Greek Bailout News (1)

"British or German taxpayers cannot finance the failures of others," German Economy Minister Rainer Bruederle said at the World Economic Forum in Davos, Switzerland, according to the Associated Press. "Solidarity also means everybody adheres to common rules."

France is not working with Germany or other countries on a support package for Greece which is managing to handle its problems on its own, a French government source said on Thursday. "I am not aware of a support plan. There is not a plan. We're not discussing one (with Germany or others)," the source told Reuters. "They are managing themselves. They are finding financing support on the market. There is no plan for a support plan. We are not working on one. Le Monde newspaper said earlier that euro zone countries were studying ways of helping Greece resolve its budget problems."

The above statements have been widely interpreted in the international press as a "no" from Germany and France to any EU bailout of Greece. But is this interpretation justified? Before going further, I think it should be pointed out that the whole argument depends on what you consider a bailout to be. If you take the view that a bailout involves a restructuring of Greek Sovereign Debt, with the EU itself offering to pay a part, then this is clearly not on the cards, at least at this point, and let's take things a day at a time. But if you consider the "bailout" which is under consideration at the present time to be simply a loan, which in some way shape or form (yet to be determined) would be guaranteed by the EU institutionally, and would thus be available at a cheaper rate of interest than the one the markets are currently charging, then it is hard to see how British or German taxpayers would be having to finance anything, except in the unikely event that Greece were unable to repay (as Moody's point out, Greece's problems are longer term, not short term), and remember, even Latvia and Hungary are likely to repay the loans already made to them, and their underlying economic situation (and competitiveness problem) is a lot worse than that of Greece. So basically the German economy minister is making a speech which generates good headlines, and political enthusiasm, but like Jüergen Starks before him, has little real significance in terms of the options which are really on the table.

On the other hand, statements like the following:

European officials on Friday sought to quell rumors of a pending bailout for Greece, insisting that the financially troubled nation could still manage to avoid a debt crisis on its own. The effort to allay market speculation came as investor confidence in Greek bonds fell this week to levels not seen in a decade, amid concern over the government's ability to close its gaping budget deficit and maintain financial stability.

Can simply be seen as officials doing the job they are paid to do, that is talk down the market pressure. Obviously, if the spread on Greek bonds could be talked back down, then there would be no need for anyone else to make a loan, but at this point in time, and especially following the ill fated proposal of Finance Minister Papconstantinou to mount a fund raising roadshow including a visit to China, this possibility looks very unlikely. After all, why should the Chinese banks risk their money buying bonds the German taxpayer is unwilling to buy? As Yu Yongding, a former adviser to the Chinese central bank said, it just isn't interesting to buy a “large chunk” of Greek government debt in order to help rescue the country simply because their securities "are more risky than U.S. Treasuries". “Let European governments and the European Central Bank rescue Greece", he said. Over to you Herr Bruederle.

And despite the fact that Joaquin Almunia strenuously denied in Davos that any kind of plan "B" existed, really they would be fools not to have a plan "B", and the people involved obviously aren't fools, ergo....

A top European Union official said on Friday there was no risk that Greece would default or leave the euro zone and the country's finance minister said he was not aware of any bailout talks. "No, Greece will not default. Please. In the euro area, the default does not exist because with a single currency the possibility to get funding in your own currency is much bigger," Monetary Affairs Commissioner Joaquin Almunia told Bloomberg TV. "There is no bailout problems."

Asked if its problems could force Greece out of the euro zone, Almunia said: "no chance. Because it is crazy to try to solve the problems the Greek economy has outside the euro zone," he said. Almunia said euro zone ministers had prepared fiscal recommendations for Greece and other countries, to be discussed at a regular meeting at European Commission level next week, but denied there was any special EU plan to rescue Greece. "It is a normal analytical document that is written every month," he said. "We have no plan B. Plan A is on the table. It is fiscal adjustment."

EU Commission "Ups the Ante"

So now lets turn to Plan A, and to that normal analytical document Señor Almunia refers to, which is due to be discussed by the Commission on Wednesday. Fortunately, the Greek web portal Ta Enea have seen the document, and Reuters have provided us with a convenient English language version of what they saw. What the Ta Enea report makes clear, is that the reason Greek Prime Minister Papandreou has not asked the EU for a "bailout loan" is connected to the conditions which would be attached to that loan. According to the reports, the EU Commission plan to go a lot further than simply providing short term funding on the cheap:

The European Union will tell Greece next week to take extra measures by May 15 to shore up its finances and cut a spiralling deficit, Greek newspaper Ta Nea said Saturday, citing a draft of the recommendations. The European Commission's recommendations, due to be made public on February 3, include cutting nominal wages in the public sector and setting a ceiling for high pensions, Ta Nea said.

Under the headline "Urgent measures to be taken by 15 May 2010," the EU document will tell Greece to "cut average nominal wages, including in central government, local governments, state agencies and other public institutions." The EU will also urge Greece to introduce advance tax payments for the self-employed and possibly a tax on luxury goods, according to the document, excerpts of which were printed by Ta Nea. Most other recommendations, as reported in the paper, are already part of the Greek plan.

