Why The Euro Crisis Is Far From Over

THE ECONOMIST

 OCT. 20, 2014

REUTERS/Thomas Peter

Poland’s Prime Minister Ewa Kopacz (L) and German Chancellor Angela Merkel address a news conference at the Chancellery in Berlin October 9, 2014.

“The Euro Trap: On Bursting Bubbles, Budgets, and Beliefs” By Hans-Werner Sinn. Oxford University Press; 380 pages.

“The 13th Labour of Hercules: Inside the Greek Crisis” By Yannis Palaiologos. Portobello; 270 pages.

THE euro crisis never seems to end. From an acute phase of worries about public debt and whether the single currency might break up it has moved on to a chronic condition of near-zero growth and fears of deflation.

The signs are that the euro zone is now back in recession, with even the German economy, the central powerhouse, slowing sharply. And that is creating new pressure on Germany’s chancellor, Angela Merkel, to borrow and spend more for the sake of Europe.

Yet there is strong resistance to this inside Germany, led by “ordoliberal” economists such as Hans-Werner Sinn of Munich University and the CESifo Group, whose latest book, “The Euro Trap”, sets out his rationale. Mr Sinn believes the European Central Bank has become too accommodating and that its plans to buy sovereign debt are illegal (the European Court of Justice has just heard arguments on this). He also reckons the euro-zone bail-outs of the past four years have created moral hazard, allowing feckless Mediterranean countries to get away with minimal reforms and only limited fiscal discipline.

Mr Sinn is particularly obsessed with Target 2 (the first German version of his book was called “The Target Trap”) liabilities, which refer to the accounts of national central banks with the ECB. The German Bundesbank is a large creditor of the system, and most Mediterranean central banks are large debtors. The worry is that German taxpayers might end up with a massive bill. Yet Target 2 is essentially an accounting matter that would only become a real issue if the euro were to break up and the ECB be dissolved.

The paradox is that the risk of that happening is increased by German-inspired austerity and a lack of growth. Mr Sinn’s solution to the euro’s problems is also problematic: he wants some countries to leave the euro and re-enter at a lower rate. As it happens, Mrs Merkel and her advisers have thought hard about a Greek exit (or Grexit), as Mr Sinn notes. But every time they looked at it, they concluded that it would be costlier, including to Germany, than doing what is needed to keep the currency together. That remains true.

REUTERS/Yannis Behrakis

Presidential guards are framed through a burned EU flag in front of the Tomb of the Unknown Soldier by the parliament in central Syntagma square in Athens May 1, 2013 following a May Day rally.

Mr Sinn would not take much comfort from Yannis Palaiologos’s searing account of Greece’s nightmare of the past five years. Poor tax collection, entrenched corruption and a dysfunctional state may lead one to ask how Greece was let into the euro in the first place. The pain caused by a fall of around 25% in GDP since Greece’s first bail-out of May 2010 has been immense.

Yet Greeks still want to stay in the euro. And reforms have now improved competitiveness and even rekindled growth. There may still be political upsets–the author’s analysis of the far-right party Golden Dawn is troubling–but at least Greece is on the mend. The current concerns, as Mr Sinn notes, are France and Italy, which are both too big to fail and too big to bail out.

No wonder the euro crisis is not over.

JP MORGAN: The ECB's New Plan Will Change The Course Of The Euro Crisis

Matthew Boesler

 Sep. 6, 2012

ECB

Mario Draghi and the ECB have been critiqued all day long since the central bank president this morning unveiled the details to its new bond-buying program aimed at turning around the euro crisis.

JPMorgan economist Malcolm Barr thinks it's a game-changer, writing in a note to clients today that "from a big picture perspective, we believe that the new approach taken by the ECB will change the course of the Euro area crisis."

However, there are a couple of details of the plan that ended up being "stricter" than JPMorgan thought would be the case (which could cause implementation issues).

And, according to Barr, "There was more Weidmann in the structure than we were expecting, but still not enough to get him on board."

As always, it all comes down to conditionality and the willingness of program countries receiving bailouts to comply with tough austerity measures ostensibly designed to improve the euro periphery's fiscal situation.

Here is Barr's take, from the note:

Relative to our expectations, there are a number of features of the OMT which are somewhat stricter than we were expecting. In particular:

First, in order to benefit from ECB intervention, countries will need to be in either a full or precautionary EFSF/ESM program. Our expectation had been that an application to the EFSF/ESM just for secondary market support would have been enough to trigger ECB involvement. What this means is that the conditionality may be a little heavier than Spain and Italy would like.

