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Sunday, January 31, 2010

Greek Bailout News (1)

"British or German taxpayers cannot finance the failures of others," German Economy Minister Rainer Bruederle said at the World Economic Forum in Davos, Switzerland, according to the Associated Press. "Solidarity also means everybody adheres to common rules."


France is not working with Germany or other countries on a support package for Greece which is managing to handle its problems on its own, a French government source said on Thursday. "I am not aware of a support plan. There is not a plan. We're not discussing one (with Germany or others)," the source told Reuters. "They are managing themselves. They are finding financing support on the market. There is no plan for a support plan. We are not working on one. Le Monde newspaper said earlier that euro zone countries were studying ways of helping Greece resolve its budget problems."


The above statements have been widely interpreted in the international press as a "no" from Germany and France to any EU bailout of Greece. But is this interpretation justified? Before going further, I think it should be pointed out that the whole argument depends on what you consider a bailout to be. If you take the view that a bailout involves a restructuring of Greek Sovereign Debt, with the EU itself offering to pay a part, then this is clearly not on the cards, at least at this point, and let's take things a day at a time. But if you consider the "bailout" which is under consideration at the present time to be simply a loan, which in some way shape or form (yet to be determined) would be guaranteed by the EU institutionally, and would thus be available at a cheaper rate of interest than the one the markets are currently charging, then it is hard to see how British or German taxpayers would be having to finance anything, except in the unikely event that Greece were unable to repay (as Moody's point out, Greece's problems are longer term, not short term), and remember, even Latvia and Hungary are likely to repay the loans already made to them, and their underlying economic situation (and competitiveness problem) is a lot worse than that of Greece. So basically the German economy minister is making a speech which generates good headlines, and political enthusiasm, but like Jüergen Starks before him, has little real significance in terms of the options which are really on the table.

On the other hand, statements like the following:

European officials on Friday sought to quell rumors of a pending bailout for Greece, insisting that the financially troubled nation could still manage to avoid a debt crisis on its own. The effort to allay market speculation came as investor confidence in Greek bonds fell this week to levels not seen in a decade, amid concern over the government's ability to close its gaping budget deficit and maintain financial stability.


Can simply be seen as officials doing the job they are paid to do, that is talk down the market pressure. Obviously, if the spread on Greek bonds could be talked back down, then there would be no need for anyone else to make a loan, but at this point in time, and especially following the ill fated proposal of Finance Minister Papconstantinou to mount a fund raising roadshow including a visit to China, this possibility looks very unlikely. After all, why should the Chinese banks risk their money buying bonds the German taxpayer is unwilling to buy? As Yu Yongding, a former adviser to the Chinese central bank said, it just isn't interesting to buy a “large chunk” of Greek government debt in order to help rescue the country simply because their securities "are more risky than U.S. Treasuries". “Let European governments and the European Central Bank rescue Greece", he said. Over to you Herr Bruederle.

And despite the fact that Joaquin Almunia strenuously denied in Davos that any kind of plan "B" existed, really they would be fools not to have a plan "B", and the people involved obviously aren't fools, ergo....

A top European Union official said on Friday there was no risk that Greece would default or leave the euro zone and the country's finance minister said he was not aware of any bailout talks. "No, Greece will not default. Please. In the euro area, the default does not exist because with a single currency the possibility to get funding in your own currency is much bigger," Monetary Affairs Commissioner Joaquin Almunia told Bloomberg TV. "There is no bailout problems."

Asked if its problems could force Greece out of the euro zone, Almunia said: "no chance. Because it is crazy to try to solve the problems the Greek economy has outside the euro zone," he said. Almunia said euro zone ministers had prepared fiscal recommendations for Greece and other countries, to be discussed at a regular meeting at European Commission level next week, but denied there was any special EU plan to rescue Greece. "It is a normal analytical document that is written every month," he said. "We have no plan B. Plan A is on the table. It is fiscal adjustment."


EU Commission "Ups the Ante"

So now lets turn to Plan A, and to that normal analytical document Señor Almunia refers to, which is due to be discussed by the Commission on Wednesday. Fortunately, the Greek web portal Ta Enea have seen the document, and Reuters have provided us with a convenient English language version of what they saw. What the Ta Enea report makes clear, is that the reason Greek Prime Minister Papandreou has not asked the EU for a "bailout loan" is connected to the conditions which would be attached to that loan. According to the reports, the EU Commission plan to go a lot further than simply providing short term funding on the cheap:

The European Union will tell Greece next week to take extra measures by May 15 to shore up its finances and cut a spiralling deficit, Greek newspaper Ta Nea said Saturday, citing a draft of the recommendations. The European Commission's recommendations, due to be made public on February 3, include cutting nominal wages in the public sector and setting a ceiling for high pensions, Ta Nea said.

Under the headline "Urgent measures to be taken by 15 May 2010," the EU document will tell Greece to "cut average nominal wages, including in central government, local governments, state agencies and other public institutions." The EU will also urge Greece to introduce advance tax payments for the self-employed and possibly a tax on luxury goods, according to the document, excerpts of which were printed by Ta Nea. Most other recommendations, as reported in the paper, are already part of the Greek plan.


Reports also mention putting a complete freeze on public sector hiring, and a system of monthly reports to the Commission along the lines of the Latvian programme. What this effectively amounts to is enforcing the implementation of an internal devaluation process along the lines of the ones adopted in Ireland and Latvia, as outlined in the most recent technical report to the commission (see here), in order to restore competitiveness to the economy and make Greek debt sustainable in the long run. It also amounts to an effective surrendering of part of Greece's national sovereignty to the EU Commission, and this is the part that virtually everyone is doubtless baulking at.

IMF Waiting On the Sidelines

Obviously, the EU Commission is not the only institution who could furbish the bailout loan, the IMF would serve just as well, and Marek Belka, Director of the IMF's European Office, has already made it very plain they are ready willing and able to help. And only last Friday John Lipsky, the first deputy managing director of the IMF, said the Fund "stands ready" to help Greece with its debt crisis. According to Lipsky's statement, the fund is in "ongoing contact" with the Greek authorities following a "scoping mission" to assess the possibilities.
"The IMF stands ready to support Greece in any way we can," Mr Lipsky said. "It is a matter for the Greek authorities to decide, in collaboration with the European Union, but we are here to help if we are wanted."


In fact, I personally favour the IMF alternative, given the time scale involved, and the likely programme implementation difficulties, and according to Edmund Conway, economics editor of the UK Daily Telegraph, this view is now shared by many "highly respected" economists:

I understand that in many of the conversations Mr Papandreou had [last week in Davos] with very senior, respected economists this week, he was directly advised to go to the IMF, which would be the 'cleanest solution'..... But an IMF intervention would have potentially to be channelled through European authorities, since Greece is a member of the euro.


But the EU Commission seems to have very strong reservations about going for the IMF route, which is why the "bitter pill" of the EU bailout loan may well need to be swallowed. My fear here is that EU reservations may mean that history sadly repeats itself, the first time in Latvia and then in Greece, as queasiness about taking on board the full implications of what is involved in correcting competitiveness distortions leads to policy-making delays and mistakes of the kind which in Latvia have produced a resession which is far deeper and longer than was actually needed, but which in Greece could easily lead to very serious problems for the entire Eurozone further on down the line.

Yet the door is certainly not closed on an IMF solution, and George Papaconstantinou did meet with IMF Managing Director Dominique Strauss-Kahn on Friday on the sidelines of the WEF in Davos. The possibility of IMF intervention was left open by IMF Managing Director Dominique Strauss-Kahn in an interview with broadcaster France 24 this weekend, although he certainly seemed to suggest that EU support was more likely. "We at the IMF are ready to intervene if asked, but that's not necessarily required," Strauss-Kahn said. "The European authorities, both in Brussels and the central bank, are looking at it and I think they'll handle it properly" ...."solidarity" within the countries sharing the euro could "fix the problem,", he said without elaborating.... "It's the first test of this kind for the euro zone,".

Contagion Danger Concentrating Minds

Perhaps the strongest argument to support the idea of imminent EU support is the level of contagion risk being experienced. Concerns that Athens may not be able to service its debt have put growing pressure on the euro, and even if some would welcome this as an aid to German export competitiveness, the attendent credibility issues hardly make the situation a desireable one. There are also growing worries that the Greek debt crisis could spill over to other weak members of the Eurogroup, such as Spain, Portugal, Ireland and Italy. The German daily Sueddeutsche Zeitung last week quoted an EU draft memorandum as saying the situation in Greece was creating a "big challenge and in the long term risky," and could force other euro-zone countries to pay higher risk premiums on their bonds. The spread between Portuguese and German 10-year government debt rose to 120.5 basis points on Friday - up from 114.9 the day before, and the spread on equivalent Spanish bonds is hovering round the 100 basis points mark. Basically, as one European leader after another stresses, it is hardly desireable to let Greece's problems lead other states to have to pay more to finance their borrowing.