Reports also mention putting a complete freeze on public sector hiring, and a system of monthly reports to the Commission along the lines of the Latvian programme. What this effectively amounts to is enforcing the implementation of an internal devaluation process along the lines of the ones adopted in Ireland and Latvia, as outlined in the most recent technical report to the commission (see here), in order to restore competitiveness to the economy and make Greek debt sustainable in the long run. It also amounts to an effective surrendering of part of Greece's national sovereignty to the EU Commission, and this is the part that virtually everyone is doubtless baulking at.

IMF Waiting On the Sidelines

Obviously, the EU Commission is not the only institution who could furbish the bailout loan, the IMF would serve just as well, and Marek Belka, Director of the IMF's European Office, has already made it very plain they are ready willing and able to help. And only last Friday John Lipsky, the first deputy managing director of the IMF, said the Fund "stands ready" to help Greece with its debt crisis. According to Lipsky's statement, the fund is in "ongoing contact" with the Greek authorities following a "scoping mission" to assess the possibilities.

"The IMF stands ready to support Greece in any way we can," Mr Lipsky said. "It is a matter for the Greek authorities to decide, in collaboration with the European Union, but we are here to help if we are wanted."

In fact, I personally favour the IMF alternative, given the time scale involved, and the likely programme implementation difficulties, and according to Edmund Conway, economics editor of the UK Daily Telegraph, this view is now shared by many "highly respected" economists:

I understand that in many of the conversations Mr Papandreou had [last week in Davos] with very senior, respected economists this week, he was directly advised to go to the IMF, which would be the 'cleanest solution'..... But an IMF intervention would have potentially to be channelled through European authorities, since Greece is a member of the euro.

But the EU Commission seems to have very strong reservations about going for the IMF route, which is why the "bitter pill" of the EU bailout loan may well need to be swallowed. My fear here is that EU reservations may mean that history sadly repeats itself, the first time in Latvia and then in Greece, as queasiness about taking on board the full implications of what is involved in correcting competitiveness distortions leads to policy-making delays and mistakes of the kind which in Latvia have produced a resession which is far deeper and longer than was actually needed, but which in Greece could easily lead to very serious problems for the entire Eurozone further on down the line.

Yet the door is certainly not closed on an IMF solution, and George Papaconstantinou did meet with IMF Managing Director Dominique Strauss-Kahn on Friday on the sidelines of the WEF in Davos. The possibility of IMF intervention was left open by IMF Managing Director Dominique Strauss-Kahn in an interview with broadcaster France 24 this weekend, although he certainly seemed to suggest that EU support was more likely. "We at the IMF are ready to intervene if asked, but that's not necessarily required," Strauss-Kahn said. "The European authorities, both in Brussels and the central bank, are looking at it and I think they'll handle it properly" ...."solidarity" within the countries sharing the euro could "fix the problem,", he said without elaborating.... "It's the first test of this kind for the euro zone,".

Contagion Danger Concentrating Minds

Perhaps the strongest argument to support the idea of imminent EU support is the level of contagion risk being experienced. Concerns that Athens may not be able to service its debt have put growing pressure on the euro, and even if some would welcome this as an aid to German export competitiveness, the attendent credibility issues hardly make the situation a desireable one. There are also growing worries that the Greek debt crisis could spill over to other weak members of the Eurogroup, such as Spain, Portugal, Ireland and Italy. The German daily Sueddeutsche Zeitung last week quoted an EU draft memorandum as saying the situation in Greece was creating a "big challenge and in the long term risky," and could force other euro-zone countries to pay higher risk premiums on their bonds. The spread between Portuguese and German 10-year government debt rose to 120.5 basis points on Friday - up from 114.9 the day before, and the spread on equivalent Spanish bonds is hovering round the 100 basis points mark. Basically, as one European leader after another stresses, it is hardly desireable to let Greece's problems lead other states to have to pay more to finance their borrowing.

Where's The Moral Hazard?

Finally, there has been considerable discussion about the dangers of moral hazard in the Greek case. If the EU offer a bailout loan, this will encourage other countries to seek something similar, so the argument goes.

"Moral hazard considerations suggest that the ECB will never openly support a bailout, but we doubt that Greece will be left on its own if the situation were to become critical," UniCredit analysts said. They referred to the danger that a rescue could reinforce ill-considered fiscal practices that have caused serious problems for Greece and others.

But if we look at the realities of the present situation, then it is clear that what is being offered to Greece in return for a possible loan is clearly not enticing, and indeed it may well be that countries would rather not accept the carrot in order to avoid the stick.

But there are other versions of moral hazard at work here. The FT's Martin Wolf put his finger on one of them:

At the same time, a bail-out by the eurozone as a whole would create a monstrous moral hazard for politicians. It would only be possible if the eurozone subsequently exercised a degree of direct control over the fiscal decisions of member states. It would, in short, be the fastest route to the political union that many initially believed was a necessary condition for success.

Indeed, the very creation of a monetary union in the absence of a political will for unification could be seen as having been the biggest moral hazard risk taken on board, and no matter how many clauses you put in Treaties beforehand, this risk cannot be avoided when push comes to shove.

