Stan Da Man
09-27-11, 19:05
Much can be written about how Europe got in this mess. But, the more interesting issue, in my opinion, is how Europe gets out of this mess. So, the purpose of this thread would be to discuss these issues, if anyone's interested.
As an initial matter, any policy prescriptions for what to do probably depend on one's view of what happens to Greece and, possibly, the other profligate spenders and slow growers in the EU. But, let's just take Greece. For my money (I've been short the Euro for some time) a default by Greece is inevitable. The only reason it hasn't occurred already is because the EU hasn't figured out any way to deal with the situation other than shoveling more cash at Greece to keep it from defaulting in the short term. That will come to an end after this second tranche, which may or may not happen, next month. But, regardless, Germany will never approve more aid after that, and the second tranche won't prevent the inevitable default. Austerity measures are politically impossible in Greece. Greece can't grow it's way out of this mess. Indeed, it's contracting. Greece can't inflate its way out of this mess. That leaves only one option: Default. It will happen. The only question is when.
So, if that is accepted as a given, the next question is: What are the consequences? Absent immediate action, the consequences are huge. For starters, the three largest French banks will immediately become insolvent, and they will cause ricocheting insolvencies throughout the EU and spread to the US. This is, in part, due to the phony stress tests the EU has been administering. Sovreign debt, such as that of Greece, is valued at 100 cents on the Euro no matter how impaired the market says the debt is. A default would render that debt worthless, and would erode these banks' capital bases, rendering them nearly insolvent in an instant. There have been proposals to allow creditors to take a 50 percent to 70 percent impairment on this debt, or to "voluntarily" lengthen the payment terms of Greek bonds. But, the ECB will have none of that. It has declared that even such supposedly voluntarily measures would be deemed a default, thereby eviscerating these banks' capital base.
There have been many clever solutions proposed. But, there's only one proposal that has any serious chance, in my opinion. A Euro TARP needs to be set up. TARP, as originally conceived by Bush and Paulson, was a bad idea. It would have allowed the government to purchase "toxic assets" from banks and would have done little to help anything. But, it was revised by Paulson in October of 2008 and made much simpler. Rather than purchasing bad assets, they instead just decided to inject capital into the banks. Since banks use leverage to increase the effect of their capital, there was about a 10-1 benefit achieved under this approach. It insulated the banks from the effects of the bad loans on their books, and it allowed them to eventually raise more capital as their stock prices rose such that they could pay back this initial round of TARP funds injections.
When Geithner came into office, this already had been accomplished. He messed up much of the work that already had been done by going back to the initial toxic asset purchase model, but the early efforts under TARP undoubtedly were successful. The government caused the mess by effectively mandating lax lending standards in the secondary market, but at least they helped fix the mess.
This is what Europe must now do. Their problems stem from the same core as the problems in the US. Bad government policies have caused this mess. Now they've got to help fix this. Essentially, they've got to recapitalize their banks before Greece fails, and then let Greece fail.
The problems is, how do they get there? The ECB wants no part of it. Stark resigned last month over bond purchases. No one knows how Draghi feels about these things. Italy was trolling in China for some money, with no luck. Paribas has been hitting up Arab investors for more capital, with no luck. US money markets are starting to refuse to lend to French banks, and Germany won't be far off, which has forced the Fed to step in. There are strong arguments that the EFSF can't legally participate in recapitalization. It's probably only got 300 billion or so Euros left, anyway, with another 100 billion earmarked for Greece in a month or so. If officials seek authority for EFSF participation, or the creation of some separate vehicle, there are serious questions whether Merkel will survive. Regardless, such a special purpose vehicle likely would require consent from all 17 EU countries. Failing ECB participation, that would appear to be the only way. Yet, it's doubtful there's sufficient time for that approval, and it may not be forthcoming anyway. Perhaps the IMF and other nations will find a way to intervene, but until then it will be pretty rocky.
The markets were up today, apparently on news that Greece likely will receive more funds, so it won't default in the near term. That's like cheering because the condemned man has been allotted more rope before the hanging. So, Greece won't default this year. There is some value in that, because it would give the other 16 EU countries time to get their act together. But, Greece will Default. When it does, the remaining questions are whether other countries like Spain and Italy also will need bailing out, and whether Europe can shore up its banks before a catastrophe happens.
