which may also be possible” (translation by El Pais)

Rajoy meets regional premier to work out a joint fiscal strategy

Mariano Rajoy hosted a ‘conference of presidents’ of Spain’s regional governments, whose final declaration included a commitment to fiscal consolidation, El Pais (English Edition) reports. The central government agreed to share the existing deficit leeway with the regions, by relaxing the regions’ deficit targets. This relates to the extra year given to Spain by the European Commission to reduce the deficit to 3%. The joint declaration also stated that the lack of growth policies in the EU would make an exit more difficult.

Catalan Regional Premier Artur Mas scenified his confrontation with Spain by not taking part in the family photo as well as not speaking to the press, which he will do in Barcelona on Wednesday.

Spanish regional liquidity fund conditions revealed

Publico reports that the Spanish Ministry of Finance and Public Administration on Monday distributed to the regions the guidelines for the regional liquidity mechanism. The document details a seniority order in which claims against the regions will be satisfied by recourse to the liquidity fund. The first priority has debt service, followed by debts to the central government and social security, then bills owed to private providers, and lastly transfers to universities or local entities. This is consistent with the Constitutional reform promoted by the PSOE and PP in September 2011 which made debt service an “absolute priority” of the public budget.

Italy risks a short circuit between rigor and growth, Audit Court warns

The main risk for Italy is a short circuit between austerity and growth, according to Luigi Giampaolino, head of the Italian Audit Court.  He said during a joint session of the House and Senate budget committees that Italy needed more aggressive growth strategies to offset the drop in aggregate demand. Il Sole 24 Ore reports quotes him as saying that, unfortunately, this was not possible, because rising taxes and lower spending won’t work in a recession. These austerity measures are expensive and partly ineffective, he said citing IMF research. Meanwhile, the president of the Italian business lobby Confindustria, Giorgio Squinzi, remarks Italy will have to wait until 2015 for a true economic recovery.

Gustavo Piga says recession is the new normal for Italy

This is a very pessimistic assessment of Italy’s strategy, which we share. Gustavo Piga writes in his blog that recession is the New Normal for Italy, as austerity and low growth feed on each other. After Bulgaria, Italy is the EU member State with the highest number of NEET people (not in employment, education, training). In the last four years the NEETs have increased by 5.7%, the biggest rise in Europe. The country’s inactivity rate is at 36.3% for the population between 15-64 years old, Italian statistical agency ISTAT said. “When the house is on fire you do not start the reconstruction, but save what can be saved,” Piga writes. Without a growth perspectives and fully comprehensive plans to boost youth employment, Italy is doomed, especially as 70% of the total fiscal adjustment comes from tax hikes.

Grilli, the Italian Finance minister, gets in embroiled in two parallel scandals

Vittorio Grilli yesterday denied rumours regarding his alleged lobbying to become governor of the Bank of Italy and his former wife’s job dealings with a state-owned Italian company.  Grilli clarified his position in a long letter after sources revealed information from a wiretapped conversation with Massimo Ponzellini, a former chairman of Banca Popolare di Milano, who is under house arrest and faces accusations of corruption. According to La Repubblica, Grilli has asked to Ponzellini to use his influence to support his possible nomination for Bank of Italy governor in 2011. The finance minister said the conversation had been just in an informal and friendly way, and that “any insinuation or other interpretation can be considered false.” Grilli also denied media reports about the relationship between Lisa Lowenstein, his ex-wife, and Finmeccanica, the aerospace company. “Ms Lowenstein was never entrusted with a consultancy by the Finmeccanica group,” Grilli said. Several newspapers, like Il Sole 24 Ore and Linkiesta, have called for Grilli’s resignation. No comments from Mario Monti.

Troika disputes €3.5bn in measures, insists on reforms ahead of next aid tranche

Greece held a new round of talks with the troika about €3.5bn of disputed austerity measures and demands for structural reforms be implemented before the next loan instalment can be approved. Sources told Kathimerini that troika representatives raised objections against €1.5bn in spending cuts for 2013, mostly from health, defence and public sector reforms and against €2bn for 2014, mostly revenue-raising measures. The troika also insisted that these reforms be implemented before Athens could receive any more money. They include the liberalization of so-called closed professions, the deregulation of goods, services and energy markets, the creation of a new body to manage state procurements and the merging of all health insurance providers with the National Organization for Healthcare Provision (EOPYY).

