The
economic crisis in Europe has reached a
crossroads, from which in all probability there is no return. The past many
months have been empty debate when the situation has further deteriorated.
Governments
depend for their financing on the sovereign bond markets, where they can
refinance existing debt, and raise new debt caused by deficit spending. Today bond investors are
shunning these sovereign bond markets as they see unacceptably high risk or are
asking interest rates that are so high as to be unaffordable for governments
with mountainous debt levels.The Greek bail out and the cram down of bond
holders also added a new element of risk that any new money from the Bail out
funds would have a preferred status, thus driving away even more bond investors. In short the bond market has
taken away from the politicians the control over the situation as regrettably
was forseen by many observers for years.
A similar
situation exists for weaker banks, which can no longer raise equity capital and
long term bond financing. Thereafter they turn to their governments for assistance,
which as explained above, they are no longer
capable of providing. Such banks are also shut out of the interbank short term
financing market, where banks lend to each other. The degree of mistrust
between banks is so great, that instead of lending to each other, stronger
banks park their cash with the ECB. The amounts involved are staggering, recently
approaching EUR 800 Billion. The cash
starved banks can obtain finance from the ECB but only on presenting valid security for these loans. We have now
reached the stage that these banks have pledged virtually all their assets
already, and can offer no security in exchange for more cash. The famous LTRO
of EUR 700 Billion last year enabled weak banks access cash, but doomed them in
the market, where their share price collapsed, as it was a flagrant proof of
weakness. Also when the bank used the cash to buy their sovereign bonds, the
market now knows the further losses they incurred. For all these reasons a
further LTRO 2 looks very unattractive.
Thus we
have reached the stage where both soverign countries and their major banks have
reached the limit of their borrowing capacities when their actual borrowing
requirement increases exponentially, and as explained above the EU and ECB
interventions while creating a short term fix have made matters even worse.
Although
this crisis has been many years in the making, historians may well come to
regard the weekend of the French and Greek elections as the turning point.
Mr Hollande
was elected on a platform of reducing retirement age, giving sweet deals to
bureaucrats, increasing spending to generate growth, and using other people’s
money to pay for it. This of course appealed so much to the French electorate
that Mr Hollande a man who has never held ministrerial office, has taken the reins
in France’s
most difficult hour. He looks set to consolidate the socialist party power in
this weekend’s local elections.
Meanwhile
in Greece,
the polarisation in politics has cannibalised the centre left and right parties
and is making way for irreconcilable extremes. Austerity has slashed living
standards for the ordinary Greek citizen, while many abusive anomolies remain.
In hospitals the situation is so desperate that Cancer patients are no longer
getting medication and the most basic hospital supplies are either rationed or
not available. Many state employees have simply not been paid, and private
businesses are shuttering their premises.
There is an
election this weekend and at this stage it is to be hoped that whatever the
errors of the past the country remains governable and does not degenerate into
anarchy.
The financial
situation in Greece
has been debated to death. The economy is contracting, while the tax revenues are
dwindling. The monies handed over to Greece
have essentially been recycled to bail
out of the insolvent banks in Northern Europe.
Virtually nothing remains in Greece.
When the Greeks do not wish to play the game of getting even more indebted, it was even proposed to hand the cash directly
to the banks and send the Greek government the bill.
In Spain the true
situation is increasingly coming to the surface. Firstly Prime Minister Rajoy
said that Spanish banks had no problems and did not need any financial assistance,
secondly Bankia reported a profit and a few days announced later a whacking multibillion loss. Then Mr Rajoy
reaffirmed that the problem could be handled in Spain, and a few days later went
cap in hand for a EUR 100 Billion bail out, for the banking sector only.
Informed
sources estimate the banking bail out, to cover primarily real estate losses, alone should be of the order of EUR 400
Billion Then there is the problem of spendthrift out of control regions, and
the funding of the massive social security commitments of a country where youth
unemployment is running at over 50%. Stopping the latter payments could lead
very rapidly to serious social unrest.