But there is a third, and more dangerous version of moral hazard in play here, and this arises from the fact that the EU Commission may itself fail to adequately identify and diagnose the roots of the problem, with the result that the correction measures prove to be inadequate, sending Greek debt snowballing off into default. At this point, if the Greek leaders had been simply "following orders", then a more substantive form of bailout would become inevitable, and Herr Bruederle's fears that the German taxpayer may end up having to foot part of the bill would be realised. With this in mind, I really suggest that Commission members and Finance Ministers think very carefully about what they are doing before signing and sealing any definitive agreement with Greece. On the other hand, if the nettle is cleanly grasped, and the necessary changes are introduced both in Greece and in the EU's institutional structure, then maybe the most important and most enduring outcome of the current economic crisis will be a Europe which is more unified and effective than ever it was before.

And It's A Bailout.....

Well, it's not fully official yet, and all the fine print certainly isn't written and signed, but the will is now clearly there, and where there's a will, there's a way, especially when you have the global financial markets breathing down your necks. The first one out of the box was the Economist's Charlemagne, earlier this afternoon.

In Brussels policy circles, the question asked about a bailout of Greece used to be: are European Union governments willing to do this? Now, I can report, the question among top EU officials has changed to: how do we do this?

Twice in the past 48 hours I have heard very senior figures - both speaking on deep background - ponder the political mechanics of how large sums in external aid could be delivered to Greece before it defaults on its debts: a crisis that would have nasty knock-on effects for the 16 countries that share the single currency. One figure said yesterday that heads of government could not wait "forever" to take decision. That means a decision in the next few months, at most.

By sundown the story had gotten a bit more traction, with the FT running an article under the header "EU signals last-resort backing for Greece".

The European Union made clear on Thursday it would not abandon Greece and let Athens’ mounting debt crisis jeopardise the eurozone, even as Germany and France played down suggestions they had already formulated an emergency rescue plan.

“It’s quite clear that economic policies are not just a matter of national concern but European concern,” José Manuel Barroso, European Commission president, told reporters in Brussels. According to high-level EU officials, Greece would in the last resort receive emergency support in an operation involving eurozone governments and the Commission but not the International Monetary Fund.

And by sundown the New York Times were running the story:

France, Germany and other European countries have begun discussing privately how they can come to the aid of fellow euro-zone member Greece, as doubts intensify over the country’s ability to get its budget under control.

Despite public attempts to discourage such expectations, discussions are under way, although the shape or scale of a possible bailout package has yet to be determined, according to officials in several capitals, all speaking on condition of anonymity.

“Greece failing is not an option and lots of people think that we will have to intervene at some stage,” said a euro-zone finance official, who was not permitted to speak publicly because of the sensitivity of the matter. “It doesn’t have to happen, and we hope it won’t, but it would be better than seeing a default.”

Of course, we haven't gotten to the actual bail out yet. Timing will depend very much on what happens in the financial markets over the next few days. The spreads on Greek bonds widened strongly again today - reaching a record 4.1 percentage points over German bunds, while Credit- default swaps on Greece jumped 28 basis points to 402, according to CMA DataVision prices. As the Economist puts it in another piece:

The bond market’s skittishness puts more pressure on the Greek government to come up with a credible plan for fiscal retrenchment. A pledge to follow Ireland’s example in making substantial cuts to public-sector wages may now be necessary to ensure Greece can fund itself at reasonable cost. Having raised €8 billion this week the Greeks probably have enough money to see them through until May, when a chunk of their long-term borrowing falls due. The danger now is that market sentiment spirals out of control. If that happens, only the most radical measures, or a euro-zone bail-out, will turn things around.

The bail-out will now surely come, but first it would be better to have the EU Finance Ministers meeting on February 9 and 10, and the national leaders summit on 11 February. The key now will be to see the conditions imposed, and whether they are realistic enough to bring about a return to economic growth and debt sustainability over a reasonable horizon.

Basically all these reports today only confirm the contents of my January 21 piece - The EU Is Reportedly Exploring Making a Loan To Greece - contents which were based on a report in European Voice, a report which, despite all the denials at the time, now seems to have been accurate. The decision also means that the Commission remains adamant not to let Greece go to the IMF. In this case, I do really hope they know what they are at, since failure in the Greek case would immediately expose Portugal, and more importantly Spain to massive market pressure.

Finally, having started this piece with a quote from Charlemagne, I will close it with another one. This time, though, there is a difference, in that in this extract it he who is citing me, rather than I who am citing him:

The bloggers over at A Fistful of Euros offer a view of the Spiegel leak that puts the report neatly in context:

"there would seem to be an underlying transition going on here, one which in EU terms is quite rapid. The EU’s own analysis of the problems in the Eurozone is coming nearer and nearer to that of both the IMF and the credit rating agencies. We are moving beyond short term fiscal deficit issues, and immediate liquidity issues, towards problems like competitiveness, and what was previously a taboo subject - the issue of Eurozone imbalances"

Rumours, Rumours, But No Greek Bond Sales To China

Well there certainly is a lot happening out there at the moment. And Monday's successful bond sale which left the Greek government triumphally proclaiming they could comfortably meet their 2010 borrowing program now seems to belong to a lifetime ago. The sale raised 8 billion euros over a 5-year syndicated bond which attracted total bids of EUR25 billion, well above the EUR 3 billion to EUR5 billion initially targeted by the government, who immediately declared a major victory.