Where's The Moral Hazard?

Finally, there has been considerable discussion about the dangers of moral hazard in the Greek case. If the EU offer a bailout loan, this will encourage other countries to seek something similar, so the argument goes.
"Moral hazard considerations suggest that the ECB will never openly support a bailout, but we doubt that Greece will be left on its own if the situation were to become critical," UniCredit analysts said. They referred to the danger that a rescue could reinforce ill-considered fiscal practices that have caused serious problems for Greece and others.


But if we look at the realities of the present situation, then it is clear that what is being offered to Greece in return for a possible loan is clearly not enticing, and indeed it may well be that countries would rather not accept the carrot in order to avoid the stick.

But there are other versions of moral hazard at work here. The FT's Martin Wolf put his finger on one of them:
At the same time, a bail-out by the eurozone as a whole would create a monstrous moral hazard for politicians. It would only be possible if the eurozone subsequently exercised a degree of direct control over the fiscal decisions of member states. It would, in short, be the fastest route to the political union that many initially believed was a necessary condition for success.


Indeed, the very creation of a monetary union in the absence of a political will for unification could be seen as having been the biggest moral hazard risk taken on board, and no matter how many clauses you put in Treaties beforehand, this risk cannot be avoided when push comes to shove.

But there is a third, and more dangerous version of moral hazard in play here, and this arises from the fact that the EU Commission may itself fail to adequately identify and diagnose the roots of the problem, with the result that the correction measures prove to be inadequate, sending Greek debt snowballing off into default. At this point, if the Greek leaders had been simply "following orders", then a more substantive form of bailout would become inevitable, and Herr Bruederle's fears that the German taxpayer may end up having to foot part of the bill would be realised. With this in mind, I really suggest that Commission members and Finance Ministers think very carefully about what they are doing before signing and sealing any definitive agreement with Greece. On the other hand, if the nettle is cleanly grasped, and the necessary changes are introduced both in Greece and in the EU's institutional structure, then maybe the most important and most enduring outcome of the current economic crisis will be a Europe which is more unified and effective than ever it was before.

Friday, January 29, 2010

After Greece, and Portugal, Does Spain Come Next?

Well, the Spanish government are due to announce their 2009 fiscal deficit number this morning, together with their adjustment plan for reducing the annual fiscal deficit to below 3% of GDP by 2013. This rather distasteful news will be presented to the Spanish people later in the same day on which they opened their morning newspapers to discover that they were all going to have to work two years longer - no crisis comes free - since the Labour Minister Celestino Corbacho has announced that the retirement age will be raised from 65 to 67 (in two-month-per-year installments) between now and 2025.

Spanish consumer confidence, as measured by the ICO index has been holding up rasonably well of late.



But if we look at why this is the case by breaking the index down into its components, then we will see the main item doing the work (see chart below) is the expectations component, which is actually showing that the Spanish people are in one of their most optimistic moments since the end of 2004, which is, well frankly, just ridiculous given all the problems which are looming this year (rising taxes, reduced services, frozen wages, mortgage payment increases, falling home values, rising unemployment, etc, etc). So I would be worried about a sharp change in sentiment as reality sinks in, and especially as the sort of news they are getting right now takes its toll on the morale of a people who were being told only yesterday that a substantial recovery was just round the corner.





Podcast With Matthew Bennett

Which brings me to my latest podcast with Matthew Bennett (here).

During the podcast we cover four broad areas: demograhpics and the need for exports to take over from internal demand, internal devaluation and how it will affect Spain, Zapatero and ‘solidarity‘ and the need for a structured immigration plan in Spain. In particuar we talk about the recent controvery surrounding immigrant registration in Vic (Catalonia), about how Spain needs immigrants to safeguard the future of its economy, but that it is also important that there be jobs for immigrants to come to - thus returning the economy to growth, attaining employment growth and carrying through the internal devaluation are all interconnected, and relate to the sustainability of Spain's external debt and pensions system in the longer term. Given this it is important the immigration process in Spain be much more structured in the future, and more in harmony with the requirements with Spain's European agreements under the Lisbon Treaty.

We also talk about how a lot of this debate is rather theoretical at this point, since the migrant flows are currently inverting (and thus following the capital flows with a time lag - see chart below). If current trends continue (and Spain doesn't start to create employment soon) the total number of immigrants in Spain will start to decline. Also, young Spanish people will soon start to leave in greater numbers in search of work elsewhere in Europe, or even farther afield. We are thus left with an additional question: would a smaller workforce manage to pay for pensions and ’solidarity’ after internal devaluation if the population drops?




Current Account Deficit Deteriorates Again In November

Spain's current account deficit stood at EUR 4.67 billion in November compared to EUR 4.15 billion in October, but down from the EUR 8.56 billion deficit of a year ago, according to Bank of Spain data out today.

The goods trade balance showed a deficit of EUR 4.40 billion in November, up from EUR 3.4 billion in October, but narrower than the EUR 5.52 billion deficit a year earlier. On the other hand, the services account logged a surplus of EUR 1.36 billion, down from EUR 2.56 billion in October, and down from EUR 1.69 billion a year ago. Basically, as we can see from the chart below, after closing quite dramatically in the first half of the year, the deficit has been opening up again of late.



The reason for this is not hard to understand, it is due to the increase in government spending and debt, which is stepping in and filling a hole left by private demand.



And this spending has been essentially funded by massive lending to Spanish banks from the ECB.



The reason the money is being spent on imports, and the current account is deteriorating is simple: Spanish domestic suppliers are simply not competitive. As we can see in this comparative Real Exchange Rate chart below - provided by BNP Paribas - current virtual exchange rates suggest Ireland and Spain are operating at a higher effective euro rate than Greece, and even more worryingly, the Greek and Spanish rates are continuing to diverge from the German ones. That is, in these two countries, no correction of the accumulated distortions is taking place.





Spain, Latvia and Greece Affirm Their Commitment To The Eurozone

Sometimes images and gestures speak louder than words, and this photo (see below) from yesterday's Davos session of the leaders of three of Europe’s most economically troubled countries stating that the financial crisis had only solidified their commitment to the euro, as they pledged to make budget cuts and other changes in order to ensure their continued membership (or in Latvia's case their possible entry) tells it all. It is evident that Greece and Spain need to stay in the Eurozone, what is not clear at this stage is how far the leaders of France and Germany are going to go to help them do this. A photo of Sarkozy and Merkel with Jean Claude Trichet might be more convincing at this point.





And again, there is what they actually said. Despite the admission by BBVA President Francisco González earlier in the week that the 325 billion euro zombie developer debt presented a major challenge for the Spanish banking system (and that they needed to now take the bull by the horns - this number is around 30% of Spanish GDP) Mr. Zapatero continued to insist to his Davos audience that Spain's banks were among the healthiest in Europe, resting much of his argument that things in Spain aren't as bad as they seem since Spain’s debt to GDP was still comparatively low given that the budget deficit had been kept well within limits set by EU Treaty before the economic crisis. So what was significant was what he didn't say, rather than what he actually said, like what would happen to Spanish debt levels if a major bank bailout did prove necessary.

He did concede however, that “Spain has to improve productivity” (by the 10% mentioned in the recent report to the EU Commission perhaps?, and if so, over what time period) and that the country needed to make its economy more competitive. The example he gave of how his government plans to achieve this - by investing more in research and development - begins to look thinner and thinner with every passing day, and I would say that by this point it is close to threadbare. No wonder that while he is roundly smiling in the photo above, the other three participants (and especially M Trichet) are looking grim, and rather concered. Unfortunately, I doubt many in Spain will be joining Mr Zapatero in his cheer.

And It's A Bailout.....

Well, it's not fully official yet, and all the fine print certainly isn't written and signed, but the will is now clearly there, and where there's a will, there's a way, especially when you have the global financial markets breathing down your necks. The first one out of the box was the Economist's Charlemagne, earlier this afternoon.

In Brussels policy circles, the question asked about a bailout of Greece used to be: are European Union governments willing to do this? Now, I can report, the question among top EU officials has changed to: how do we do this?

Twice in the past 48 hours I have heard very senior figures - both speaking on deep background - ponder the political mechanics of how large sums in external aid could be delivered to Greece before it defaults on its debts: a crisis that would have nasty knock-on effects for the 16 countries that share the single currency. One figure said yesterday that heads of government could not wait "forever" to take decision. That means a decision in the next few months, at most.


By sundown the story had gotten a bit more traction, with the FT running an article under the header "EU signals last-resort backing for Greece".

