Wednesday, November 16, 2011

EU Debt Plan Draws Backing?

Riva Froymovic of the WSJ reports, An EU Debt Plan Draws Backing:
The European Union remains focused on finding a way to expand its bailout fund, but Economics Commissioner Olli Rehn said a new proposal from German economists to counter the euro-zone debt crisis deserves attention.

"We aim at coining a balanced package between substantial reinforcement of economic governance, on the one hand, and presenting options for stability bonds, on the other," said Mr. Rehn.

"Such bonds could, if well designed, strengthen financial stability and fiscal discipline in the euro area, and thus facilitate sustainable growth and job creation in Europe as a whole," he said in the interview.

Common euro-zone bonds, or "stability bonds," have garnered strong support from members of the European Parliament, weaker euro-zone member states and notable economists, as a way to pool regional risks and support troubled economies.

However, German Chancellor Angela Merkel has in the past rejected mutualizing euro-zone risk through joint bonds, and has been cool to the redemption fund proposal.

In order to ensure that countries start reducing excess debt toward the 60% debt-to-GDP threshold, the proposal calls for countries using the redemption fund to introduce debt brakes into their constitutions. In addition, unlike previous euro bond suggestions, the European Redemption Fund would expire after about 25 years, once all the debt accumulated is dissolved.

"At the end of the roll-in phase, the size of the new Fund would be approximately €2.3 trillion, if all members of the euro zone participated which are currently not supported by the European Financial Stability Facility," says the German report.

The current lending capacity of the euro-zone rescue fund, the EFSF, is €440 billion. Policymakers are currently working on ways to expand the fund to €1 trillion. However, officials said this week that discussions over boosting the fund have failed to yield real progress as big differences remain among euro-zone member governments.

"Work is in motion on developing the two options for EFSF leveraging," Mr. Rehn said on Tuesday.

Michael Lambrianos, Head of Analysis & Investment Strategy at Eurobank EFG Mutual Funds in Athens, sent me this comment on France now wanting the ECB to end the crisis:

The ECB and the Germans thought that the idea of an ECB rescue operation to end the crisis was off the table. But they were wrong, as Francois Beroin told Les Echos. “We are in favour of an intervention of all European institutions including the ECB in order to bring the best answers to the crisis”, the French finance minister said in an interview. “The central bank, which is independent, has taken the engagement to be there in case of difficulties. Germany, for historic reasons, has closed the door to a direct implication of the ECB.” Baroin reminded his interviewers that the Fed, the Bank of Japan and the Bank of England all intervened to dampen the crisis without losing their independence. Asked about Bundesbank president Jens Weidmann’s repeated insistence that it was up to the governments to solve the crisis Baroin said. “We continue to think that the ECB is one answer and probably even an important element in this crisis. In the declaration of October 27 (the last EU summit) the ECB has committed to fully play its role in order to guarantee the stability of the eurozone. We have trust in that.”

And Michael says that some are even thinking of changing the ECB's mandate:

In yet another sign that France continues to push for the ECB to become the eurozone’s lender of last resort, Le Monde has a story about the clashes between Latin Europe (France and the South) and Northern Europe (Germany and the other Northern Europeans) about the central banks role. The paper writes that France and to lesser extend Germany had toyed with the idea that the ECB would intervene on the markets with the explicit aim of not letting the spread between the bund and other government bonds get beyond a certain threshold. According to Le Monde some even want to use the treaty revisions around the construction of a eurozone government in order to change the ECB’s mandate (according to which the bank is independent and its principal aim is to guarantee price stability). “Nobody dares go down that road”, the paper quotes an advisor to Herman Van Rompuy, the council president who steers the treaty revision work. “This question is a real taboo in Germany.”

But will the ECB be able to end the eurozone's crisis? Neil Shah of the WSJ reports, Bridgewater Frets Over Euro Zone's Reliance On Central Bank:
Bridgewater Associates LP, the world's biggest hedge-fund firm, is uneasy about how much Europe's shaky governments and banks are counting on the European Central Bank to help them through the debt crisis, according to a note to clients.