That was before yesterday, and the Financial Times announcement that Athens was wooing Beijing to buy up to €25bn of government bonds in a deal being negotiated using Goldman Sachs as intermediary. China had not agreed to such a purchase, according to the FT at the time. In the wake of this announcement - as the FT put it - "Greece’s debt crisis returned to financial markets with a vengeance as agitated investors demanded the highest premiums to buy its government bonds since the launch of European monetary union over a decade ago".

In fact, the yield spread between 10-year Greek bonds and benchmark German Bunds widened dramatically, and were up by almost 0.7 percentage points at one stage, as a general panic set in among sellers who were rattled by doubts about Greece’s ability to refinance its debt - or their willingness to make the reforms which would make their debt sustainable in the longer term. If they were so keen to make all the necessary changes, why were they talking to the Chinese, and not the ECB and the EU Commission, who can, of course, easily guarantee funding for such a small quantity of money?

But the biggest impetus to the debacle actually came not from the FT announcement itself, but from the Greek government's clumsy attempts to deny they had asked for help from Goldman Sachs in order to sell government debt to China. In the end Greek 10-year bond yields closed at 6.70 per cent, up 0.48 percentage points up on the day. In fact, the lid was virtually sealed on the Greek fate by statements reported in Bloomberg from Yu Yongding, a former adviser to the Chinese central bank, who is quoted as saying that China shouldn’t buy a “large chunk” of Greek government debt to help rescue the country because their securities "are more risky than U.S. Treasuries". “Let European governments and the European Central Bank rescue Greece", he said. Exactly. This is the point.

The Greek finance ministry reacted by coming out with an attempt to deny that any such negotiations were taking place: "The Finance Ministry categorically denies that there is any deal to sell Greek bonds to China.......The Finance Ministry has not mandated Goldman Sachs to negotiate any deal with China." Fine, but wording here is important. Evidently there is no deal, and Goldman Sachs were given no "mandate" - but that doesn't mean they weren't in Beijing, negotiating on Greece's behalf. In fact, as the FT notes, this issue has a relatively long historyand goes back to at least last autumn:

Greece’s attempt to attract Chinese investors to buy a slice of its sovereign debt took shape last November at a lunch attended by George Papandreou, the prime minister, and Gary Cohn, chief operating officer of Goldman Sachs, the US investment bank. Faced by a soaring budget deficit and record public debt, the newly installed socialist government was eager for ideas about how to finance this year’s €55bn ($77.5bn, £48bn) borrowing requirement, the FT has learnt.

Goldman was keen to promote a Greek bond sale to the Chinese government and the State Administration of Foreign Exchange, which manages the country’s foreign exchange reserves – increasing at a rate of $50bn (€35bn, £31bn) monthly in recent months.

Goldman Sachs has close involvement with the struggling Greek government. The investment bank – along with Deutsche Bank – last month organised the government’s first roadshow to London, led by George Papaconstantinou, the finance minister. It was also one of four foreign banks – the others were Deutsche Bank, Credit Suisse and Morgan Stanley – that arranged Monday’s successful bond offering, along with two Greek banks.

The Greek press has long been rife with speculation about possible Chinese investments in the country, and some of the earliest stories go back to 2008, when Chinese port operator Cosco Pacific signed a 3.4 billion euro deal to run and upgrade facilities at Piraeus Port, which is Greece's biggest, although none of the deals mentioned ever fully materialised, since the Chinese have been unable to operationalise their Piraeus asset following a dockworkers strike last October which lead all concerned to have second thoughts.

This time the rumour mill had it that the Greek government were willing to cede some control over one of their strategic assets - National Bank of Greece - in return for the funding. Analysts in Athens saw the government’s appointment of Vassilis Constantacopoulos, a senior Greek shipowner, as a non-executive director of NBG earlier this month as a signal that a deal with a Chinese investor might be in the offing. Mr Constantacopoulos’s shipping company charters container vessels to China’s Cosco shipping and ports group, and it was he who facilitated the above mentioned €4bn concession for Cosco to operate a container terminal at Piraeus port.

The Greek Prime Minister George Papandreou has vigourously denied all these reports - although again, watch the wording. Speaking at Davos today he said that recent media reports that China would buy up to E25 billion worth of Greek sovereign bonds are "wrong," and that Greece has "not asked for money anywhere else." He added: "We are in a jittery time" in which "rumors can create problems." Greece's Finance Minister George Papaconstantinou also reiterated the same points: "We have not talked to China and no investment bank has a mandate from us to talk to China," he said in an interview with The Wall Street Journal.

But it is strange to here Mr Papconstantinou saying this, since if we go back just to last Tuesday - the day before the current rumpus broke out - Mr Papaconstantinou gave an earlier interview to the Wall Street Journal, but this time the Greek Finance Minister was there to detail a diversified global borrowing plan to plug government fiscal gaps - including, he mentioed, aspirations to raise up to $10 billion from Chinese and other Asian investors.