The European Union made clear on Thursday it would not abandon Greece and let Athens’ mounting debt crisis jeopardise the eurozone, even as Germany and France played down suggestions they had already formulated an emergency rescue plan.

“It’s quite clear that economic policies are not just a matter of national concern but European concern,” José Manuel Barroso, European Commission president, told reporters in Brussels. According to high-level EU officials, Greece would in the last resort receive emergency support in an operation involving eurozone governments and the Commission but not the International Monetary Fund.


And by sundown the New York Times were running the story:



France, Germany and other European countries have begun discussing privately how they can come to the aid of fellow euro-zone member Greece, as doubts intensify over the country’s ability to get its budget under control.

Despite public attempts to discourage such expectations, discussions are under way, although the shape or scale of a possible bailout package has yet to be determined, according to officials in several capitals, all speaking on condition of anonymity.

“Greece failing is not an option and lots of people think that we will have to intervene at some stage,” said a euro-zone finance official, who was not permitted to speak publicly because of the sensitivity of the matter. “It doesn’t have to happen, and we hope it won’t, but it would be better than seeing a default.”


Of course, we haven't gotten to the actual bail out yet. Timing will depend very much on what happens in the financial markets over the next few days. The spreads on Greek bonds widened strongly again today - reaching a record 4.1 percentage points over German bunds, while Credit- default swaps on Greece jumped 28 basis points to 402, according to CMA DataVision prices. As the Economist puts it in another piece:

The bond market’s skittishness puts more pressure on the Greek government to come up with a credible plan for fiscal retrenchment. A pledge to follow Ireland’s example in making substantial cuts to public-sector wages may now be necessary to ensure Greece can fund itself at reasonable cost. Having raised €8 billion this week the Greeks probably have enough money to see them through until May, when a chunk of their long-term borrowing falls due. The danger now is that market sentiment spirals out of control. If that happens, only the most radical measures, or a euro-zone bail-out, will turn things around.


The bail-out will now surely come, but first it would be better to have the EU Finance Ministers meeting on February 9 and 10, and the national leaders summit on 11 February. The key now will be to see the conditions imposed, and whether they are realistic enough to bring about a return to economic growth and debt sustainability over a reasonable horizon.

Basically all these reports today only confirm the contents of my January 21 piece - The EU Is Reportedly Exploring Making a Loan To Greece - contents which were based on a report in European Voice, a report which, despite all the denials at the time, now seems to have been accurate. The decision also means that the Commission remains adamant not to let Greece go to the IMF. In this case, I do really hope they know what they are at, since failure in the Greek case would immediately expose Portugal, and more importantly Spain to massive market pressure.

Finally, having started this piece with a quote from Charlemagne, I will close it with another one. This time, though, there is a difference, in that in this extract it he who is citing me, rather than I who am citing him:

The bloggers over at A Fistful of Euros offer a view of the Spiegel leak that puts the report neatly in context:

"there would seem to be an underlying transition going on here, one which in EU terms is quite rapid. The EU’s own analysis of the problems in the Eurozone is coming nearer and nearer to that of both the IMF and the credit rating agencies. We are moving beyond short term fiscal deficit issues, and immediate liquidity issues, towards problems like competitiveness, and what was previously a taboo subject - the issue of Eurozone imbalances"

Thursday, January 28, 2010

Rumours, Rumours, But No Greek Bond Sales To China

Well there certainly is a lot happening out there at the moment. And Monday's successful bond sale which left the Greek government triumphally proclaiming they could comfortably meet their 2010 borrowing program now seems to belong to a lifetime ago. The sale raised 8 billion euros over a 5-year syndicated bond which attracted total bids of EUR25 billion, well above the EUR 3 billion to EUR5 billion initially targeted by the government, who immediately declared a major victory.

That was before yesterday, and the Financial Times announcement that Athens was wooing Beijing to buy up to €25bn of government bonds in a deal being negotiated using Goldman Sachs as intermediary. China had not agreed to such a purchase, according to the FT at the time. In the wake of this announcement - as the FT put it - "Greece’s debt crisis returned to financial markets with a vengeance as agitated investors demanded the highest premiums to buy its government bonds since the launch of European monetary union over a decade ago".

In fact, the yield spread between 10-year Greek bonds and benchmark German Bunds widened dramatically, and were up by almost 0.7 percentage points at one stage, as a general panic set in among sellers who were rattled by doubts about Greece’s ability to refinance its debt - or their willingness to make the reforms which would make their debt sustainable in the longer term. If they were so keen to make all the necessary changes, why were they talking to the Chinese, and not the ECB and the EU Commission, who can, of course, easily guarantee funding for such a small quantity of money?

But the biggest impetus to the debacle actually came not from the FT announcement itself, but from the Greek government's clumsy attempts to deny they had asked for help from Goldman Sachs in order to sell government debt to China. In the end Greek 10-year bond yields closed at 6.70 per cent, up 0.48 percentage points up on the day. In fact, the lid was virtually sealed on the Greek fate by statements reported in Bloomberg from Yu Yongding, a former adviser to the Chinese central bank, who is quoted as saying that China shouldn’t buy a “large chunk” of Greek government debt to help rescue the country because their securities "are more risky than U.S. Treasuries". “Let European governments and the European Central Bank rescue Greece", he said. Exactly. This is the point.

The Greek finance ministry reacted by coming out with an attempt to deny that any such negotiations were taking place: "The Finance Ministry categorically denies that there is any deal to sell Greek bonds to China.......The Finance Ministry has not mandated Goldman Sachs to negotiate any deal with China." Fine, but wording here is important. Evidently there is no deal, and Goldman Sachs were given no "mandate" - but that doesn't mean they weren't in Beijing, negotiating on Greece's behalf. In fact, as the FT notes, this issue has a relatively long historyand goes back to at least last autumn:

Greece’s attempt to attract Chinese investors to buy a slice of its sovereign debt took shape last November at a lunch attended by George Papandreou, the prime minister, and Gary Cohn, chief operating officer of Goldman Sachs, the US investment bank. Faced by a soaring budget deficit and record public debt, the newly installed socialist government was eager for ideas about how to finance this year’s €55bn ($77.5bn, £48bn) borrowing requirement, the FT has learnt.

Goldman was keen to promote a Greek bond sale to the Chinese government and the State Administration of Foreign Exchange, which manages the country’s foreign exchange reserves – increasing at a rate of $50bn (€35bn, £31bn) monthly in recent months.

Goldman Sachs has close involvement with the struggling Greek government. The investment bank – along with Deutsche Bank – last month organised the government’s first roadshow to London, led by George Papaconstantinou, the finance minister. It was also one of four foreign banks – the others were Deutsche Bank, Credit Suisse and Morgan Stanley – that arranged Monday’s successful bond offering, along with two Greek banks.


The Greek press has long been rife with speculation about possible Chinese investments in the country, and some of the earliest stories go back to 2008, when Chinese port operator Cosco Pacific signed a 3.4 billion euro deal to run and upgrade facilities at Piraeus Port, which is Greece's biggest, although none of the deals mentioned ever fully materialised, since the Chinese have been unable to operationalise their Piraeus asset following a dockworkers strike last October which lead all concerned to have second thoughts.

This time the rumour mill had it that the Greek government were willing to cede some control over one of their strategic assets - National Bank of Greece - in return for the funding. Analysts in Athens saw the government’s appointment of Vassilis Constantacopoulos, a senior Greek shipowner, as a non-executive director of NBG earlier this month as a signal that a deal with a Chinese investor might be in the offing. Mr Constantacopoulos’s shipping company charters container vessels to China’s Cosco shipping and ports group, and it was he who facilitated the above mentioned €4bn concession for Cosco to operate a container terminal at Piraeus port.

The Greek Prime Minister George Papandreou has vigourously denied all these reports - although again, watch the wording. Speaking at Davos today he said that recent media reports that China would buy up to E25 billion worth of Greek sovereign bonds are "wrong," and that Greece has "not asked for money anywhere else." He added: "We are in a jittery time" in which "rumors can create problems." Greece's Finance Minister George Papaconstantinou also reiterated the same points: "We have not talked to China and no investment bank has a mandate from us to talk to China," he said in an interview with The Wall Street Journal.

But it is strange to here Mr Papconstantinou saying this, since if we go back just to last Tuesday - the day before the current rumpus broke out - Mr Papaconstantinou gave an earlier interview to the Wall Street Journal, but this time the Greek Finance Minister was there to detail a diversified global borrowing plan to plug government fiscal gaps - including, he mentioed, aspirations to raise up to $10 billion from Chinese and other Asian investors.
Papaconstantinou will lead a delegation next month to the U.S. and Asia to market Greek debt valued at at least $1.5 billion to $2 billion denominated in euros, dollars and possibly yen. But Greek officials hope that the bond tour, which will include stops in Beijing, Shanghai and Hong Kong, could bring in five times that amount if Chinese investors are attracted to the deal. "There is a lot of liquidity in China. There are big funds in China. This is why China is going to be part of the road show," he said, adding that if Chinese investors are to get involved the bond size has to be "significant... possibly $5 billion to $10 billion." A person familiar with the situation has told Dow Jones that Greece is trying to place as much as EUR20 billion to EUR25 billion overall with Chinese investors.