Spain has in addition substantial commitments to various
EU solidarity funds and also to the ECB. Estimates of its true Debt/GDP ratio
is closer to an unviable 120%, pre bank bail out, to which should be added the
projected deficits for the coming years
This is
reflected in Spain’s
cost of 10 yr borrowing at around 7% in today’s market. This is reported as
excessive, which is simply not true, When Spain borrowed in Peseta’s, interest
rates were much higher, which curtailed
the borrowings.. Debt levels are the real problem.
In Italy
where the EU nominated Mr Monti to became
technocratic Prime Minister, the situation is equally grim. The debt/GDP is
approximately 180% but at least Italy
does not have a colossal real estate bubble. However their banks also have
shaky balance sheets and the economy very weak.
Italy also has significant contingent liabilites to EU
solidarity funds.and also to the ECB.
The
inherent risks are reflected in 10 yr borrowing costs only slightly lower than Spain
In the past
the commitments and contingent liabilites were never really considered by
Governments as cash liabilities as nobody foresaw that they would ever be used.
This is rather like an insurance company not collecting a premium and never
expecting to have a claim. Now however all the signs are that each and every one
will be called to the full and there is absolutely no cash availaible to meet
these demands.
Each
country has also realised that the
sooner you get in line for a bail out, the better your chances of not being
asked to contribute to another country’s bail out.
The
quickest way to achieve this is to make sure one of the country’s too big to
fail banks has a run on funds, a crashing share price and is on the edge of
bankruptcy. At that point the Government will promise to bail out the bank and
run cap in hand to the EU for funding, and announce oh by the way we also need
cash for the other banks.
Spain has outmaneuvred Italy very effectively leaving Mr
Monti fuming. When the Austrian finance minister suggested that Italy may be
next, he furiously denied it. “Methinks he doth protest too much” – Shakespeare
We are also
seeing Slovenia and Cyprus
threatening to join the queue
What Monti
does know is that with Greece,
Portugal, Ireland, and Spain
and potentially Slovenia and
Cyprus
out of the game the burden falls on those left standing. Italy on its
own may just survive but is in no position to shoulder its share of the burden
imposed by others.
Thereafter France with high Debt/GDP ratio, increasing
deficit spending, massive EU contingent
liabilities, and its domestic banks
overcommitted to Spain, Italy and Greece, could go under overnight.
Mrs Merkell has strongly criticised France
today for its present policies as she rightly fears a situation where France, instead
of being an ally becomes yet one more liability.
There is no way Germany virtually alone could
redress the situation. The amounts of money required to rectify the situation are
vast. Germany
would have to take on massive debt burdens much higher interest costs and lower
its standard of living to that of the EU average, while continuing to work much
harder and being far more productive. This is a tough sell to a teutonic electorate,
already widely disliked by those they
would help.
The
extraordinary thing, never mentioned by the EU political elites, is that even if
the slate were wiped clean, the imbalances which created this mess, differing
productivity, same exchange rate, same interest rate for all, would create the
problem all over again.
In summary,
sovereign states have run out of cash
simultaneously and cannot access the
credit markets on acceptable terms for the amounts needed. The major banks with
few exceptions are in the same situation.
The EU rescue
mechanisms ESM/EFSF meant to save
individual states in difficulty are largely unfunded, and there is no legal and
political agreement as to how the funds should be deployed. Even if totally
funded they are perhaps adequate to deal
with Greece and Portugal, but are completely completely overwhelmed by
the scale of the problem posed by Spain, Italy et al.
This in
financial parlace is “Contagion” but in reality it simple arithmetic. These numbers have been
known for years. The problem is that the philosophy of “extend and pretend “ so
loved by politicians, has its limits. Ultimately
it transitions into “lie until you die”
which is where we are today.
The problem
has never been Greece
despite all one reads in the media, contagion has always been the problem. Contagion
can only happen when all the others are only slightly stronger than the weakest
link.
At some
point very soon this festering situation has to explode and when it does Europe and probably the world will never be the same
again.