As I mentioned, I'm short the Euro until I see that they can get a Euro TARP passed. Anyone else have any thoughts on solutions to this mess?
As an initial matter, any policy prescriptions for what to do probably depend on one's view of what happens to Greece and, possibly, the other profligate spenders and slow growers in the EU. But, let's just take Greece. For my money (I've been short the Euro for some time) a default by Greece is inevitable. The only reason it hasn't occurred already is because the EU hasn't figured out any way to deal with the situation other than shoveling more cash at Greece to keep it from defaulting in the short term. That will come to an end after this second tranche, which may or may not happen, next month. But, regardless, Germany will never approve more aid after that, and the second tranche won't prevent the inevitable default. Austerity measures are politically impossible in Greece. Greece can't grow it's way out of this mess. Indeed, it's contracting. Greece can't inflate its way out of this mess. That leaves only one option: Default. It will happen. The only question is when.
So, if that is accepted as a given, the next question is: What are the consequences? Absent immediate action, the consequences are huge. For starters, the three largest French banks will immediately become insolvent, and they will cause ricocheting insolvencies throughout the EU and spread to the US. This is, in part, due to the phony stress tests the EU has been administering. Sovreign debt, such as that of Greece, is valued at 100 cents on the Euro no matter how impaired the market says the debt is. A default would render that debt worthless, and would erode these banks' capital bases, rendering them nearly insolvent in an instant. There have been proposals to allow creditors to take a 50 percent to 70 percent impairment on this debt, or to "voluntarily" lengthen the payment terms of Greek bonds. But, the ECB will have none of that. It has declared that even such supposedly voluntarily measures would be deemed a default, thereby eviscerating these banks' capital base.
There have been many clever solutions proposed. But, there's only one proposal that has any serious chance, in my opinion. A Euro TARP needs to be set up. TARP, as originally conceived by Bush and Paulson, was a bad idea. It would have allowed the government to purchase "toxic assets" from banks and would have done little to help anything. But, it was revised by Paulson in October of 2008 and made much simpler. Rather than purchasing bad assets, they instead just decided to inject capital into the banks. Since banks use leverage to increase the effect of their capital, there was about a 10-1 benefit achieved under this approach. It insulated the banks from the effects of the bad loans on their books, and it allowed them to eventually raise more capital as their stock prices rose such that they could pay back this initial round of TARP funds injections.
When Geithner came into office, this already had been accomplished. He messed up much of the work that already had been done by going back to the initial toxic asset purchase model, but the early efforts under TARP undoubtedly were successful. The government caused the mess by effectively mandating lax lending standards in the secondary market, but at least they helped fix the mess.
This is what Europe must now do. Their problems stem from the same core as the problems in the US. Bad government policies have caused this mess. Now they've got to help fix this. Essentially, they've got to recapitalize their banks before Greece fails, and then let Greece fail.
The problems is, how do they get there? The ECB wants no part of it. Stark resigned last month over bond purchases. No one knows how Draghi feels about these things. Italy was trolling in China for some money, with no luck. Paribas has been hitting up Arab investors for more capital, with no luck. US money markets are starting to refuse to lend to French banks, and Germany won't be far off, which has forced the Fed to step in. There are strong arguments that the EFSF can't legally participate in recapitalization. It's probably only got 300 billion or so Euros left, anyway, with another 100 billion earmarked for Greece in a month or so. If officials seek authority for EFSF participation, or the creation of some separate vehicle, there are serious questions whether Merkel will survive. Regardless, such a special purpose vehicle likely would require consent from all 17 EU countries. Failing ECB participation, that would appear to be the only way. Yet, it's doubtful there's sufficient time for that approval, and it may not be forthcoming anyway. Perhaps the IMF and other nations will find a way to intervene, but until then it will be pretty rocky.
The markets were up today, apparently on news that Greece likely will receive more funds, so it won't default in the near term. That's like cheering because the condemned man has been allotted more rope before the hanging. So, Greece won't default this year. There is some value in that, because it would give the other 16 EU countries time to get their act together. But, Greece will Default. When it does, the remaining questions are whether other countries like Spain and Italy also will need bailing out, and whether Europe can shore up its banks before a catastrophe happens.
As I mentioned, I'm short the Euro until I see that they can get a Euro TARP passed. Anyone else have any thoughts on solutions to this mess?