Indeed the Greek government have not gone so far as to deny the roadshow ever exitsed, but Reuters today do report that they have backtracked somewhat, since while they had previously announced they were going to stage the roadshow sometime in the near future, the head of the Greek debt agency (PDMA) is now stressing that no date has in fact yet been set: "Finance ministry officials said the roadshow might take place at the end of February or in March, depending on Greece's borrowing plan, which has not been finalised."

Really, this is all a very, very sorry story, and the main issue facing the Greek authorities at this point is one of credibility since, as the Financial Times says: "at the heart of Greece’s problems is a lack of confidence in its trustworthiness". Such confidence has been lost in the course of a decade of "incidents" with the EU Commission and the Eurostat statistics office, and it is just this loss of confidence which the recent handling by the Greek administration of the China bond issue will have done little to restore. Is the Greek government batting with us or against us at this point?

Tuesday, January 26, 2010

Competitiveness Gaps Could Hurt The Euro - No Really!

Reuters Jan Strupczewski gives more details of the EU Commission report first leaked by Der Spiegel. According to Strupczewski the "new European Commission report has expressed concern about gaps in competitiveness that could undermine confidence in the euro zone and point to tensions related to wage levels and capital flows in the 16-member club". The report was prepared for the finance ministers meeting on January 16.

Of particular interest the report acknowledges that the real effective exchange rate for Greece, Spain and Portugal is overvalued by more than 10 percent - I would put the Spanish figure at nearer 20%, but still, a start is a start - and this gives us an indication of how much either wages and prices in these countrieshave to fall, or productivity rise, to make them competitive again, given that they are locked into the euro.

The report also said that large and persistent differences in competitiveness across the zone are a serious concern and can undermine confidence in the single currency "Competitiveness divergences within the euro area may hamper the functioning of the Economic and Monetary Union, because of large trade and financial spillovers across Member States.......In particular, the persistence of large cross-country differences jeopardises confidence in the euro and threatens the cohesiveness of the euro area,"

The report, which runs to 172 pages, was requisitioned by the Commission to examine the competitiveness problem in the 16 countries using the single currency, such differences in competitiveness are reflected, for example, in the size of the respective current account deficits or surpluses in the eurozone.

To put things in perspective, the Commission estimates Greece had a current account gap of 8.8 percent of GDP last year, Spain 5.4 and Portugal 10.2 percent. Cyprus had a current account gap of 11.6 percent while Germany had a surplus of 4 percent, Luxembourg 9.4 percent, the Netherlands 3.1 and Finland 1.1 percent. These numbers are well down from 2008 in the cases of Greece, Spain and Portugal, where the deficits were more like 15%, 10% and 9%. As Krugman says, its all about "numbers, numbers, numbers".

The note said that the accumulation of large current account deficits could not be sustained forever and that they entailed a build-up of external and private sector debt. "If [these imbalances] remain unaddressed, the eventual correction can be abrupt and highly disruptive not only for the countries concerned but also for the rest of the euro area," it said.

"The combination of competitiveness losses and the excessive accumulation of public debt in some Member States are worrying in that context," the note said. Rigidities in labour and product markets may make regaining lost competitiveness a long and painful process , but the longer the adjustment is postponed the higher the ultimate cost will be, the Commission said.


"The divergence trend observed in the early years of euro reflects a worrying build-up of a range of domestic imbalances in some Member States," according to the Commission.

More controversially, the report suggests that while the real effective exchange rate for Greece, Spain and Portugal is overvalued, Germany's was 5.1 to 3.1 percent undervalued last year, indicating that companies have scope for wage increases without losing competitiveness. This is controversial, because naturally this rise in wages would bring Germany back into trade equilibrium, GDP growth would turn negative, since as a high median age society Germany is now completely dependent on its trade surplus for growth.

In addition the report said that most indicators of price and cost competitiveness pointed to a further divergence in competitiveness in the many euro zone countries during the financial crisis and in the early stages of the recovery. This is not good news, and the only clear signs of rebalancing come from Ireland gaining in competitiveness in 2008 and 2009.

"A smooth adjustment of intra-euro area competitiveness divergence and macroeconomic rebalancing is key for the recovery and, more generally, for the economic resilience and a smooth functioning of EMU in the long term.......It is therefore essential that Member States put in place an ambitious and comprehensive policy response geared at speeding up and improving intra-area adjustment mechanisms......The successful adjustment of intra-euro area competitiveness divergence and macroeconomic imbalances is of vital importance for the long-term functioning of EMU.

The EU Does Have The Legal Power To Organise Bailouts

Sometimes I am surprised by what some people consider to be news. Tony Barber points out today in the FT Brussels blog that the EU has the power to mount bailouts of any member country under "exceptional circumstances". As Tony rightly points out, under Article 122 of the EU’s Lisbon treaty, which came into effect last December, when a member-state is:

"in difficulties or is seriously threatened with severe difficulties caused by natural disasters or exceptional occurrences beyond its control, the Council [of national governments], on a proposal from the Commission, may grant, under certain conditions, Union financial assistance to the member-state concerned.”


So there it is, as he says, "in black and white", whatever the propaganda smokescreen some widely quoted but anonymous "EU Officials" have been mounting for the press in recent days.

What Tony omitted to mention is that Article 122 of the Lisbon Treaty is simply another version of article 119 of the [Foundation] Treaty of the EU (which was presumeably incorporated directly into the Lisbon Treaty. Article 122 stated the following:

Where a Member State is in difficulties or is seriously threatened with difficulties as regards its balance of payments either as a result of an overall disequilibrium in its balance of payments, or as a result of the type of currency at its disposal, and where such difficulties are liable in particular to jeopardise the functioning of the common market or the progressive implementation of the common commercial policy, the Commission shall immediately investigate the position of the State in question and the action which, making use of all the means at its disposal, that State has taken or may take in accordance with the provisions of this Treaty


This was the article cited in justification for the assistance to Latvia and Hungary, and as I pointed out in February last year, give the grounds to justify the issue of EU Bonds (as was in fact done). Now some recent statements of EU Officials point to the fact that help was given to Hungary and Latvia was only given as a result of the fact they were suffering from a "Balance of Payments" crisis, since the crisis those countries (Latvia and Hungary) was described in this way, and that this help would not be available to members of what is now being called the EuroGroup of countries. They say this, correctly, since these countries can't (almost by definition) suffer a Balance of Payments crisis, since the Eurosystem funds trade and current account deficits almost automatically. Precisely, there "danger signal" problems can't arise. But what can arise are funding problems for the government debt which eventually arises in their wake, which is where we are now in the cases of Greece, Ireland, Portugal and Spain.

So we move on to the second line of defence, which is "as a result of the type of currency at its disposal". This wording was no doubt adopted to cover cases of those countries with so called "vulnerable currencies", but when you stop and think about it, it perfectly describes the predicament of those countries, who given the lack of an adequate (red light flashing) warning mechanism on balance of payments and reserves issues, now find themselves in a much deeper problem and with no currency of their own to devalue. The definition fits the case like a glove.

The thing is, as Tony Barber points out:
Article 122 stresses it would be EU national governments, acting on advice from the Commission, that would take the decision to rescue Greece - or Ireland, Portugal and so on. There is nothing in the treaty requiring the ECB to state its opinion one way or the other. So, on this question, it is important to listen to eurozone political leaders, above all Chancellor Angela Merkel of Germany and President Nicolas Sarkozy of France, as well as Commission president José Manuel Barroso.


So look tot he statements of national leaders and EU Commission Officials for road maps on how this particular topic will develop.

The ECB Is Here To Help

But there is another area we need to think about, and that is liquidity provision. Here the ECB can be of enormous help. Basically, as I outlined in my Debt Snowball post, the critical debt to GDP ratio depends on two factors: growth in nominal GDP and the interest rate spread on government bonds. Now, EU Bonds (or whatever) can help with nominal GDP, since they can be used for fiscal support, and to provide domestic demand to an economy during the correction, but the ECB liquidity provision to the banks can also help to keep spreads under control, and thus reduce the cost of borrowing for national governments.

If we are all Europeans, and all in this together, isn't this what our leaders should be doing - for those countries willing to make sacrifices and trying to put their house in order - providing fiscal and demand support via the powers of the Commission, and liquidity support via the spreads. Is this not what M. Trichet meant when he said "we are here to help" - it would be a strange form of Union wheree the main collective institutions were working against the interests of the individual members.

