This page has been archived and commenting is disabled.

Open Europe Summarizes What To Expect From Today's European Summit

Tyler Durden's picture




 

One of the premier Euroskeptic think tanks, Open Europe, chimes in with, as expected, a rather bleak outlook on what to expect from today's Summit which is just now starting: "The hope for a “comprehensive plan” to save the eurozone, as originally touted by the eurozone leaders, looks to be a lost cause. The best outcome we can hope for today looks to be a broad political agreement, with technical details left to be sorted at a later date. Given previous experiences with technical changes (notably the second Greek bailout package and the Finnish collateral deal) it is definitely possible that the deal could be watered down, for example with investors being offered greater guarantees over their involvement in the second Greek bailout or with the bank recapitalisation actually turning out to be less stringent than expected."

How might the revised second Greek bailout look?

The IMF, Germany and most eurozone countries are pushing for a 60% face value cut, although the Institute for International Finance (IIF) – effectively representing banks - still seems someway from agreeing to that. Write down on Greece’s debt are likely to be between 50% and 60%, probably achieved through a bond swap with the new bonds having a maturity of 30 years. EFSF – the eurozone’s temporary bailout fund – is unlikely to offer collateral, although Kathimerini reports that some portion of the bonds may be swapped in cash (essentially bought out or retired, presumably using bailout funds).

Open Europe’s take:

- We still don’t have an exactly detailed plan, but if EU leaders managed to push through a 60% write down, that would be positive. However, the lack of participation and the ‘voluntary’ nature of the plan mean that the actual debt reduction may still be limited and far below what is needed in Greece.
- There is still an on-going desire amongst some eurozone countries, the ECB and the IMF to avoid a so-called “credit event”, involving the triggering of credit default swaps (CDS) – a form of insurance on government debt, which would force some investors and banks to take significant losses. Such an event may be triggered anyway given size of haircuts, but even if it were, he evidence suggests a cascading effect would not take place. It’s also worth keeping in mind that not triggering CDS also has an impact, as it could ruin the finances of those who take losses, since that can’t recoup from the hedges they have in place.
- IIF will always have stronger negotiating position until the ‘voluntary’ nature of the plan is abandoned, meaning that banks can still avoid losses despite them having to be incurred sooner or later. In short: a full hard restructuring is needed and will only become more costly in the future.

Can we expect details on the leveraging of the EFSF?

In a word…No. There will be some details, with the plans focusing around two options which can be implemented separately or together:

1) Using the remaining EFSF funds to insure new issues of sovereign debt, likely to be 20% for countries such as Italy and Spain. The insurance is expected to be tradable, not permanently tied to bond it is issued with, and may take form of a certificate with a claim to EFSF bonds or cash repayment.
2) Creating a Special Purpose Investment Vehicle (SPIV) to attract foreign investors (public and private). The SPIV will purchase sovereign debt of struggling eurozone countries, and is likely to take the form of an account with IMF, to which IMF will contribute (amount tbc). Other countries (BRICS and their sovereign wealth funds in particular) and private investors could also invest in this fund. They may chose to create numerous SPIVs, for country specific purchases, and would likely need some EFSF guarantees to get it going, but could then issue its own debt instruments or get capital contributions.

Open Europe’s take:

- This proposal is still massively vague on technical details and how much leverage is achievable. However, no matter what the details look like, the insurance plan is fundamentally flawed, given that guarantees may not be viable when they are most needed and 20% wouldn’t be enough to calm markets any way (see here for a full breakdown of our thoughts). As we’ve noted before, a complicated and tradable form of default insurance is precisely what EU politicians have spent years to try to regulate against. So their ‘solution’ is riddled with irony given many eurozone leaders aversion to CDS. Furthermore, since the current plan suggests offering EFSF bonds as insurance rather than a cash pay-out, it may be close to worthless since it would only be needed in a situation where a default of Italy or Spain is a real risk. So, in such a worst case scenario, the EFSF insurance scheme becomes almost redundant.
- The SPIV plans also hinge on who is willing to invest. Given the massively correlated nature of the risky assets which these funds will be buying, we’d imagine that investors may ultimately get cold feet. To get up and running the SPIV may require significant guarantees from EFSF (such as a pledge to take the first loss, similar to the insurance plan) which would be self-defeating, since the EFSF could not afford this.
- Again, there’s massive irony here, as Europe is now falling back on massively complex ‘Anglo-Saxon’ financial instruments to help save the eurozone. Putting these at the heart of an already complex, diverse and flawed monetary union is far from desirable.