Most of the funding gaps of struggling European banks and countries are being filled by the ECB through its emergency lending and bond-buying programs, the Westport, Conn. firm said. It's important for European banks to eventually get access to private-sector funding, because while ECB loans may help them reduce their debt, these may not boost the expansion of credit in the euro zone.

"The ECB continues to be stuck providing the lion's share of the money and credit needed to prevent a collapse," Bridgewater's team told clients last week in a note reviewed by the Wall Street Journal.

The firm, founded by Ray Dalio, said weaker euro-zone economies will need EUR596 billion in the next 12 months, EUR470 billion in 2013 and EUR444 billion in 2014, beyond various existing European bailouts. Most of these needs, which cover maturing debts, government deficits and public bank recapitalizations, come from Italy and Spain.

Bridgewater's estimates of total European bank recapitalizations are, at EUR375 billion, nearly four times those of European banking authorities, the firm said.

The views of Bridgewater, whose moves are closely followed by professional investors, may have shifted since its note last week. Since then, political crises in Greece and Italy have eased, yet investors remain worried that troubled euro-zone nations like Italy and Spain will struggle to reduce their debt loads without shrinking the economic growth they need to pay their debts.

The euro tumbled 0.6% to $1.3555 on Tuesday as European debt concerns resurfaced. Prices of Italian bonds fell, once again pushing the country's key borrowing rate above the 7% level seen as a pressure point for ailing euro club members.

Bridgewater's team has been especially concerned about European growth this year. Its $71 billion flagship fund was up more than 20% this year as of mid-August.

The failure of the ECB to ease countries' borrowing costs by supporting their bond markets with significant purchases suggests Bridgewater's estimates of the euro zone's funding needs are in the right ballpark, the firm said.

"We don't think that bank funding conditions will improve and banks' reliance on the ECB diminish until banks are adequately capitalized or enough money is provided to create a credible plan to prevent sovereign defaults," Bridgewater said.

A big concern is the impact of the ECB's measures on its own balance sheet, which has "gotten more risky."

Will the latest EU debt plan save the eurozone? I'm skeptical of any plan that relies on the ECB and doesn't take a serious look into creating an EU Treasury that emits eurobonds. But German Chancellor Angela Merkel once again reiterated her opposition to eurobonds on Wednesday stating that it would remove the incentive for countries to pursue solid fiscal policies.

Meanwhile the unelected eurocrats in Greece and Italy march on. Mario Monti
was sworn in as Italian prime minister and finance minister and Greek Prime Minister Lucas Papademos won a confidence vote in parliament, receiving a mandate to push through budget measures necessary to secure financing designed to avert a collapse of the economy and keep Greece in the euro.

But tensions in Europe are running high where European Union President Herman Van Rompuy dismissed U.K. concerns that deeper cooperation among euro-area governments risks creating a “two-tier” EU:

“There has been much exaggerated talk about this,” Van Rompuy told the European Parliament today in Strasbourg, France. “It is time to de-dramatize this debate. After all, it is perfectly natural that those who share a common currency take some decisions together.”

British Prime Minister David Cameron has pressed the 17- nation euro region to involve all EU countries in talks to stem the Greece-triggered debt crisis that threatens the single European currency. The U.K. is one of 10 EU nations outside the euro area.

Tensions erupted in the run-up to debt-crisis meetings of EU leaders in late October, when Cameron said “we must safeguard the interests of countries that want to stay outside the euro.” As a compromise, Van Rompuy hosted a meeting of all 27 EU national leaders on Oct. 26 to discuss bank recapitalization before chairing a euro-area summit that ended the following morning with an agreement on a second Greek rescue including 130 billion euros ($176 billion) in new public aid and 50 percent losses for private holders of Greece’s debt.

‘Everybody’s Interest’

“It is in the interest of the non euro-zone EU members that its financial stability is organized and secured,” said Van Rompuy. “A better structured euro area is in everybody’s interest.”

The euro area is seeking to prevent Italy and Spain from being engulfed by debt troubles that forced Greece to seek an initial rescue in April 2010, pushed Ireland and Portugal into aid programs over the following year and led to the new Greek bailout last month. The region has increased surveillance of national budgets, toughened the enforcement of penalties for excessive deficits and debt and expanded the role of a rescue fund known as the European Financial Stability Facility.