Surely it is this sense that we should read yesterday's statement by ECB council member Axel Weber (one of the leading pretenders to M Trichet's thrown) that the bank will discuss reverting to long-term refinancing auctions after March,according to a report in the German newspaper Boersen-Zeitung.
After the end of the first quarter, “we will talk about returning to the auction process in the refinancing operations with longer maturities,” Weber said, according to the newspaper.

This makes perfect sense, as any other approach would be near suicidal, given the difficulties we are now all facing. Flexibility is the word.

And it is in this sense we should be looking at another piece of news that has generated considerable interest today. According to reports, investors placed about €20bn in orders for the new Greek five-year, fixed-rate bond - four times more than the government had reckoned on offering. A sign of success? Hardly, since if you look at the interest spread they needed to offer, it is clear that Greece is being made to pay dearly for all those years of fiscal profligacy, with the bond carring a record high interest rate spread relative to the rate for German bonds, the eurozone’s benchmark. The terms were described by Bloomberg as "generous".

Greece sold 8 billion euros ($11.3 billion) of bonds at premium yields to ensure the country’s first debt issue since being downgraded was a success. The five-year securities yield 6.2 percent, the Greek ministry of finance said late yesterday in an e-mailed statement. The ministry said it received 25 billion euros in orders, after offering 0.3 percentage point more yield than on the nation’s existing debt with similar maturities. The new bonds yield 3.5 percentage points more than the benchmark mid-swap rate, after being first offered at 3.75 percentage points. That compares with 3.2 percentage points on Greece’s 3.7 percent notes due July 2015, according to ING Groep NV prices on Bloomberg. The yield on Greece’s existing five-year bonds declined 7 basis points yesterday to 5.88 percent. That narrowed the difference with comparable German debt, the European benchmark, to 358 basis points, from 365 basis points last week, the widest since Greece joined the euro in 2001.

“It showed we have the ability to raise funds that we need,” according to Spyros Papanicolaou, head of the Greek debt agency. “We expect the spread to start to tighten after the sale, because Greece has been misread and misjudged.”

But Mr Papanicolaou needs to read the Credit Rating Reports (and paricularly Moodys) more carefully (or alternately he could read my blog). In fact Moodys (who stand apart from the other agencies on this one) argued only last month that investors' fears that the Greek government may be exposed to a liquidity crisis in the short term are totally misplaced. As they said in their press release "the risk that the Greek government cannot roll over its existing debt or finance its deficit over the next few years is not materially different from that faced by several other euro area member states". And they took this view since it is obvious, as a member state of the EuroGroup they can receive liquidity via the ECB (one of the strongest liquidity providers in the world), and if they implement an EU Commission approved correction programme, then the ECB is obliged to help them. It makes no sense at all, for any of us, to make this correction process more difficult.

And Spain Will Need All the Help It Can Get, From Both The EU Commission and the ECB

Now finally, one piece of news few seem interested in. Santos Gonzalez, President of AHE (Spain’s Mortgage Association) has come out today and warned that Spain's banks do not have the financial capacity to assume the outstanding debt of property developers, which amounts to around 325 billion Euros, This he says "gravely endangers the viability of the Spanish property sector as well as Spain’s financial industry".

The problem is growing, according to Gonzalez, since the need to refinance 15,000 million euros worth of interest payments annually against assets which are continuously losing value becomes insustainable. The numbers are not so much what matters here as the growing number of people who are coming out and talking publicly about the problem.

As Mark Stucklin editor of Spain Property Insight says, "You can see how bad the situation is just driving down the Spanish coast. Vast quantities of capital have been sunk into unsold developments and abandoned building sites, the result of deranged lending during the boom. Debts have will have to be written down further to get the market going again. The longer it takes the more painful it will be. Spain needs to grab the bull by the horns".


Unfortunately the links are in Spanish, but the gist of the problem is that the number mentioned is around 30% of Spanish GDP, and if the government have to mount a bailout of this order (as I have long been arguing they will need to, and this is only for the developers) then Spanish sovereign spreads are going bo be in for a very bumpy ride. Maybe English language journalists should broaden their horizons a little.

Eurozone Imbalances Weaken Trust in The Euro and Undermine Euro Area Cohesion

This is the conclusion drawn - rather surprisingly - not by some bank analyst, or by a Credit Ratings Agency, but by the European Commission itself, according to the contents of a report "leaked" to the German magazine Der Spiegel at the end of last week. "(The imbalances) weaken trust in the euro and endanger the cohesion of the monetary union,".

Here is a rough translation of the Der Spiegel report:
The EU Commission Sees Monetary Union At Risk

The EU Commission is concerned about the survival of monetary union. The differences in competitiveness between member countries and the resulting imbalances give "cause for serious concern for the eurozone as a whole", according to a presentation given by the Directorate General for Economy and Finance to the finance ministers of the Eurogroup.

The experts who advise the Finnish Commissioner-designate Olli Rehn fear that the differential development of the economies in the various Member States undermine confidence in the euro and may ultimately threaten the cohesiveness of the monetary union. Of particular concern to the Brussels officials is the economic condition of those countries who in the past ran huge deficits in their current account balances, because they lived for many years thanks to ample credit which was avaialable due to the low interest rates prevailing. Now these countries are suffering, especially Spain, Greece and Ireland, under the weight of escalating government deficits. "The combination of declining competitiveness and excessive accumulation of public debt worrying in this context," the experts say.

As a way out of trouble, the EU officials first propose that the countries concerned put their own houses in order and introduce the necessary reforms. Wage levels need to be set with due consideration to falling productivity and the loss of competitiveness. In plain language: workers ambitions should be modest, with low wage settlements. "The adjustment will be accompanied by a marked increase in unemployment."

The Commission officials also recommend that the deficit countries employ a strategy which was used by Germany in its recent efforts to exit from many years of weak growth. At the same time the German federal government does not escape criticism in the report, since Germany and other relatively successful countries such as Austria and the Netherlands need to tackle the chronic weakness in their domestic demand.

To achieve this the Brussels experts recommend enabling more competition in the services sector, the intriduction of tax reforms and the elimination of credit hurdles. The longer the countries concerned delay introducing the necessary measures, the higher the social costs which will be incurred. The Commission believes the euro countries have no choice: "These adjustments are vital for the long-term functioning of monetary union."


As far as can be seen from this Spiegel report, while it is the case that some of the wording used is similar to things we have seen before, there would seem to be an underlying transition going on here, one which in EU terms is quite rapid. The EU's own analysis of the problems in the Eurozone is coming nearer and nearer to that of both the IMF and the credit rating agencies. We are moving beyond short term fiscal deficit issues, and immediate liquidity issues, towards problems like competitiveness, and what was previously a taboo subject - the issue of Eurozone imbalances. These were, in fact, supposed to disappear with the passage of time, so it was expected that they would have diminished rather than increased. In that sense there is now an implicit admission that the institutional environment in which the common currency has been operated was severely deficient and badly needs to be improved. In my view this change in approach is already a big improvement, as is the fact that people are begining to face up to the reality that the Euro has exacerbated the imbalances, rather than reducing them.

In particular the Commission seem to be starting recognising that countries like Spain whose main export became pieces of paper (or IOUs on their future) which were securitised against assets which we can now see didn't have the value they were thought to have (the housing stock, or should I say glut) entered a dynamic which was seriously unstable. Now we need to see the measures which can be applied for correcting these distortions.

Juergen Stark, member of the Executive Council of the ECB was out with another interview more or less along the same lines on Saturday:
Stark told the Welt am Sonntag newspaper that Greece, which is battling to get its budget under control, must make comprehensive consolidation a priority but also reform its economy to stop producing deficits. "Countries like Greece must not only bring their deficits under control, but also enact a fundamental reorientation of their economic policy," Stark said. "Some countries have even managed to accept falling wages -- there is no alternative for economies in a difficult situation," he added in the interview, which had been held on Thursday.


The reference in the Spiegel report to the earlier German expience is to the earlier "internal devaluation" Germany carried out between 2001 and 2005 in an attempt to restore competitiveness after having entered the common currency at an exchange rate which was later discovered to have been too high. The thing is, the German devaluation was quite limited and quite slow. Greece and Spain have large devaluations to carry out, and the time scale is likely to need to be short, since it is urgentto restore growth to these economies to avoid the debt to GDP percentages snowballing upwards.

Another aspect to this whole problem is the new emphasis on correcting the imbalances as a shared process, one which, as Mr Zapatero would have it, involves "solidarity", and joint responsibility. That is to say the surplus countries are going to be expected to play their part: no wonder the German economy minister became so angry with Mr Zapatero's 2020 strategy initiative.