Second, the involvement of the IMF “will be sought” in establishing conditionality. This has connotations of a further loss of sovereignty which Spain and Italy will dislike.

Third, the ECB has excluded existing program countries unless they are “regaining market access”. We had expected the ECB to reinforce Draghi’s message today by intervening in Portugal, which is already compliant in a full program. The rather arbitrary choice of timing on when to intervene undermines the notion that the OMT is about the transmission mechanism.

Fourth, Draghi highlighted that if countries are not compliant with conditionality, ECB intervention will stop. If this were to happen it would be a rather abrupt event. We had been expecting a more continuous approach where the ECB would adapt its yield objective as a country started to slip away from program compliance.

Barr remains optimistic despite the issues raised above, saying that the bond-buying plan "will evolve over time as the ECB gains experience," and addresses the third point – which perhaps seems to introduce something of a contradiction – by writing, "The ECB is surely aware that the ability of a program country to re-access markets will not be independent of the central bank’s behaviour."

One Thing That Could Actually End The Euro Crisis

Simone Foxman

 May 21, 2012

New York Times Syndicate

EU leaders will talk about managing a rebellious Greece during Wednesday's EU summit in Brussels, but there is one, even more important issue you should be watching: eurobonds.

Support for anti-bailout parties in Greece has generated market angst, but EU leaders will make few decisions on how to handle the troublesome country until after the results of a new round of parliamentary elections are published on July 17.

Instead, their discussion of eurobonds will be crucial. Support for common euro area bonds has ballooned since they were first proposed as a possible solution to the crisis last year, and they hold the potential to take significant pressure off of troubled EU sovereigns almost immediately.

What are eurobonds and how legitimate of a crisis solution would they be? Click below to read our complete guide.

Click to learn everything you need to know about eurobonds >

1.  Eurobonds with "several" guarantees 

would split the burden between countries.

AP/Daniel Olchoa de Olza

The least radical approach to common eurobonds would come in the shape of centrally issued bonds with "several" guarantees. This would force each country to repay a certain amount of the debt issued based on the level of its debt burden, but would not force other countries to step to guarantee obligations from other countries in the event that one or more becomes unable to pay.

Because such an approach does not violate a clause in the EU treaties preventing countries from bailing one another out, the issuance of eurobonds with several guarantees would be permitted under the current EU treaties. Then again, the fact that these bonds don't provide for loss-sharing in the event one contributor cannot pay could compromise their credit rating and might not alleviate significant pressure from troubled EU sovereigns.

2. "Jointly" guaranteed bonds would force 

European countries to share the burden for debts.

AP/Michael Probst

"Joint" guarantees would ensure that investors receive the face value of their bonds,

regardless of whether certain members can make good 

on their promise to pay a percentage of those bonds.

Such pooling of debt might be illegal under the current terms of the EU Treaty, 

as countries are prohibited from assuming the losses of other countries. 

Thus, approval of such a program would likely face some political backlash, 

as Northern Europeans might balk at assuming the debts 

of their less disciplined Southern neighbors.

On the other hand, jointly guaranteed bonds would go a long way

 towards stemming the crisis, as it would convince investors 

that strong economies like Germany and France would 

step in to prop up their neighbors and keep the eurozone whole.

3. Prominent plans consider 

"joint" AND "several" guarantees

YouTube

Two studies of eurobonds undertaken by the German Council of Economic Experts

 and the European Commission suggested that a middle solution—

eurobonds with joint and several guarantees—

might be a practical manner of eurobond issuance.

In each situation, stronger economies would have 

to pay a higher fee to borrow, while borrowing costs 

for weaker countries would come under control.

4. Here's how a plan from 

Germany's Council of Experts would work:

AP/Markus Schreiber

• Immediately, countries with sovereign debt over 60%
  of GDP will be able to jointly finance the debt exceeding 
  this level via a proposed European Redemption Fund.
• Joining the fund would require acceptance of certain 
  automatic tax and spending restrictions and 
  would require the country to put down 20% 
  of its borrowing in gold or foreign exchange collateral.
• If all eurozone countries participated, 
  the fund would amount to €2.7 trillion ($3.6 trillion), 
  with German and Italian debts amounting to
   25% and 40% of the fund, respectively.
• EZ countries would sign a European Redemption Pact,
   outlining how they will lower their gross public debt to
   60% of GDP over the next 20 years. 
  After that point, the pact would expire.