Papaconstantinou will lead a delegation next month to the U.S. and Asia to market Greek debt valued at at least $1.5 billion to $2 billion denominated in euros, dollars and possibly yen. But Greek officials hope that the bond tour, which will include stops in Beijing, Shanghai and Hong Kong, could bring in five times that amount if Chinese investors are attracted to the deal. "There is a lot of liquidity in China. There are big funds in China. This is why China is going to be part of the road show," he said, adding that if Chinese investors are to get involved the bond size has to be "significant... possibly $5 billion to $10 billion." A person familiar with the situation has told Dow Jones that Greece is trying to place as much as EUR20 billion to EUR25 billion overall with Chinese investors.

Indeed the Greek government have not gone so far as to deny the roadshow ever exitsed, but Reuters today do report that they have backtracked somewhat, since while they had previously announced they were going to stage the roadshow sometime in the near future, the head of the Greek debt agency (PDMA) is now stressing that no date has in fact yet been set: "Finance ministry officials said the roadshow might take place at the end of February or in March, depending on Greece's borrowing plan, which has not been finalised."

Really, this is all a very, very sorry story, and the main issue facing the Greek authorities at this point is one of credibility since, as the Financial Times says: "at the heart of Greece’s problems is a lack of confidence in its trustworthiness". Such confidence has been lost in the course of a decade of "incidents" with the EU Commission and the Eurostat statistics office, and it is just this loss of confidence which the recent handling by the Greek administration of the China bond issue will have done little to restore. Is the Greek government batting with us or against us at this point?

Competitiveness Gaps Could Hurt Euro - No Really!

Reuters Jan Strupczewski gives more details of the EU Commission report first leaked by Der Spiegel. According to Strupczewski the "new European Commission report has expressed concern about gaps in competitiveness that could undermine confidence in the euro zone and point to tensions related to wage levels and capital flows in the 16-member club". The report was prepared for the finance ministers meeting on January 16.

Of particular interest the report acknowledges that the real effective exchange rate for Greece, Spain and Portugal is overvalued by more than 10 percent - I would put the Spanish figure at nearer 20%, but still, a start is a start - and this gives us an indication of how much either wages and prices in these countrieshave to fall, or productivity rise, to make them competitive again, given that they are locked into the euro.

The report also said that large and persistent differences in competitiveness across the zone are a serious concern and can undermine confidence in the single currency "Competitiveness divergences within the euro area may hamper the functioning of the Economic and Monetary Union, because of large trade and financial spillovers across Member States.......In particular, the persistence of large cross-country differences jeopardises confidence in the euro and threatens the cohesiveness of the euro area,"

The report, which runs to 172 pages, was requisitioned by the Commission to examine the competitiveness problem in the 16 countries using the single currency, such differences in competitiveness are reflected, for example, in the size of the respective current account deficits or surpluses in the eurozone.

To put things in perspective, the Commission estimates Greece had a current account gap of 8.8 percent of GDP last year, Spain 5.4 and Portugal 10.2 percent. Cyprus had a current account gap of 11.6 percent while Germany had a surplus of 4 percent, Luxembourg 9.4 percent, the Netherlands 3.1 and Finland 1.1 percent. These numbers are well down from 2008 in the cases of Greece, Spain and Portugal, where the deficits were more like 15%, 10% and 9%. As Krugman says, its all about "numbers, numbers, numbers".

The note said that the accumulation of large current account deficits could not be sustained forever and that they entailed a build-up of external and private sector debt. "If [these imbalances] remain unaddressed, the eventual correction can be abrupt and highly disruptive not only for the countries concerned but also for the rest of the euro area," it said.

"The combination of competitiveness losses and the excessive accumulation of public debt in some Member States are worrying in that context," the note said. Rigidities in labour and product markets may make regaining lost competitiveness a long and painful process , but the longer the adjustment is postponed the higher the ultimate cost will be, the Commission said.


"The divergence trend observed in the early years of euro reflects a worrying build-up of a range of domestic imbalances in some Member States," according to the Commission.

More controversially, the report suggests that while the real effective exchange rate for Greece, Spain and Portugal is overvalued, Germany's was 5.1 to 3.1 percent undervalued last year, indicating that companies have scope for wage increases without losing competitiveness. This is controversial, because naturally this rise in wages would bring Germany back into trade equilibrium, GDP growth would turn negative, since as a high median age society Germany is now completely dependent on its trade surplus for growth.

In addition the report said that most indicators of price and cost competitiveness pointed to a further divergence in competitiveness in the many euro zone countries during the financial crisis and in the early stages of the recovery. This is not good news, and the only clear signs of rebalancing come from Ireland gaining in competitiveness in 2008 and 2009.

"A smooth adjustment of intra-euro area competitiveness divergence and macroeconomic rebalancing is key for the recovery and, more generally, for the economic resilience and a smooth functioning of EMU in the long term.......It is therefore essential that Member States put in place an ambitious and comprehensive policy response geared at speeding up and improving intra-area adjustment mechanisms......The successful adjustment of intra-euro area competitiveness divergence and macroeconomic imbalances is of vital importance for the long-term functioning of EMU.

