While only the market, and no one else, seems to have a grasp on the unknown unknowns in the Eurozone crisis, and has voted two toes up, despite really having no clue what is coming for Europe, here is a report from Exclusive-Analysis that summarizes the known unknowns, and comes up with a bleak conclusion: "We remain very doubtful that the relative optimism that has followed the EU summit will last. Last time, the 10th of October, following a Berlusconi announcement of austerity in the previous week, it took markets only a few days to distinguish between the detail of what was agreed and the more optimistic principles that were announced." So as everyone scrambles to figure out what is still missing from European bailout plan, perhaps focus on what is already present, because if that is any indication, the Thursday rally is nothing but yet another confirmation of just how broken the market as a discounting mechanism truly is.
From the report's executive summary:
- European leaders’ agreement to increase the size of the European bailout fund is unlikely to have an impact given the absence of clarity on where the final figure of 1trn euros funding will come from.
- The Bundestag has sent a clear message that it will commit no more than the 211bn that it already has. China is likely to only commit token sums and then only for significant political and business concessions or perhaps physical assets.
- The vague concepts of “leverage” and “insurance” that have filled the gap between what is available and what is needed. These are unlikely to appease anxious creditors and financial markets for long.
- The relief of the markets seems to be that a Lehmans style credit-event did not follow the Eurozone leaders meeting of 26 October, but the threat of one clearly remains. With 61bn euros of debt repayments due in February 2012 alone, Italy will likely have to reschedule.
- The forecasting scenario choice is between a managed default and a disorderly recalibration of currencies, liabilities and obligations such as happened after Lehman declared bankruptcy on 14 September 2008.
We remain very doubtful that the relative optimism that has followed the EU summit will last. Last time, the 10th of October, following a Berlusconi announcement of austerity in the previous week, it took markets only a few days to distinguish between the detail of what was agreed and the more optimistic principles that were announced.
The EU leaders have agreed to raise the funds available to the European Finance Stability Facility (EFSF) to 440bn euros, which is not enough to cover the PIIGS’ financial obligations in 2012. The rise of the EFSF to 1trillion euros, loosely agreed on 26 October, would avoid a disorderly default in 2012. The problem, however, is that it is not clear where this extra 560bn euro will come from.
Germany at the Limit
Of the possible sources, Germany is solidly behind its commitment of 211bn euros. But our political analysis of the Bundestag shows clearly that German is at, or very near, the limit of what it will offer. To underscore this, the German constitutional court has just ruled out a fast-track committee based decision process that would bypass a full parliament.
Our contacts in China have been telling us for months that China does not trust any part of the euro-system it is now being asked to bail out. Not the currency (which is being printed), not the people (who in the summer promised banks "a one off" 20% haircut over Greece but now impose a 50% haircut, even wanting the banks to say it was voluntary). They do not trust a system where the ECB cannot control monetary and fiscal policy or where EuroStat failed to scrutinise Greek economic data on accession to the Euro. They certainly do not trust the European political process and its relatively powerless central bank. They are unlikely to have found the fist fights in the Italian parliament reassuring. If China contributes it is likely to be for a high political price and at a symbolic level. They would be more interested in buying brands and physical assets cheaply but that is not what is presently on offer.
Private money will want a high risk premium if it wants to come in at all. Thus, as has we have noted before, most of the money will need to be printed. The Germans are not quite ready for that, so the crisis will drift on.
We are very keen on clear language. ‘Leverage’ is vague and aspirational. ‘Insurance’ is not wholly accurate. Insurance is when the unfortunate-few are bailed out by prior and collective contributions of the careful-many. It is hard to map those two definitions onto the present crisis. If the fund only covers the first 20% of defaults then it is simply too small, and calling it insurance does not change that. More specifically, The unfortunate-few (the PIIGS) are already identified. Thus, they do not need insurance; they need a bail out. There is no sense in which they are now (or ever were) part of the careful-many (Germany, Finland etc). Greek default is less a risk than a near-certainty, which makes the fund a bailout, not insurance. All of which makes the fund as big as it is and no bigger.
And then there are the banks, which is not a problem the summit addressed on a convincing scale. The value of the PIIGS’ debt held by the 20th most exposed banks sum up 529bn euros, which means that the European authorities expect that 80% of these debt will be serviced – a too optimistic figure given that the same authorities have demanded that the banks accept a 50% haircut on Greek debt alone.
We are still where we started.
For us this is not a contest between scenarios of Euro survival and Euro failure. The question is whether recalibration will be orderly (i.e. managed by politicians over weeks or months) or disorderly (i.e. managed by central bankers over a weekend in a credit event like the Lehman default). Clearly, we are still on the orderly transition pathway in that a credit event did not occur but it remains a credible scenario in the next few months. In both cases, as we have concluded previously, money will be created, debts and assets married up regardless of the history (e.g. bad banks forced on good banks); cash piles like pension funds and corporate cash perhaps forcibly diverted into bonds and so on. In short, there will be a major redistribution of wealth. The second question is after the recalibration, how long will it take to reset the system?