Friday, October 28, 2011

The latest euro rescue plan

Kevin Hall reports on the guarded good news of the EU/eurozone emergency summit midweek. Markets reacted positively to news that a deal was struck. but as Michelle Bachmann might say, the devil is in the details. Or, in this case, the lack of them. Here's a report from Aljazeera English's Inside Story, Buying time in the eurozone YouTube date 10/28/2011:

The best news is that the deal recognizes that the banks that hold Greek paper have to take as much as a 50% "haircut" (loss of principal). That means that the EU is finally recognizing the reality that all the players have known for months that Greece is only going to be able to pay back half or less of its current debt load.

More precisely, it's potentially misleading to say banks will have to take the haircut. The arrangement is voluntary. So even the best news is only qualified good news. But as one of the guests in the Inside Story program points out, that voluntary 50% haircut applies only to Greek debt held by private banks, not the large amount held by public institutions like the European Central Bank (ECB) or by the International Monetary Fund (IMF). So it's not a writedown of 50% of all the Greek debt, which means even if the voluntary writedown works out, it's just a stopgap.

It's also encouraging that the EU plans to raise capital requirements for the banks. This should provide more stability.

It's hard to tell what is the worst news. The ECB is still unwilling to assume the role of lender of last resort, which is a necessary element of any permanent euro solution. The provisions for the bailout funds are tentative; they actually expect Brazil and China to participate in it! How much of a sweetheart deal the banks will get has still not been determined. There is certainly no indication that the EU will abandon its destructive, anti-democratic insistence that Greece and other countries with credit troubles impoverish themselves and dismantle critical elements of their social benefits systems.

And hanging over it all is a big unknown. We don't know how much interconnection there is between the financial commitments of the major international banks. As David Freedman helpfully explains in the Nov 2011 Scientific American, "A Formula for Economic Calamity" 10/26/2011, regulators don't know the extent to which derivatives and re-insurance arrangements interlink the risks of various financial institutions, a critical blank spot which left the US and other governments unprepared for the effects of the Lehman collapse in 2008. It was a critical risk factor that was not well understood, and our understanding of it has essentially improved since 2008. Nor has regulation of those risks.

In this case, writedowns of Greek debt by European banks may trigger interest-rate swaps and insurance provisions that will spread weakness to the institutions providing that relief. And financial companies that hold significant amounts of Greek debt may also be on the hook to other companies that hold Greek debt via those other financial instruments. In other words, a company getting hammered my losses on Greek debt may also wind up having to pay money to other companies simultaneously writing down Greek debt.

Kevin Hall reports on the deal for McClatchy Newspapers in Europe averts financial disaster, but much remains to be done 10/27/2011:

However, wild mood swings on Wall Street have become the norm, so whether the relief rally has legs is an open question.

What's clear to experts who follow Europe's economy is this: There's less to the EU compromise than meets the eye.

"I'm totally downbeat," said Nicolas Veron, a senior economist for the European think tank Bruegel in Brussels. Veron and other experts are particularly unhappy with the European move to require banks to build a big buffer against future losses, but then giving them until June to do so.

"They're sort of admitting you don't have enough capital in the system," Sebastian Mallaby, a senior fellow for economics at the Council on Foreign Relations, said during a conference call with reporters. "You are admitting that for the next eight months, when the markets are in high panic, you don't have enough funds."

The move to raise bank reserves came after an earlier round of so-called stress testing was criticized for simulating economic scenarios that were hardly stressful. Thursday's agreement shows that criticism was correct, yet it gives banks a long lead time to get to safer ground.
German financial firms that may be especially vulnerable to Greek debt problems include Commerzbank, DZ Bank (the holding company for Raiffeisenbank and Volksbank), Hypo Real Estate, Landesbank Baden-Württemberg and NordLB. (Stefan Kaiser, Euro-Gipfel: Jetzt müssen die Banken bluten Spiegel Online 27.10.2011) Some large French, Spanish and Italian banks could be put under big pressure by this. And Greek banks are in bigtime peril with their own holdings of Greek public debt along with the week economy being made disastrously weaker by the Herbert Hoover economics being forced on Greece by the EU on behalf of the big German and French banks.

Whether the financial lobby is making rational calculations on behalf of their own industry's cupidity in pushing for such destructive austerity measures is another question. But aside from their short-term focus, does anyone who remembers the 2008 collapse really seriously think the financial industry is dominated by rational thinking? Or that they can't be gulled by ideology when it comes to public policy?

This rotten performance by European leaders is way beyond normal routine political mediocrity. This is failure of leadership on a 1914 scale, though fortunately without the immediately apocalyptic military implications.

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