The EU Does Have The Legal Power To Organise Bailouts

Sometimes I am surprised by what some people consider to be news. Tony Barber points out today in the FT Brussels blog that the EU has the power to mount bailouts of any member country under "exceptional circumstances". As Tony rightly points out, under Article 122 of the EU’s Lisbon treaty, which came into effect last December, when a member-state is:

"in difficulties or is seriously threatened with severe difficulties caused by natural disasters or exceptional occurrences beyond its control, the Council [of national governments], on a proposal from the Commission, may grant, under certain conditions, Union financial assistance to the member-state concerned.”

So there it is, as he says, "in black and white", whatever the propaganda smokescreen some widely quoted but anonymous "EU Officials" have been mounting for the press in recent days.

What Tony omitted to mention is that Article 122 of the Lisbon Treaty is simply another version of article 119 of the [Foundation] Treaty of the EU (which was presumeably incorporated directly into the Lisbon Treaty. Article 122 stated the following:

Where a Member State is in difficulties or is seriously threatened with difficulties as regards its balance of payments either as a result of an overall disequilibrium in its balance of payments, or as a result of the type of currency at its disposal, and where such difficulties are liable in particular to jeopardise the functioning of the common market or the progressive implementation of the common commercial policy, the Commission shall immediately investigate the position of the State in question and the action which, making use of all the means at its disposal, that State has taken or may take in accordance with the provisions of this Treaty

This was the article cited in justification for the assistance to Latvia and Hungary, and as I pointed out in February last year, give the grounds to justify the issue of EU Bonds (as was in fact done). Now some recent statements of EU Officials point to the fact that help was given to Hungary and Latvia was only given as a result of the fact they were suffering from a "Balance of Payments" crisis, since the crisis those countries (Latvia and Hungary) was described in this way, and that this help would not be available to members of what is now being called the EuroGroup of countries. They say this, correctly, since these countries can't (almost by definition) suffer a Balance of Payments crisis, since the Eurosystem funds trade and current account deficits almost automatically. Precisely, there "danger signal" problems can't arise. But what can arise are funding problems for the government debt which eventually arises in their wake, which is where we are now in the cases of Greece, Ireland, Portugal and Spain.

So we move on to the second line of defence, which is "as a result of the type of currency at its disposal". This wording was no doubt adopted to cover cases of those countries with so called "vulnerable currencies", but when you stop and think about it, it perfectly describes the predicament of those countries, who given the lack of an adequate (red light flashing) warning mechanism on balance of payments and reserves issues, now find themselves in a much deeper problem and with no currency of their own to devalue. The definition fits the case like a glove.

The thing is, as Tony Barber points out:

Article 122 stresses it would be EU national governments, acting on advice from the Commission, that would take the decision to rescue Greece - or Ireland, Portugal and so on. There is nothing in the treaty requiring the ECB to state its opinion one way or the other. So, on this question, it is important to listen to eurozone political leaders, above all Chancellor Angela Merkel of Germany and President Nicolas Sarkozy of France, as well as Commission president José Manuel Barroso.

So look tot he statements of national leaders and EU Commission Officials for road maps on how this particular topic will develop.

The ECB Is Here To Help

But there is another area we need to think about, and that is liquidity provision. Here the ECB can be of enormous help. Basically, as I outlined in my Debt Snowball post, the critical debt to GDP ratio depends on two factors: growth in nominal GDP and the interest rate spread on government bonds. Now, EU Bonds (or whatever) can help with nominal GDP, since they can be used for fiscal support, and to provide domestic demand to an economy during the correction, but the ECB liquidity provision to the banks can also help to keep spreads under control, and thus reduce the cost of borrowing for national governments.

If we are all Europeans, and all in this together, isn't this what our leaders should be doing - for those countries willing to make sacrifices and trying to put their house in order - providing fiscal and demand support via the powers of the Commission, and liquidity support via the spreads. Is this not what M. Trichet meant when he said "we are here to help" - it would be a strange form of Union wheree the main collective institutions were working against the interests of the individual members.

Surely it is this sense that we should read yesterday's statement by ECB council member Axel Weber (one of the leading pretenders to M Trichet's thrown) that the bank will discuss reverting to long-term refinancing auctions after March,according to a report in the German newspaper Boersen-Zeitung.

After the end of the first quarter, “we will talk about returning to the auction process in the refinancing operations with longer maturities,” Weber said, according to the newspaper.

This makes perfect sense, as any other approach would be near suicidal, given the difficulties we are now all facing. Flexibility is the word.

And it is in this sense we should be looking at another piece of news that has generated considerable interest today. According to reports, investors placed about €20bn in orders for the new Greek five-year, fixed-rate bond - four times more than the government had reckoned on offering. A sign of success? Hardly, since if you look at the interest spread they needed to offer, it is clear that Greece is being made to pay dearly for all those years of fiscal profligacy, with the bond carring a record high interest rate spread relative to the rate for German bonds, the eurozone’s benchmark. The terms were described by Bloomberg as "generous".