What structure could the bank recapitalisation take?

- Probably marking to market on debt as of 30 September 2011, with target capital tier one ratio of 9% (not clear on which set of Basel rules this measure will be based). Expected to total €108bn, and needs to be done by 30 June 2012
- Banks must first attempt to raise capital from private sources (including debt-to-equity swaps). Drafts suggest that until this is done there will be restrictions on the dividends and bonuses which banks can pay. If the capital cannot be raised on the private markets then governments will have to step in with an effective bank bailout, and failing that, the buck will be passed to the EFSF. We expect that funds from governments and the EFSF will have even greater conditionality, and will probably require some restructuring of the bank.
- Some guarantees of bank liabilities (or bank bonds) may also be required to allow banks access to funding and to stop them shrinking their balance sheets (meaning that they could stop lending money to, say, small businesses).

Open Europe’s take:

- Bank recapitalisation is definitely necessary, although the marking to market on all sovereign debt does set a dangerously pro-cyclical precedent. Again more technical details to come, but definition of 9% threshold is key - if watered down, this could undermine the whole process.
- Applying restrictions to banks raising money on the private market is also not necessarily desirable. This could cause huge fluctuations in share prices and lead to market distortions. Obviously, it is important to make sure banks recapitalise during the given time frame, however, setting these conditions could do more harm than good. Strong conditionality needs to be imposed on banks when the governments or the EFSF lend them money.
- Offering guarantees can also be dangerous, as was demonstrated in Ireland. Some guaranteeing of bank bonds to maintain access to funding may be necessary, but offering broader guarantees could begin to weigh on the debt and deficit of states.

What role will the ECB play in all of this?

Germany has won out the argument over whether the ECB should step in and fully back stop Italy and Spain, despite protestations from France. So the ECB is likely to play a limited role for now – though that could change should there be no solution to the crisis this week. Recently, France was still pushing to include a phrase which encouraged the ECB to continue its bond buying even after the EFSF was leveraged, however this looks to have been dropped from the draft summit conclusions.

Meanwhile, Martin Wolf’s article in the FT today called for the ECB to step in and backstop the eurozone.

Open Europe’s take:

- It’s definitely desirable to keep the ECB role at a minimum, given already big questions over its independence, credibility, and the risks on its opaque balance sheet. The ECB currently has an exposure of €590bn to the PIIGS, up from €444bn only 4 months ago.
- In his article, Wolf makes some valid and interesting points, but, uncharacteristically, glosses over the fact that the problems with the ECB’s monetary policy helped to fuel the crisis (by cycling cheap credit to the peripheral economies, which fuelled asset bubbles and sovereign spending). Looking at the averages of the eurozone is massively misleading and says very little. On average the picture for the eurozone doesn’t look too bad but it masks the huge divergences and imbalances which are nearly impossible to overcome.
- Having the ECB step in now and expand its balance sheet with no clear exit strategy or conditionality would have unknown effects and would be undesirable in the long run.
- The ECB cannot act as full lender of last resort in the eurozone without engaging in fiscal policy. This is a structural flaw in the eurozone, which cannot be overcome by some panic solution.
- The ECB will ask for a say in exchange for providing the funds – having policy dictated by an independent, unelected central bank is not desirable or sustainable. To expect the ECB to just put up the funds without a say would make it a political pawn and would cease to be effective at any of its goals.
- In any case, forcing it through would risk German support for the eurozone. There’s no point sacrificing the long-term viability of the eurozone, in return for short-term stability.
- See here and here for a full discussion of the ECB issue.