Of course, it is not really posible to present the problem in quite this way, since one set of economies are competitive, and another set are not, so it is hard for the Greeks and the Spanish to really blame the Germans and the Dutch for their present situation, although everyone, both centre and periphery, will have to play a part in the search for solutions. I tend to put it this way: the South must make sacrifices, and then the centre must help. Thus talk of no "financial bailout being possible", or, as M Trichet would have it, simply stating that the "external surpluses of some member countries (in the balance of payments) finance the external deficits of some others" without recognising that the presence of these very same surpluses form a problematic part of the internal Eurozone imbalances is hardly helpful at this point.

As Martin Wolf said recently:
What people do not seem to understand is that peripheral European countries cannot escape from their trap because they are caught in a game of competitive deflation with Germany (and the Netherlands). So long as the eurozone has an external balance (roughly) and Germany has a vast surplus, the rest of the zone MUST be running aggregate deficits. That is a subtraction from their domestic demand. This then means that either the private sector runs deficits (spends more than its income) or the public sector does. If the latter is pushed towards balance, by eurozone pressure, GDP must contract enough to force the private sector finally back into deficit and so towards bankruptcy. Ultimately, the only way out of the trap is for nominal wages and costs in peripheral Europe to fall so much that it forces core Europe into depression . That also means a depression in peripheral Europe. No advanced polity can cope with a permanent depression. Anything can then happen. I have always feared that the euro could break the EU. I believe this is quite possible.

"Alternatively, demand must start to rise substantially in core Europe. Is that possible? The other alternative would be for the eurozone as a whole to move into surplus - but how, given the weakness of external demand and the strong euro?"


No easy answers yet awhile, but lots of interesting problems to talk about, and plenty of food for thought.

Thursday, January 21, 2010

The EU Is Reportedly Exploring Making a Loan To Greece

Pressure on Greek finances continues unabated. According to European Voice this morning the EU Commission and Finance Ministers remain most reluctant to call in the IMF (which I think would be the best solution) but they are themselves actively comtemplating providing some kind of IMF-type "straightjacket loan". My only big fear here is that they take too long to put the necessary mechanisms in place while the situation in Spain continues to deteriorate, leaving wide open a serious contagion risk.

European Union officials are exploring the possibility of providing a heavily-conditioned loan to Greece instead of seeing it turn to the International Monetary Fund. Officials are worried about the possible impact on banks elsewhere in the eurozone of Greece defaulting on its sovereign debt. But they would prefer to avoid the ignominy of a eurozone country seeking IMF assistance.


The worry is not, in fact, that Greece might leave the Eurozone, or even default in the short term, but that unless someone external takes control of the situation the Greek government will prove unable to sell those much needed competitiveness reforms to a population which will not be happy about being faced with what looks set to be quite a steep economic contraction. As Martin Wolf said on Monday:

Given these tight constraints, a big structural fiscal tightening will generate a deep recession. That is sure to increase the cyclical deficit. Assume, cautiously, that for every percentage point of structural tightening there would be 0.2 points of offsetting fiscal deterioration. Then the structural tightening needed to reduce the actual deficit to 3 per cent of GDP would be close to 12 percentage points. The Greek government would find that, for every step it takes forward, it would slip a bit backwards. So far Greece has not suffered a significant recession. That seems sure to change. The government will soon be facing miserable public and private sectors, with no policy levers.


And PNB Paribas's Luigi Speranza remains equally unconvinced:

In sum, while ambitious, the Greek Stability Programme did not resolve the main concerns expressed by the markets. Amongst the main shortcomings are: persistent lack of credibility of Greek statistics on fiscal accounts, lack of details on the adjustment beyond 2010 and overly-optimistic growth projections. A credible long-term strategy should be focused on sharp cuts to public spending, particularly for wages and pensions. But this would probably lead to strong social opposition. Against this backdrop, markets will remain sceptical on the feasibility of the overall planned adjustment.




The big fear has to be that a "contagion process" will lead the Greek problem to become a Spanish one.

In an interview with the Wall Street Journal yesterday Spain's Finance Minister Elena Salgado stated that the government was preparing "deep" cuts in spending, cuts which will only add to the difficulties of an economy which is already reeling under the weight of a very strong contraction:

Spain's Socialist-led government is trying to forge a broad political consensus with the country's regional leaders to rein in one of the euro zone's highest budget deficits, Finance Minister Elena Salgado said in an interview. Getting bipartisan support for deep spending cuts would be a crucial step to avoid the credit ratings downgrades now plaguing Greece, which this week has been scrambling to convince financial markets that it can get fiscal imbalances under control.


She also admitted that Spain's deficit was likely to come in above the government forecast, which makes me rather nervous about the kind of market reaction we might then see, given the nervousness which has been produced by events in Greece.

The government recently warned it would surpass its forecast of a 2009 deficit of 9.5% of GDP. "It will be a little more, we hope not too much," Ms. Salgado said, adding the overrun is the result of a new benefit introduced for the long-term unemployed and lower-than-expected value-added-tax revenue from a still ailing real-estate sector.


Basically, what the Spanish government lacks is a credible policy not only for reducing the deficit, but also for restoring growth and creating employment. How all this will finally work out is hard to see at the moment. It is, as they say, a "developing situation". As one Greek economist friend pointed out to me Finance Minister Papaconstantinou yesterday limited himself simply to saying "We are not expecting anyone to come to our rescue," ...he didn't say Greece didn't NEED anyone to come to the rescue. Reading between the lines is evidently something of a fine art in the Greek case. But then, ever since the time of Demosthenes, the art of rhetoric has been one of their strong points.

In similar vein, a spokeswoman for the European Commission, on being asked this morning by Dow Jones Wire Service about the reports said "she isn't aware of any financial bailout packages being arranged for Greece". Well, in the first place they may exist, even without her knowledge of them, and in the second, they would have to be total fools (which they most definitely are not) not to have any kind of contingency arrangement under the circumstances (for imminentl deployment or otherwise), and even while some degree of Euro weakening has been welcomed by some, there must be a "stop loss" button they can hit somewhere if the slide continues and if the spreads continue to rise. In Greek markets, the premium demanded by investors to buy Greek bonds compared with benchmark German Bunds rose to 311 basis points yesterday, the highest since the euro was introduced. The yield on Greek 10-year bonds is now 6.2 percent. And talk of issuing a people's bond, or bonds in US Dollars or Yen will do nothing to calm things down. And the yield premium on ten year Spanish bonds over the German bund jumped to over 100 bps this morning, a level which hasn't been seen since April last year. Whatever the issues of communal pride, simple damage containment considerations suggest the Greek government should be calmly told to go to the IMF, and they should be told to go now.

Wednesday, January 20, 2010

Spain Gets Frobbed-Off By The EU Commission

FROB, for those of you who are wondering, stands for "Fund for Orderly Bank Restructuring" and is an entitly created by the Spanish government in June last year, in order to facilitate (in particular) the restructuring of Spain's hard hit Savings Banks (Cajas). There is just one problem: as of the present time - and over seven months later - the FROB still is waiting to receive approval from the European Commission.

"The essence of the FROB in fostering the reorganisation of the sector in an orderly manner and in the most financially efficient way, as well as the key role of the Bank of Spain in most of the phases of the restructuring and integration processes, are positive." says Carmen Munoz, Senior Director, Fitch's Financial Institutions group. "Fitch will assess the rating impact, if any, on a case-by-case basis with respect to financial institutions."

"While the number of financial institutions that could receive support from the plan remains uncertain, Fitch believes that the orderly consolidation process reduces the risk of multi-notch downgrades for financial institutions that act as counterparties in securitizations," says Rui J. Pereira, Managing Director, Fitch's Structured Finance group. "At present, FROB will have a neutral affect on outstanding Spanish structured finance ratings and any later developments will be analyzed on a case-by case basis."


The FROB came into existence, or was officially born, on 28 June 2009. At the present point in time it is not clear when it will be able to get to work. Having denied for so long that the banking system was having any major problems, it may well be that the country's banking system have missed out on the near free lunch that was offered to everyone else (Monsieur Trichet recently said there would be no second opportunity for the banks), and so the first tentative efforts to clean up the mess are now hitting straight up against the EUs unfair competition regulations.

Initially furbished with 9 billion euros in capital, the Fund was also empowered to issue up to 27 billion euros in third party debt during the remainder of 2009, and a further quanity from 1 January 2010, up to a grand total of 90 billion euros.

Fitch actually assigned a AAA rating to FROB's first bond issue, on the basis of the fact that it was backed by the Kingdom of Spain, which also currently enjoys an AAA rating (from Fitch at least, if no longer from Standard and Poor's). As Fitch point out, "the 'AAA' rating reflects the explicit, irrevocable and unconditional guarantee provided by the Kingdom of Spain, the Bank of Spain will act as paying agent, under a Spanish Treasury arrangement, and bond issues are zero risk weighted and ECB repo-eligible". (well, you can read a bit more about Fitch's assessment of FROB here).