Greece sold 8 billion euros ($11.3 billion) of bonds at premium yields to ensure the country’s first debt issue since being downgraded was a success. The five-year securities yield 6.2 percent, the Greek ministry of finance said late yesterday in an e-mailed statement. The ministry said it received 25 billion euros in orders, after offering 0.3 percentage point more yield than on the nation’s existing debt with similar maturities. The new bonds yield 3.5 percentage points more than the benchmark mid-swap rate, after being first offered at 3.75 percentage points. That compares with 3.2 percentage points on Greece’s 3.7 percent notes due July 2015, according to ING Groep NV prices on Bloomberg. The yield on Greece’s existing five-year bonds declined 7 basis points yesterday to 5.88 percent. That narrowed the difference with comparable German debt, the European benchmark, to 358 basis points, from 365 basis points last week, the widest since Greece joined the euro in 2001.

“It showed we have the ability to raise funds that we need,” according to Spyros Papanicolaou, head of the Greek debt agency. “We expect the spread to start to tighten after the sale, because Greece has been misread and misjudged.”

But Mr Papanicolaou needs to read the Credit Rating Reports (and paricularly Moodys) more carefully (or alternately he could read my blog). In fact Moodys (who stand apart from the other agencies on this one) argued only last month that investors' fears that the Greek government may be exposed to a liquidity crisis in the short term are totally misplaced. As they said in their press release "the risk that the Greek government cannot roll over its existing debt or finance its deficit over the next few years is not materially different from that faced by several other euro area member states". And they took this view since it is obvious, as a member state of the EuroGroup they can receive liquidity via the ECB (one of the strongest liquidity providers in the world), and if they implement an EU Commission approved correction programme, then the ECB is obliged to help them. It makes no sense at all, for any of us, to make this correction process more difficult.

And Spain Will Need All the Help It Can Get, From Both The EU Commission and the ECB

Now finally, one piece of news few seem interested in. Santos Gonzalez, President of AHE (Spain’s Mortgage Association) has come out today and warned that Spain's banks do not have the financial capacity to assume the outstanding debt of property developers, which amounts to around 325 billion Euros, This he says "gravely endangers the viability of the Spanish property sector as well as Spain’s financial industry".

The problem is growing, according to Gonzalez, since the need to refinance 15,000 million euros worth of interest payments annually against assets which are continuously losing value becomes insustainable. The numbers are not so much what matters here as the growing number of people who are coming out and talking publicly about the problem.

As Mark Stucklin editor of Spain Property Insight says, "You can see how bad the situation is just driving down the Spanish coast. Vast quantities of capital have been sunk into unsold developments and abandoned building sites, the result of deranged lending during the boom. Debts have will have to be written down further to get the market going again. The longer it takes the more painful it will be. Spain needs to grab the bull by the horns".


Unfortunately the links are in Spanish, but the gist of the problem is that the number mentioned is around 30% of Spanish GDP, and if the government have to mount a bailout of this order (as I have long been arguing they will need to, and this is only for the developers) then Spanish sovereign spreads are going bo be in for a very bumpy ride. Maybe English language journalists should broaden their horizons a little.

Eurozone Imbalances Weaken Trust in The Euro and Undermine Euro Area Cohesion

This is the conclusion drawn - rather surprisingly - not by some bank analyst, or by a Credit Ratings Agency, but by the European Commission itself, according to the contents of a report "leaked" to the German magazine Der Spiegel at the end of last week. "(The imbalances) weaken trust in the euro and endanger the cohesion of the monetary union,".

Here is a rough translation of the Der Spiegel report:

The EU Commission Sees Monetary Union At Risk

The EU Commission is concerned about the survival of monetary union. The differences in competitiveness between member countries and the resulting imbalances give "cause for serious concern for the eurozone as a whole", according to a presentation given by the Directorate General for Economy and Finance to the finance ministers of the Eurogroup.

The experts who advise the Finnish Commissioner-designate Olli Rehn fear that the differential development of the economies in the various Member States undermine confidence in the euro and may ultimately threaten the cohesiveness of the monetary union. Of particular concern to the Brussels officials is the economic condition of those countries who in the past ran huge deficits in their current account balances, because they lived for many years thanks to ample credit which was avaialable due to the low interest rates prevailing. Now these countries are suffering, especially Spain, Greece and Ireland, under the weight of escalating government deficits. "The combination of declining competitiveness and excessive accumulation of public debt worrying in this context," the experts say.

As a way out of trouble, the EU officials first propose that the countries concerned put their own houses in order and introduce the necessary reforms. Wage levels need to be set with due consideration to falling productivity and the loss of competitiveness. In plain language: workers ambitions should be modest, with low wage settlements. "The adjustment will be accompanied by a marked increase in unemployment."

The Commission officials also recommend that the deficit countries employ a strategy which was used by Germany in its recent efforts to exit from many years of weak growth. At the same time the German federal government does not escape criticism in the report, since Germany and other relatively successful countries such as Austria and the Netherlands need to tackle the chronic weakness in their domestic demand.