5. Three options have also been 

considered by the European Commission,

 under the term "stability bonds":

New York TImes Syndicate

• Stability bonds with several guarantees, 
  where each country is responsible for a percentage contribution to each redemption
• Stability bonds with several guarantees that are 
  reinforced with other guarantees. 
  The commission suggested 
  1) assigning some countries senior status in stability bond issuance,
  
  
   2) backing up issuances with collateral like gold,
   shares of public companies, etc., and 
  
  
  3) devoting parts of governments' revenue streams towards the payment of these bonds.
  
  
• Stability bonds with joint and several guarantees,
  where countries are not only responsible
   for their own percentage contribution to the bond, 
  but also for covering the unpaid contributions of any other state.
  
  

The Commission noted that, while bonds with several 

but not joint guarantees could be issued under the EU Treaty, 

the third plan would require a change to the EU treaties

 because it would violate regulations prohibiting countries from bailing each other out.

 Further, EU leaders would have to decide on 

how much of a country's debt should be denominated in eurobonds.

While the Commission acknowledged that

 this approach entailed significant risks, 

it concluded that they have "significant potential benefits." 

It has subsequently supported consideration of eurobonds publicly.

6. Both these plans called for a fiscal compact 

that would enforce economic reforms

AP

Moral hazard is one of the main arguments against eurobonds,

 as they could reassure countries with poor spending habits

 that their neighbors will pick up the slack.

Thus a prerequisite for eurobonds under both plans 

was a strict fiscal compact,

 the likes of which leaders proposed as part of a new EU treaty in December.

7. Support is gaining for eurobonds, 

but how far will it go?

Pawelmorski

Eurobonds are likely to be the number one topic of conversation 

on the table at the May 23 EU summit. 

ndeed, it will likely be a sore point for German Chancellor Angela Merkel,

 who has repeatedly argued that the eurozone currently lacks

 the financial integration necessary to sustain eurobonds.

However, newly elected French President Francois Hollande 

advocated eurobonds as part of his election campaign, 

and his ideas have won support from 

Italian PM Mario Monti and Spanish PM Mariano Rajoy, 

not to mention a host of other EU leaders.

We've Just Witnessed A Major Turning Point In The Euro Crisis

Simone Foxman 

 Dec. 5, 2011

 5:59 PM

Standard & Poor's decision to put 15 eurozone countries on downgrade watch today threatens the fabric of programs that are meant to salvage the euro, in particular the European Financial Stability Facility (the euro rescue fund).

That fund has been at the heart of all plans to fix the euro up to date. Now it's all but dead, and that may not be such a bad thing.

With S&P threatening to cut France's rating by two notches, it's unlikely that S&P would refrain from making at least a one-notch cut to the country's sovereign rating. Moody's and Fitch have long been warning that they will follow suit.
While we doubt that S&P—or any of the other ratings agencies—would actually go ahead with a ratings cut for Germany, the fact that the country is on downgrade watch is nonetheless troubling, particularly for the EFSF.

All 17 eurozone states contribute to the EFSF's €440 billion ($590 billion) war chest, but its AAA rating is highly dependent upon the ratings of France and Germany. Right now, AAA-rated sovereigns contribute 58% of those funds, with France alone contributing 20.3%.

Thus even if France were the only AAA-rated sovereign to be downgraded, the entire EFSF would be downgraded, too. Lack of a triple A rating would introduce risk (albeit limited) into the Facility's dealings, materially reducing the impact it can make. Plans to insure first losses on bonds or even the attractiveness of EFSF bonds as an investment will be jeopardized by such a downgrade.
But the death of the EFSF means EU leaders no longer have any credible short-term backstop to prevent the crisis from spreading in the short-term. They can no longer rely on a mechanism which analysts have long questioned; they have to do something bigger.

German Chancellor Angela Merkel and French President Nicolas Sarkozy said they have bigger plans in mind, proposing a new EU treaty that could correct the problems that caused the crisis. But their proposals do not provide for the here and now.