The key point to notice about FROB is, I feel, that while debt issued is guaranteed by the government, it does not form part of gross Spanish government debt for Eurostat audit purposes. You could call its debt, if you want, a form off-balance-sheet debt, and the FROB could be thought of as some kind of Spanish Sovereign SIV. Indeed, the condition that the bonds are repo-eligible suggests that the Spanish banks can simply earn carry from the spread by taking them over to the ECB as collateral for loans. As we know, Spain's banks have been making considerable us of ECB funding in recent months - although it is not clear what happens as the ECB longer term enhanced liquidity programme is wound down.



Indeed, the Irish government in their October 2009 letter to Eurostat explicitly describe Ireland's bad bank NAMA as an SPV, and interestingly enough the EU Commission in their November 2009 Forecast for Ireland say the following:

"In line with the 19 October 2009 preliminary view of Eurostat, the bonds (around 30% of GDP) expected to be issued by the Special Purpose Vehicle associated to the NAMA to finance the purchase of loan books from certain financial institutions are not recorded as government debt, while the majority of those bonds are guaranteed by the Irish State."


So clearly, financing the removal of toxic assets from Spain's banks and cajas in this way has one big advantage - it doesn't add to sovereign debt on a one for one basis - but it has the peculiar disadvantage that no one really knows what happens if the people receiving the aid cannot pay up eventually. That is, if the issue to hand is a solvency and not a liquidity one. Well, it is known what would happen in the sense that Spain's government would have to assume its responsibilities, but the unwinding would evidently be messy.

So what is the delay? Well basically, when this whole structure was set up the Bank of Spain didn't seem to be fully aware that the EU Competition rules put a limit on direct aid to banks and cajas at 2 percent of their risk capital. Aid above this level would violate the EU unfair competition regulations.

The FROB is mainly directed at Spain's Cajas, since the 45 largely unlisted savings banks have been hit badly by the slump in the country's property sector after a decade-long boom and have some of the highest non-performing loan ratios in the financial sector.

Now it appears that the needs of the first three Caixas (the Catalan version of Caja) seeking to restructure under the FROB (Manresa, Tarragona and Catalunya) may well go beyond the 1.315 billion euros currently available under the regulations. And they may therefore need additional aid from the Spanish government under another heading. And it is just how to go about effecting this support that seems to be the sticking point in the negotiations - negotiations which have now dragged out over several months, depsite the fact that the situation needs somewhat urgent resolution.

Help does however now seem to be at hand. The three savings banks in question agreed last week to postpone plans to merge until the European Union's executive Commission had ratified the FROB restructuring plan, and the European Commission said on Monday it was confident of issuing a positive decision on Spanish government scheme. The Commission, which has the responsibility for ensuring that state aid does not skew competition across the 27-country EU, is in "constructive discussions" with the Spanish authorities over the plan, according to Commission spokesman Jonathan Todd. And just in case the discussions need that little bit extra gusto, the Spanish Economy Commission Joaquin Almunia will shortly be taking over as Competition Commissioner in the forthcoming reshufle.

According to Jonathan Todd "The Spanish authorities have to clarify what their intentions are". Honourable I hope!. Todd also stated that while there was no fundamental problem, the Commission had to ensure that the scheme complied with EU state aid rules. In particular the sticking points seem to revolve around the interest rate the Cajas will have to pay to the FROB, and whether or not any additional bailouts from the Spanish government will need to go to Brussels on a case by case basis. Whoever was it who said, sometimes trying to make things easy you end up making them more difficult.

"The Commission is confident that we will be able to come to a positive outcome on the regime."

Housing Stats Under The Spotlight

Moving on to other matters, a great deal of attention has been showered of late on the perceived weaknesses of the Greek statistical agency. But Greece is far from being the only example of a European country were the process of statistics gathering is rather unsatisfactory. Enrico Giovannini, chairman of the Italy’s national statistics institute, also recently argued that national statistic agencies should have the same autonomy as central banks to avoid attempts by government to influence economic data.


Well, Spanish Property Insight blogger Mark Stucklin just drew attention to another example of a practice which is far from perfect - the Spanish housing ministry's property prices statistics.

Mark draws our attention to the fact that the Economist, in their latest house affordability survey, find that Spanish house prices are "still 55% above their fair value despite Spain’s property market crash". Indeed using its "fair-value measure" methodology for property "based on the ratio of house prices to rents" the Economist find that Spain's property is the most overvalued among the countries surveyed -overvalued by 55%, followed by Hong Kong (+53%), Australia (+50%), France (+40%), Sweden (+35%), Ireland (+30%), and Britain (+29%).

Not so says Mark:

The problem with this method is it’s based on official housing market price statistics, which in Spain’s case are detached from reality. As I explain in my last article Spanish property prices down just 6pc in 2009 says Government, everyone in Spain knows that the Ministry of Housing’s figures are baloney. There are no reliable figures for the Spanish property market, but I guess that prices are probably down by more than 10% on average last year, and by 30% or more since the peak. If The Economist used real transaction price figures it would find that Spanish housing prices are much closer to fair value than they think.


and as Mark also points out:

Given how damaging it is for Spain to have international creditors read in a prestigious magazine like The Economist that Spanish property prices are the most overvalued in the world, you would think the Ministry of Housing would be racing to make its figures more accurate. That one step alone would do more good than all the ineffective initiatives produced by the Ministry of Housing in the last decade.


You would think Spain's Housing Ministry would eventually recognise this, wouldn't you? We live in hope. In the meantime EU Finance ministers agreed this week to seek powers for the EU’s statistics division to audit official financial information from member states. An earlier - 2005 - Commission proposal would have given just this “audit capacity” to Eurostat, but it was rejected by the EU governments. The failure to take this decision then is something which is bitterly regreted by many of those involved.

“We asked for these audit capacities in some cases, not every day, not every time, not under every condition, but under several conditions that will justify this kind of audit capacity,” Mr Almunia told reporters in Brussels. “We didn’t get it. We intend to repeat the same proposal now with the new evidence about the need for having this capacity.”


Spanish economy minister Elena Salgado, who chaired the Finance Ministers meeting, in subsequent questions with journalists dismissed a suggestion that Greece would default on its debt. “I think Greece is going to do all that is necessary so we’re not worried about that,” she reportedly told journalists. I only wish I could bring myself to think that M. Salgado was going to do all that was necessary to bring down Spain's deficit by taking the economy back to job creation and growth. Unlike her, I am worried about that, and remain unconvinced by all her statements to the contrary.

Tuesday, January 12, 2010

Will She....Won't She? The Greek Government's "Latin Tango" With The IMF

Well the wires are really alive this morning. Greece is receiving a visit from the IMF today. The meeting was scheduled well in advance, but that doesn't mean the agenda was.
A team of International Monetary Fund officials arrive in Greece today to aid the government in its efforts to tame Europe’s biggest budget deficit. The mission, “within the context of the regular surveillance that the IMF provides to its membership,” will help the government with “pension reform, tax policy, tax administration and budget management,” a spokeswoman for the Washington-based lender said in an e-mailed statement yesterday.


Really we have what is know as a "fluid" situation right now, and no one seems to be very clear about what happens next. The IMF arrive in the wake of an Athens visit by EU and European Central Bank officials last week (to discuss the government’s plan to be submitted to the EU before the end of the month), and EU President Herman van Rompuy is also scheduled to visit today. It is hard to know what the outcome of last week's visit was, but press reports speak of the delegation pushing Greece to adopt tougher measures to cut the fiscal deficit.

It is however very important to understand that the issue in Greece is not simply one of reducing public spending to rein-in the deficit. The underlying problem is the external deficit (15% of GDP current account deficit) and the distortions in the economy and loss of competitiveness that this reflects. Simply cutting the fiscal deficit without addressing these issues will not reduce the government debt to GDP ratio, and may well actually increase it. It is the sustainability of Greek finances in the longer term that is the issue, and the only way of putting government finances back on a sustainable path is to return growth to the economy, and the only way to do that is to carry out an internal devaluation.

This is one of the principle reasons that I personally am arguing of the the IMF to take Greece into its arms now. Basically, I fear the Greek government itself is far from convinced of the necessity for the measures it needs to take, and a government which is itself not convinced will prove incapable of convincing a citizenry who still remain substantially in the dark about why what is about to happen needs to happen. The IMF is the only institution which I can see available at this point to oversee the process with the firmness which will be needed.