Facts on Italian and Spanish funding:

- Even if the rumoured leverage of €1.25trn - €1.4trn could be achieved, it will not be enough to fully backstop Italy and Spain. Italian funding needs over the next three years total between €825bn and €907bn, depending on budget policies. Spanish funding needs could reach between €500bn and €602bn. Add into this the cost of bank recapitalisation and the needs of other countries and it becomes clear the fund can never really be large enough to act as the full backstop which markets want.

- The main point in the short term is that it significantly undermines the budget cuts of only €47bn. If yields reach these levels or increase, then Italy will miss its deficit targets for the next few years. This will increase market fears and impatience of Eurozone leaders and ECB.
- All of this adds significantly to longer term debt, plays on debt dynamics, as average interest rate paid increases and makes it harder to keep balanced budget.

 

- advertisements -

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
Wed, 10/26/2011 - 12:29 | 1813012 Mr Lennon Hendrix
Mr Lennon Hendrix's picture

Expect chaos, bitchez.

Wed, 10/26/2011 - 12:40 | 1813053 slaughterer
slaughterer's picture

With €2-3 trillion they can kick the can on all of EZ for 2-3 years. Maybe that is all the market needs right now to see this Euro-summit as a "success."

Wed, 10/26/2011 - 12:44 | 1813068 redpill
redpill's picture

It's starting to get entertaining, they are at each others' throats!  No, really!

http://www.reuters.com/article/2011/10/26/us-italy-fight-idUSTRE79P37V20111026

Wed, 10/26/2011 - 12:48 | 1813082 Mark123
Mark123's picture

Hilarious!  where is the video?

Wed, 10/26/2011 - 13:28 | 1813219 SheepDog-One
SheepDog-One's picture

Ive been hearing 'they can kick it 2-3 years', for 3 years now.

Wed, 10/26/2011 - 13:52 | 1813331 Crisismode
Crisismode's picture

And you will continue to hear it for another 3 years from now.

Wed, 10/26/2011 - 12:50 | 1813088 Richard Chesler
Richard Chesler's picture

Fraudulent accounting practices - Proudly serving eurozone leaders since 1999.

 

Wed, 10/26/2011 - 12:31 | 1813018 I am a Man I am...
I am a Man I am Forty's picture

Can't find the video yet, but Russell Simmons gave an excellent interview on CNBC today, hope ZH posts it for those who missed it.

Wed, 10/26/2011 - 12:57 | 1813116 SRV - ES339
SRV - ES339's picture

You are so right... hit every attempt to brand him a hypocrite out of the park... great interview!

http://youtu.be/YQff9eAVsXc

Wed, 10/26/2011 - 12:31 | 1813022 SeverinSlade
SeverinSlade's picture

So in short, expect none of the problems to be solved.

Wed, 10/26/2011 - 12:33 | 1813024 GeneMarchbanks
GeneMarchbanks's picture

'However, no matter what the details look like, the insurance plan is fundamentally flawed, given that guarantees may not be viable when they are most needed and 20% wouldn’t be enough to calm markets any way (see here for a full breakdown of our thoughts).'

Don't know what you're talking about the 'markets' have never been calmer...

Wed, 10/26/2011 - 13:30 | 1813229 SheepDog-One
SheepDog-One's picture

Markets seem to be fully dosed with Thorazine....at any sign of a break down at all, markets suddenly jump up and dance around the mental ward throwing sparkle confetti in the air. 

Wed, 10/26/2011 - 12:34 | 1813028 s2man
s2man's picture

We're in for a world of hurt.  Pun intended.

Wed, 10/26/2011 - 12:36 | 1813041 Segestan
Segestan's picture

The only result will be an wakening call.... that the dream... well it was just a dream.

Wed, 10/26/2011 - 12:42 | 1813060 Manthong
Manthong's picture

Maybe the plan all along was to let some fireworks happen before the G20 in order to bolster global participation in the Euro CF.

Wed, 10/26/2011 - 12:43 | 1813063 midgetrannyporn
midgetrannyporn's picture

The banks and insurance companies sell copious CDS then the politicians do their damnedest to make sure they never have to pay off. What a racket!

Wed, 10/26/2011 - 13:30 | 1813235 SheepDog-One
SheepDog-One's picture

Who do they sell them to?