With market pressure mounting on Italy and Spain (despite occasional lulls, like the last week or two)—not to mention France and Belgium—it seems clear that Italy and Spain may not last until March, the earliest date that treaty changes to go into effect. Something drastic needs to be done right now to halt market momentum, regardless of how unappealing that solution may be to Germany, the Netherlands, and Finland.
With the EFSF dead, now EU leaders will have no alternative—they'll be forced to face the cold, hard truth.

DAVID ZERVOS: This Is How The Euro Crisis Will End

Joe Weisenthal 

 Nov. 2, 2011

 11:42 AM 

Image: CNBC

Yesterday, David Zervos of Jefferies sent out a wildly popular note on the Papandreou referendum gambit, in which he explained that this was a classic Greek politician move, and that Papandreou's own father, Andreas Papandreou, once pulled a similar blackmail stunt when he was the Greek PM.

Said Zervos:

Bravo to Papandreou. He is peeling back the layers of the rotten onion that is EMU and exposing the Italian, French and Belgian situations for what they really are!

Since the note was so popular and smart, we figured we'd talk to Zervos directly to have him flesh out his thoughts on Papandreou, the referendum, and the endgame of the crisis.

As he sees it, it basically boils down to this: Greeks believe in Democracy, and don't take referendums lightly. Papandreou doesn't have the answer, and the opposition party hasn't offered anything, except trying to grab power. So it goes to a vote.
The outcome of the vote is all about how it's framed: If it's framed as staying in the Eurozone, it will pass. If it's framed around the costs, perhaps it won't. Ultimately though it's a bad precedent, since Greece will face years of pain and could always just do another referendum down the road.

In the meantime, this is a game of loss distribution: Who pays: The ECB? Taxpayers? The banks? The PIIGS? It's not unlike the loss distribution for the subprime crisis. You were never going to get the homeowner to pay, so it had to be the taxpayer.

Zervos expects Greece to leave, if not soon, then down the road, at which point the large countries will agree to form Euro-bonds that the ECB will feel comfortable monetizing, and establishing a fiscal union.

Germany and even Italy will stick around, the latter since Germany will be worried that if Italy did leave, it would be able to competitively devalue its currency too much.
Below are our fuller notes and quotes from Zervos.
---------------------

Regarding the referendum decision:

"One of the bigger negatives of all that is that he didn't really consult with the rest of the Europeans. Not that he has to do that ... The Germans aren't consulting him on a bunderstag vote."

So what drove Papandreou's decision if it wasn't part of the discussion that happened last week with his European counterparties:

"October 28  is an incredibly important day in Greek history, and to have the politicians run out and the people effectively throw eggs at them imagine if people threw Molotov cocktails at U.S. politicians on memorial day." 

"The Greeks are big believers in democracy."

"Where I come away with all of this: Papandreou thinks deep down is I don't know the answers, so okay, you're going to have to pick."

So how will the Greek's vote?

"It's a complicated bet. It's going to depend a lot on what the questions is." [In other words, if its just framed as staying in the Euro, it will pass. If the question acknowledges the huge costs of staying in, then it's a much dicier proposition.]

"I think it's going to be a very hard choice for a lot of people."

Either way, this is still a very bad outcome for the Eurozone, to even have this vote:

"We're still not talking about a solution." [Since Greece debt would still be un-sustainably high under the haircut plan last decided on last week.]

"If the Greeks get frustrated in the future, there's no reason why they don't have another referendum."

As for what the current negotiations are all about:

"We're just trying to figure out the loss distribution." [In other words, we know that loans were made at a level that will never be paid back, so it's just a matter of who pays: Taxpayers through bailouts, bank write-downs, savers through ECB monetization, the PIIGS through a lower standard of living."

"You're never going to get this money from the Greeks."

"Ultimately going to fall on the banks that lent the money, and the taxpayers."

"You're going to hurt savers and taxpayers."

The U.S. of course wrapped private sector losses with the government guarantees, but of course ...

"Europe is having a lot more trouble doing that wrap, since you have 17 different nations."

So how does this end? Eventually a few bad players get punished and leave the Eurozone (probably Greece sooner or later) and then ...

"I think the ECB will be much more comfortable in buying debt, and conducting QE once there are Eurobonds.

"My endgame for Europe is: We lose a few people along the way, some losses are distributed to banks ... and then you wrap the whole thing up in a toasty little eurobond, and then the ECB starts buying the eurobonds."

"The endgame of fiscal union becomes a reality."