To achieve this the Brussels experts recommend enabling more competition in the services sector, the intriduction of tax reforms and the elimination of credit hurdles. The longer the countries concerned delay introducing the necessary measures, the higher the social costs which will be incurred. The Commission believes the euro countries have no choice: "These adjustments are vital for the long-term functioning of monetary union."

As far as can be seen from this Spiegel report, while it is the case that some of the wording used is similar to things we have seen before, there would seem to be an underlying transition going on here, one which in EU terms is quite rapid. The EU's own analysis of the problems in the Eurozone is coming nearer and nearer to that of both the IMF and the credit rating agencies. We are moving beyond short term fiscal deficit issues, and immediate liquidity issues, towards problems like competitiveness, and what was previously a taboo subject - the issue of Eurozone imbalances. These were, in fact, supposed to disappear with the passage of time, so it was expected that they would have diminished rather than increased. In that sense there is now an implicit admission that the institutional environment in which the common currency has been operated was severely deficient and badly needs to be improved. In my view this change in approach is already a big improvement, as is the fact that people are begining to face up to the reality that the Euro has exacerbated the imbalances, rather than reducing them.

In particular the Commission seem to be starting recognising that countries like Spain whose main export became pieces of paper (or IOUs on their future) which were securitised against assets which we can now see didn't have the value they were thought to have (the housing stock, or should I say glut) entered a dynamic which was seriously unstable. Now we need to see the measures which can be applied for correcting these distortions.

Juergen Stark, member of the Executive Council of the ECB was out with another interview more or less along the same lines on Saturday:

Stark told the Welt am Sonntag newspaper that Greece, which is battling to get its budget under control, must make comprehensive consolidation a priority but also reform its economy to stop producing deficits. "Countries like Greece must not only bring their deficits under control, but also enact a fundamental reorientation of their economic policy," Stark said. "Some countries have even managed to accept falling wages -- there is no alternative for economies in a difficult situation," he added in the interview, which had been held on Thursday.

The reference in the Spiegel report to the earlier German expience is to the earlier "internal devaluation" Germany carried out between 2001 and 2005 in an attempt to restore competitiveness after having entered the common currency at an exchange rate which was later discovered to have been too high. The thing is, the German devaluation was quite limited and quite slow. Greece and Spain have large devaluations to carry out, and the time scale is likely to need to be short, since it is urgentto restore growth to these economies to avoid the debt to GDP percentages snowballing upwards.

Another aspect to this whole problem is the new emphasis on correcting the imbalances as a shared process, one which, as Mr Zapatero would have it, involves "solidarity", and joint responsibility. That is to say the surplus countries are going to be expected to play their part: no wonder the German economy minister became so angry with Mr Zapatero's 2020 strategy initiative.

Of course, it is not really posible to present the problem in quite this way, since one set of economies are competitive, and another set are not, so it is hard for the Greeks and the Spanish to really blame the Germans and the Dutch for their present situation, although everyone, both centre and periphery, will have to play a part in the search for solutions. I tend to put it this way: the South must make sacrifices, and then the centre must help. Thus talk of no "financial bailout being possible", or, as M Trichet would have it, simply stating that the "external surpluses of some member countries (in the balance of payments) finance the external deficits of some others" without recognising that the presence of these very same surpluses form a problematic part of the internal Eurozone imbalances is hardly helpful at this point.

As Martin Wolf said recently:

What people do not seem to understand is that peripheral European countries cannot escape from their trap because they are caught in a game of competitive deflation with Germany (and the Netherlands). So long as the eurozone has an external balance (roughly) and Germany has a vast surplus, the rest of the zone MUST be running aggregate deficits. That is a subtraction from their domestic demand. This then means that either the private sector runs deficits (spends more than its income) or the public sector does. If the latter is pushed towards balance, by eurozone pressure, GDP must contract enough to force the private sector finally back into deficit and so towards bankruptcy. Ultimately, the only way out of the trap is for nominal wages and costs in peripheral Europe to fall so much that it forces core Europe into depression . That also means a depression in peripheral Europe. No advanced polity can cope with a permanent depression. Anything can then happen. I have always feared that the euro could break the EU. I believe this is quite possible.

"Alternatively, demand must start to rise substantially in core Europe. Is that possible? The other alternative would be for the eurozone as a whole to move into surplus - but how, given the weakness of external demand and the strong euro?"

No easy answers yet awhile, but lots of interesting problems to talk about, and plenty of food for thought.

Half a League Onward Rode the Six Hundred

Well you may doubt their wisdom, and you may doubt their rigour, but there's no doubting their tenacity. This looks like being Marathon all over again.

New EUR 5 Year Mandate for Greece

The Hellenic Republic, rated A2/BBB+/BBB+, has mandated Credit Suisse, Deutsche Bank, Eurobank EFG, Goldman Sachs International, Morgan Stanley and National Bank of Greece for its forthcoming Greek Government 5-year Euro benchmark. Due 20 August 2015, the transaction will be launched and priced in the near future subject to market conditions.

And here's how the ten year bond spread with the comparable German bund performed today.