Yields on Spanish five-year government securities today reached 5.82 percent, the highest level since before the euro was created in 1999. Bonds issued by euro countries from Finland to Austria slid yesterday, driving up their premiums over benchmark German securities.

U.S. President Barack Obama pressed Europe to act more forcefully to stem the crisis, saying financial markets will remain unsettled until policy makers persuade investors that they will “do what it takes” to ensure the integrity of the euro region.

‘Deeply Concerned’

“We’re going to continue to see the kinds of turmoil that we saw in the markets” yesterday until a concrete plan is put in place, Obama said in a joint news conference in Canberra with Australian Prime Minister Julia Gillard. “I’m deeply concerned, have been deeply concerned -- I suspect will be deeply concerned tomorrow and next week and the week after that.”

Van Rompuy said he was examining further steps to bolster economic-policy coordination in the euro area and would present an interim report in December and final conclusions by next March or June. Some proposals might involve “limited” changes to the EU treaty, he said.

The focus is on “strengthening economic convergence within the euro area, improving fiscal discipline and deepening economic union,” Van Rompuy said. “The task I see for us is clear: we have to bring the economic monetary union to a solid end-state.”

‘Truly Systemic’

In the EU Parliament debate, European Commission President Jose Barroso said the euro region faced a “truly systemic crisis” and Europe’s partners were justified in demanding a bolder reaction. He said veto powers of individual euro-area governments over common decisions had slowed Europe’s response.

“The markets, the investors are not only looking at the deficits or the levels of debt but also the capacity of the euro area and the European Union to take decisions,” Barroso said. “All levers of action must now be used without delay.”

Barroso repeated that the commission, the EU’s regulatory arm, would present options on Nov. 23 for joint euro-area bond sales opposed by Germany while he signaled that any such step in practice would have to await a deepening of national policy coordination. Barroso has called such common securities “stability bonds.”

“I believe that euro stability bonds will be seen as natural when we achieve our goal of reinforced governance and, of course, discipline and convergence in the euro area,” he said. “There will be a concrete demonstration of the principles of responsibility and solidarity.”

‘Dangerous Point’

Guy Verhofstadt, leader of the 736-seat EU Parliament’s pro-business Liberal group and a former Belgian prime minister, said joint euro-area debt sales should be a priority.

“Nothing less than full economic and fiscal union including euro bonds will do,” Verhofstadt said. “The euro- zone crisis has reached a very dangerous point. We are now witnessing increasing spreads on interest rates between national sovereign bonds and the benchmark German bund even for countries with a AAA credit rating.”

Luxembourg Prime Minister Jean-Claude Juncker, who took part in the European assembly debate in his other role as head of the group of euro-area finance ministers, expressed “hope” that work on leveraging the 440 billion-euro EFSF will be completed before the end of November.

Two Options

As part of its Oct. 27 accord, the euro area is examining two options for giving the EFSF as much as 1 trillion euros of spending power. One option is to guarantee a portion of new debt sold by a distressed euro-area government; the other is to create a special investment vehicle that would court outside money.

The question of leveraging the AAA rated EFSF has arisen because of the political hurdles in countries such as Germany to increasing the national guarantees that back the facility. The Luxembourg-based EFSF, established last year to sell bonds to finance loans for distressed euro nations, has since also gained the authority to buy sovereign bonds on the secondary and primary markets, offer credit lines to governments and recapitalize banks as the debt troubles have spread.

In remarks to journalists after the EU Parliament debate, Juncker said making the upgraded EFSF operational was an “urgency.” Juncker also said he believed the EFSF’s chief executive officer, Klaus Regling, has the ability to attract the needed investors.

Looking at the EU leaders squabble makes you wonder whether Australia's Prime Minister, Julia Gillard, is absolutely right to be very concerned. The U.S. and Britain are now pressing hard for a resolution to the debt crisis but unless Merkel quickly warms up to idea of eurobonds, political and economic turmoil will continue, increasing the likelihood of a eurozone implosion and another global meltdown.

Below, listen to President of the European Commission, Jose Manuel Barroso, on why he believes EU fragmentation will not make the euro stronger. I also embedded an exchange between MEPs on the Franco-German partnership. Listen to Daniel Cohn-Bendit, "c'est de la folie!"

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