Wed, 10/26/2011 - 13:55 | 1813345 Crisismode
Crisismode's picture

Each other.

 

You see, it all balances out.

Wed, 10/26/2011 - 12:44 | 1813069 CrimsonAvenger
CrimsonAvenger's picture

Fancy political talk aside, here's what's going to happen to the taxpayers: http://www.youtube.com/watch?v=fjd63o0sbio

Wed, 10/26/2011 - 12:45 | 1813071 Mark123
Mark123's picture

What I don't understand is the ECB buying of PIIGS bonds....is that not the same as QE?  Whatever, if and when they stop buying then most if not all of the PIIGS will be locked out of the real bond markets or pay crazy rates.  This whole EFSF concept just seems to defer the date at which the ECB has to make the final decision on bond buying.

 

There is a good article from Ambrose Evans-Pritchard in the Telegraph about some of the debate in the German parliament (except for his conclusion that the ECB should do more QE like the UK and USA).  Why don't we hear the same from our politicians?  Because they are ALL bought and paid for by the same crooks.

 

http://blogs.telegraph.co.uk/finance/ambroseevans-pritchard/100012823/th...

Wed, 10/26/2011 - 13:34 | 1813255 Tao 4 the Show
Tao 4 the Show's picture

Yes - The arguments are moot. Whether they leverage funds, sell bonds backed by German taxes, or follow various other paths, it all amounts to money creation, at least in the short run. To pretend it is not printing is disingenuous.

But the most surreal aspect is hearing all this about the current emergency, creating all sorts of gymnastic distortions of reality, without dealing with the fact that the problem is ongoing. Bailing anything out now solves nothing for next year or even the coming months, unless the PIGS governments are taken over and a MASSIVE military effort is initiated to enforce slave-level tax collection with martial law.

Either there are revolutionary changes being planned behind the scenes or the level of stupidity and denial are monumental.

Wed, 10/26/2011 - 14:34 | 1813597 Uchtdorf
Uchtdorf's picture

@Tao 4
"Either there are revolutionary changes being planned behind the scenes or the level of stupidity and denial are monumental."

Yes and yes.

Wed, 10/26/2011 - 14:43 | 1813662 Tao 4 the Show
Tao 4 the Show's picture

Any ideas what they are?

Wed, 10/26/2011 - 12:47 | 1813077 BillyTheBlade
BillyTheBlade's picture

Who needs soap operas and reality tv when you can watch this train wreck!

Wed, 10/26/2011 - 13:12 | 1813160 Unprepared
Unprepared's picture

Seriously. I turned off my TV, canceled cable and sold all my fiction novels about 4 years ago.

Since then I had enough entertainment, thrills, twists and turns, drama, tears and laughter just following the political and economic joke the world is becoming.

Very cheap entertainment.

Wed, 10/26/2011 - 12:47 | 1813078 Rhone_Ranger
Rhone_Ranger's picture

Buy Toilet Paper

Wed, 10/26/2011 - 12:53 | 1813096 digalert
digalert's picture

What to expect from summit?

FIST FIGHTS!

Wed, 10/26/2011 - 12:53 | 1813100 Little John
Little John's picture

Oh what a tangled web weave when first we practice to deceive fractional reserve banking.

Wed, 10/26/2011 - 12:56 | 1813112 Little John
Little John's picture

Oh what a tangled web weave when first we practice to deceive fractional reserve banking.

Wed, 10/26/2011 - 12:58 | 1813120 Rhone_Ranger
Rhone_Ranger's picture

The banks better take the haircut...  Otherwise, they may have to accept a full blade shave and possibly one of those Brazillian Jobs?

Wed, 10/26/2011 - 13:01 | 1813129 Mark123
Mark123's picture

So, ECB buys PIIGS bonds, and USA/UK has their central banks buy their government's debt.  What's the diff?  Both just keep the government pork barrel full of goodies.

Some country somewhere could do really well if they issued a real currency.  In Canada the Royal Mint came out with a silver $20 coin - limit 3 per household. Sold out immediately.

Wed, 10/26/2011 - 13:03 | 1813135 Flounder
Flounder's picture

Harmony in the Eurozone?

