WHAT the EU move on Greece really means to us ... and why it’s doomed.
The latest “solution” to the eurozone crisis leaves us with the worst of all possible worlds. Not alone will the measures announced by Europe’s leaders be insufficient to solve the single currency’s problems, by “leveraging up” the bailout fund the risks are dangerously concentrated. We answer your questions.
Q: What happened at the EU leaders’ summit?
A: A lot less than you might think. A 50pc write-down in Greek debt was the least the markets had been expecting, a €105bn bank bailout was at the lower end of what most analysts reckoned was needed and “leveraging up” the EFSF, AKA the bailout fund, to over €1 trillion was also at the lower end of market expectations.
Q: Okay, so we would all have liked Europe’s leaders to do more but the latest deal still represents significant progress to solving the crisis?
A: Not necessarily. For a start it would appear that the banks who hold Greek debt, which had an original face value of at least €340bn, are not all on board for the “voluntary” haircut of 50pc. The banks had been hoping to restrict the write-down to 40pc while Germany had been holding out for 60pc. Now some of the banks are threatening to refuse to agree to a “voluntary” write-down. This would trigger a formal Greek debt default, an outcome this agreement was supposed to avoid at all costs.
Q: But surely the agreement on a €105bn bailout package for mainland European banks is good news?
A: Mainland European, particularly French and German, banks will be hit hard by the write-down in the value of their holdings of Greek government bonds. The bank bailout package is supposed to provide fresh capital to help plug the holes in their balance sheets caused by the Greek debt write-down. But will it be enough? The IMF estimated that recapitalising Europe’s banks after they have written down Greek debt could cost at least €200bn while many
analysts reckon this figure could double, ie. to €400bn, when losses in the “shadow” banking system are added.
Q: So the latest deal isn’t perfect but at least the increase in the EFSF is a big step forward?
A: Almost certainly not. Firstly the EFSF isn’t being increased. It stays at its previous level of €440bn. When the €160bn or so that the EU has committed as its share of the Greek, Portuguese and Irish bailouts along with the €105bn going to the European banks, most of which will come from the EFSF, is deducted, that leaves a maximum of about €200bn.
While details are still sketchy, what Europe’s leaders seem to be proposing is to convert most of the remainder of the EFSF into a giant insurance fund which would insure the first 20pc of the bonds of peripheral eurozone countries against losses. By “leveraging up” the EFSF in this way, it apparently magically converts €200bn into €1 trillion without having to put up a cent of new cash.
Unfortunately you get nothing for nothing in this world. The price of this “leveraging up” is to concentrate the risk of bond write-downs on the EFSF.
With Greek bonds in the process of being written down by at least 50pc and, even after the recent rally in prices, |10-year Irish Government bonds still trading at a discount of almost 20pc to their face value, the likelihood is that bondholders will start to claim on the insurance being provided by the |EFSF sooner rather than |later, quickly wiping out the insurance fund in the |process.
Q: So what should Europe’s leaders have done?
A: I thought you would never ask. Instead of endless spatchcock “solutions”, Europe’s leaders must allow the ECB to start acting like a real central bank. After faffing around for more than three years, it will take a huge commitment, probably at least €3trillion, to convince the markets that finally the EU gets it. That sort of money can only come from one source, the ECB.
It must be instructed to follow the example of both the Federal Reserve and the Bank of England and print trillions of euro of new money to underpin European bond markets and rescue the banks.
Unless Germany can be persuaded to overcome its inflation phobia by allowing the ECB to let the printing presses rip and act as a credible lender of last resort, the single currency is doomed, no matter what Europe’s leaders agree to.