IMF and EU disagreement over what to do next

The talks between the troika and the Greek government were complicated further by a disagreement between the EU and the IMF over how to solve the Greek crisis, Reuters reports. The IMF wants Greece to cut its debt further to make up for going hugely off-track from the terms of its bailout, while Europe are resisting the option of a new debt restructuring and instead prefer to give Athens more time to get back on track. (It is hard to see how more time can solve a debt crisis. The latest effort to kick the can down the road is surely motivated by the German election timetable).

The Fiscal pact and the division of the French left

In his speech as reported by Les Echos, Jean-Marc Ayrault tried his utmost to woo deputies of the left into voting for the fiscal pact. The fiscal pact should not divide the left, but it does. Reuters is citing several top Socialists publicly questioning next year’s deficit target. The final vote on the is due on October 9 with a law to enforce the pact due by the end of the month. Many economists already believe that France will miss the 2013 target by a few percentage points because the budget is based on a 0.8% growth forecast considered as too pessimistic.

A new hybrid bond

The FT has an interesting technical story on a proposal by banks to introduce a new debt security as  a direct response to new EU banking rules. The new bond would rank above senior unsecured debt and below “tier two” capital, and is aimed to provide a kind of a top layer of risky debt that is not ring-fenced in case of a bankruptcy, but which is of a higher quality than ordinary unsecured debt. The article says Nomura had been investigating whether there is a case for introducing a loss absorbing tranche of “senior subordinated notes”. A similar option would be “priority bail-in notes”, which would be loss-absorbing in case of a bail-in event but would rank equally with other senior debt should a bank become insolvent. The article includes an estimate by Nomura according to which European banks have a potential shortfall of up to €530bn if they want to meet the new rules.

Moody’s see problems with the Spanish estimates for bank recapitalisation needs

This is from Moody’s, via FT Alphaville. Moody’s see many of the assumptions in the Spanish stress test seem conservative, while some are open to question. Here is the kicker:

“For example, the headline adverse-case cumulative credit loss of €270 billion is largely offset by assumed ‘loss absorption capacity’. That loss absorption comes primarily in the form of existing provisions (€110 billion), excess capital buffer (€73 billion), and forecast pre-provision earnings (€61 billion). Notably, the required capital target is relaxed to 6% core Tier 1 in the adverse scenario from 9% core Tier 1 in the base scenario, providing €51 billion of additional capital to offset bank credit losses…

“According to our estimates, banks will need between €70bna nd €105bn of capital to recognize their embedded losses upfront and still meet the 8% or 10% capital requirements established in previous legislation, RD 2/2011.3 We use different capital thresholds in our stressed scenario (8% or 10%), versus the independent firm’s threshold of 6% in its stressed scenario, along with other methodological differences such as the time horizon for the recognition of losses.”

Verhofstadt: change policy or Spain will never recover

When Daniel Cohn-Bendit and Guy Verhofstadt speak, you get refreshingly old-fashioned federalist bluntness. Speaking at  a book launch, they said Italy and Spain will never get out of the crisis with the current policies. This is because budget austerity “efforts are half-wasted in interest rate rises” on debt paid to “not even European” investors, and advocated a debt redemption fund or “even better” a “single debt market”, reports El Economista.

New Europe reports more fully on the presentation of the book ‘For Europe! A manifesto for a post-national revolution in Europe’. Verhofstadt and Cohn-Bendit say that the euro was incompatible with the European nation states as currently configured, and they attack the inability of the EU national governments to work for the common European interest. And they want a new Constitution:

“After the 2014 election, the European Parliament should proclaim itself as the Constituent Assembly, in agreement with the Council of Ministers, the other legislative chamber, and should draw up a draft European Constitution, which will not be a repeat of the current treaties”.

10-Y spreads, Forex, ZC Swaps and Euribor-Ois

The market don’t know what to make of Rajoy’s intentions.

10-year spreads
	Previous day	Yesterday	This Morning
France	0.752	0.746	0.746
Italy	3.626	3.617	3.619
Spain	4.443	4.299	4.343
Portugal	7.468	7.430	7.731
Greece	17.890	17.699	-1.46
Ireland	3.668	3.611	3.762
Belgium	1.109	1.098	1.099
Bund Yield	1.45	1.457	1.455
Euro Bilateral Exchange Rate
	Previous	This morning
Dollar	1.289	1.2899
Yen	100.630	100.82
Pound	0.799	0.7998
Swiss Franc	1.209	1.2096
ZC Inflation Swaps
	previous	last close
1 yr	1.88	1.89
2 yr	1.78	1.7
5 yr	1.8	1.8
10 yr	2.14	2.04
Euribor-OIS Spread
	previous	last close
1 Week	-7.843	0
1 Month	-3.800	-3.2
3 Months	3.857	5.957
1 Year	56.657	56.157
Source: Reuters