"Germany paid Greece $67 million in war reparations in the 1960s and has since refused to pay any more."

http://www.reuters.com/article/2011/10/26/us-greece-germany-relations-id...

...don't give us a bailout, give us reparations for what you stole during WWII...


Wed, 10/26/2011 - 13:13 | 1813170 Segestan
Segestan's picture

Greece was also invaded by Italy. Greece has fought other wars, but they don't seek payment. Typical BS .

Wed, 10/26/2011 - 13:07 | 1813146 YesWeKahn
YesWeKahn's picture

Anglo-saxon isn't even in the Euro.

Wed, 10/26/2011 - 13:19 | 1813186 Mugatu
Mugatu's picture

Excuse me here, but wouldn't it be easier for the EFSF to do the obvious - buy Credit Default Swaps for Bonds on the open market for 20% of a country's issue. It does the same thing, and it does it cheaper.  It also would not increase their contingent liability.  

Ohhhh!  But that would expose their hypocracy about their attack on the CDS market.

Wed, 10/26/2011 - 13:27 | 1813212 earleflorida
earleflorida's picture

{"What structure could the banks recapitalization take?" - ,... with target tier 1 ratio at 9% (not clear on which set of Basel rules this measure will be based),... - some guarantees of bank liabilities (or bank bonds) may also be required to allow banks access to funding and to stop their shrinking balance sheets (* meaning that they could stop lending money to, say, small businesses)}

Question: "With Basel Rules ?" Basel #1;  Basel #2;  Basel #3 or a triptych collage of all "Basel Trident's", laying to rest the EU, USA, and BRIC's?

Please answer me this,... and why it has so much to do with the mess were in - yet, falls upon deaf ears: ref:

"Current Bank [Regulator's] / Regulation cause criminal harm to the Economies"___ by Per Kurowski

http://bit.ly/t7tGip

thankyou tyler 

Wed, 10/26/2011 - 13:36 | 1813261 Caviar Emptor
Caviar Emptor's picture

Here's the disconnect: Going "Anglo" with complex instruments, taking the Ponzi to higher order of derivative, asserts faith in the whole Keynesian "system" and back your banksters at the expense of citizens (and perhaps your nation's future). Alternative? 5 Trillion currency Bazooka with TARP-like legal cover to bail everyone out. Or put ALL toxic assets on Fed's balance sheet and call it a day. Or declare debt jubilee and send your banksters to work a real job in Iceland 

Wed, 10/26/2011 - 13:58 | 1813373 Mark123
Mark123's picture

Merkel is so pathetic....time to thaw out Hitler?

 

He was frozen in Argentina right?

Wed, 10/26/2011 - 14:11 | 1813467 Mark123
Mark123's picture

Since 2000 global debt has increased by about $25 trillion (per the debt clock on Economist website).  This does not include any unfunded liabilities.

 

As far as |I know, the only country that has significantly increased it's reserves is China....maybe by $2 trillion at most?  So all this growth in fiat debt is leveraged about 10 to 1 at least.  Sooooo....if global debt is written down bu 10% then the entire system blows up?

Wed, 10/26/2011 - 14:13 | 1813485 Uchtdorf
Uchtdorf's picture

“France is totally mobilized and engaged in the success of today’s summit,” Mr. Sarkozy’s budget minister, Valérie Pécresse, was quoted as saying by Bloomberg News in Cannes, France, where she was preparing for a Group of 20 summit there next month. (NYT article)

Fricking Cannes. I bet they are staying at the Motel 6 there to save money though, brave, true, moral, and economical leaders that they are. Heroes, everyone of them. It's fricking 1984.

Wed, 10/26/2011 - 19:28 | 1814713 htp
htp's picture

The problem in both US and Europe is most people don't think it's a real currency crisis, or else they'd be buying precious metals en mass.

With this much attention on the euro, hopefully more Europeans will wake up. When they do, they'll find the solution naturally -- do away with fiat currency and all these ills associated with it.

Thus the best politicians can do right now, is not to "solve" the crisis, but to let people know there is no solution. Merkel is doing a fine job.

Do NOT follow this link or you will be banned from the site!