Olli Rehn Fails To Convince

What is required of Europe's leaders at this point in time is some clear speaking, and this is exactly what we are not receiving. Asked by the Catalan MEP Ramon Tremosa (CDC) during his confirmation hearing yesterday whether he intended to put in place the kind of mechanism which IMF European Director Marek Belka has been calling for Rehn fought shy of an outright commitment to direct means of compulsion, and suggested that the desired result could be achieved by using “incentives” to encourage states which found themselves in difficulty to move toward compliance adding that there was a need for “broader surveillance”. But he did pledge to use “all instruments” to help member states restore their finances and come into compliance with the terms of the stability and growth pact, so I imagine that we are still talking about a "fluid situation" whose actual significance will only become clearer at the February EU summit. It could simply be that in order to get the 2020 plan consensually agreed Olli Rehn is putting the emphasis on incentives rather than coercion, but it must be evident that the means of coercion must be there if needed, and this must be clear to all, and in particular to the electors who vote-in those otherwise wavering politicians.

Certainly Spain's leader José Luis Zapatero hasn't made things easy for Rehn, as he seems to have bungled matters yet one more time in the present case, and his proposal that the EU should adopt "biting economic safeguards" only met with a full frontal rebuttal from German Economy Minister Rainer Brüderle, who on being interviewed stated he was opposed to what he described as plans by the Spanish EU Presidency to "sanction" member states who do not comply with the European Union's "growth objectives".

Basically this confusion is all Zapatero's fault, since he presented the proposals as a move to set binding economic goals for member states under the coming 10-year plan to boost growth and competiveness, and called for corrective measures for those that do not comply. The 2020 strategy is intended to replace an earlier plan (the Lisbon aganda) that has manifestly failed in its goal of making the EU the world's most competitive economy by 2010.
"It's absolutely necessary for the 2020 strategy [...] to take on a new nature, a binding nature," Zapatero told reporters in Madrid one week after Spain began its six-month EU presidency, a mainly organisational role in which it can influence policy. He made clear he had not secured the agreement of other member states to make the economic goals binding under the 2020 strategy, but called for such proposals to be discussed at an economic summit in Brussels next month. "The informal summit on 11 February must bring up, in my opinion, measures including incentives and corrective measures for objectives set out in our economic policy," he said. "European competitiveness depends on two words - unity and competitiveness. European unity and a competitive economy."


All of this is really a complete confusion. The "binding measures" are need to reinforce the Excess Deficit Procedure which is applied under the Stability and Growth pact, and to give the right to the Commission to oversee the necessary structural reforms and internal devaluations. They are not needed to police growth targets which may or may not be realistic. No wonder the German economy minister got irritated. These measures are likely to be used against Spain, not Germany, and the growth issue only arises in the context of enforcing the SGP, since for those countries who enter a negative debt dynamic, a return to growth is essential, if default is not to be come inevitable.

Greece Is Not Argentina, Yet

Moving now from the ridiculous to the even more ridiculous, Desmond Lachman has an article in the Financial Times this morning entitled Greece looks set to go the way of Argentina.

"....much like Argentina a decade ago, Greece is approaching the final stages of its currency arrangement. There is every prospect that within two to three years, after much official money is thrown its way, Greece's euro membership will end with a bang."

This is nonsense, at least at this point. At this moment in time no country is either near, or even remotely near leaving the Eurozone, and I'll tell you why. If Greece's Eurozone membership ends with a pop (or even a whimper) that wouldn't be anywhere near the end of the matter, since Spain would come hurtling right along behind, producing in the process the largest external debt default in recorded history, and the most likely aftermath would be that the whole Eurozone would end with a bang (with totally unknown consequences for the global financial system). So, quite simply, we cannot let that happen. Greece would not be Argentina (which was, after all the shouting, a mere financial pinprick). Greece could potentially be a much more serious matter than Argentina ever was.

I repeat, the issue is internal devaluation, and enforcing it. And if we can't do it in the Greek case the markets would be quite entitled to draw the conclusion that we won't be able to do it in the Spanish one.

The basic problem is returning the key countries to a sustainable growth path. As Standard & Poor's stated when they took their recent decision to lower their ratings outlook on Spain, the reason for the change was the probability that the country will see "significantly lower" gross domestic product growth and "persistently high fiscal deficits relative to peers over the medium term".

Personally I find nothing especially exaggerated in this judgement. S&P's preoccupations seem valid, and widely shared, among others by the technical staff who prepare forecasts for the European Commission. The issue is not that Greece and Spain are on the verge of default, but that it would be dangerous to allow the situation in these two countries to deteriorate further. Reducing the level of external debt has to be one of the top priorities for both the Greek and the Spanish administrations, and it is clear that the only way to do this is by exporting more, importing less, and running a trade surplus. This is what the whole issue of restoring price competitiveness is all about, and since Spain no longer has the means to carry out a conventional devaluation the technique known as internal devaluation is the only one presently on the table and able to do the work in the time available.


So the immediate issue is not the inability of Greece and Spain to repay their external debt, but the fact that anti-crisis measures that simply have the effect of pushing up both the external debt to GDP ratio and the government debt to GDP one are hardly a helpful contribution. Both countries need to correct their external imbalances, not increase them further. What the Greek and Spanish governments need to apply are not policies which simply allow their countries to limp along from one year to the next, but reform measures which help them straighten out all the distortions which have accumulated during the course of the property bubble.


Obviously it would be proposterous to compare Spain's fiscal situation with that of Greece, and indeed I know no one who has actually suggested that this is the situation. The concern being expressed is not that Spanish finances are on the verge of bankruptcy, but rather that the level of government debt to GDP is rising very rapidly, and that unless growth is restored to the economy the sustainability of public finances will become a problem in the longer term. According to the most recent EU Commission forecast Spanish gross government debt to GDP is set to rise from 39.7% in 2008 to 74% in 2011.

The situation with unemployment and job creation is similar. José Luis Zapatero has at long last publicly recognised that Spanish unemployment will only start to fall in 2010 (and not 2009 as previously forecast). The only problem with this is that outside Spain no one seems to recognise this seemingly good news, since the EU Commission and the IMF both maintain their forecasts for no improvement in unemployment in 2010 or 2011. In fact the forecasts for growth in GDP are still so low for 2011 (1% in the best of circumstances) that it will obviously be impossible to create increased aggregate employment if there is even a minimum level of productivity improvement.

Let us be clear then: the number one topic facing the Spanish government is how to restore growth to the economy. All the policy measures applied up to now have evidently failed to achieve this end. And now, following pressure the European Union to change course, Spain is going to have to increase taxes and reducing spending, while interest rates are likely to start to rise slowly. Far from adding momentum to the economy, all of these developments will simply serve to reinforce the recession, driving the level of GDP further and further downwards, and of course debt to GDP levels further and further upwards.

Evidently the Spanish situation is not yet as severe as the Greek one is. But risks abound. In the first place, and as Olli Rehn says, what happens to Greece is vital importance to Spain.
“The problem in Greece concerning the excessive deficit and rapidly rising debt is a very serious one,” Rehn said. “It has also potential spill-over effects for the whole euro zone.”


But risks to Spain are also accumulating inside the country itself, in particular in the form of the large stock of unsold houses the banks effectively are taking onto their balance sheets, houses whose value are effectively an unknown quantity. There are an estimated one and a half million new properties in Spain awaiting a buyer. Some of them are on bank balance sheets after being accepted in debt for property swaps. But far, far more are indirectly on their balance sheet via loans to property developers which will eventually be defaulted on. Many of these loans are continuing to be restructured, with developers generally now unable to afford even the interest payments, which are tending to get "rolled over".

And now a new threat is looming: the rising rate of repossesions that the banks will need to accept in 2010. According to a recent article in the Spanish daily Publico - as reported by Spain Property Insight's Mark Stucklin - Spain's banks will have to cope with between a further 100,000 and 150,000 repossessions which are likely to come to a head in 2010. Many of these foreclosures started as far back as 2008, but have been delayed by overloaded courts unable to process the avalanche of repossession demands. From now on these foreclosures will be the “biggest problem for the banks” according to one real estate professional quoted in the article.

And the situation has become even more complicated, since the banks now find it very difficult to take such properties to auction, for the simple reason that the people who are normally there to buy them - the subasteros - are unable to get the credit from the banks that they normally use to buy with.

As Mark points out:
The big question is what impact this new batch of repossession – the equivalent of 15% to 20% of the current inventory of property for sale – will have on the market. Unable to sell at auction, the banks might end up offering them for sale at their write-off values. The danger is that an avalanche of these properties dumped on the market at write off values will send the market into a spin, with prices falling another 20% to 30%.


So, my final point is, we should not take the idea that the Eurozone is not about to fall apart as a reason for being complacent. Risks abound, and are painfully evident. And what we now need from Europe's leaders is action, more action, and yet more action to establish clearly in everyone's mind that they are aware of the task in hand, and are up to the job of carrying it through.