Europe: Grimmer by the Minute
Here is a good summary from CNNMoney of the issues swirling around the debt crisis in Europe–revealing why it is a crisis indeed.
NEW YORK (CNNMoney) — European leaders insist they are making progress on a comprehensive plan to tackle the eurozone’s debt and banking crisis. But the details are foggy and last-minute delays suggest that significant disagreements remain unresolved.
On Wednesday, government heads from all 27 members of the European Union will gather for a second time, following a summit over the weekend. EU politicians have promised to deliver an ambitious and durable solution to a crisis that poses the biggest threat to the euro since the common currency was launched over a decade ago.
“The sovereign debt crisis threatens the very existence of the eurozone,” said Howard Archer, chief European economist at IHS Global. “It is therefore absolutely imperative that European policymakers finally deliver a major package.” The latest talks have focused on a three challenges: restructuring the Greek government’s crushing debt load, strengthening European banks and boosting the effectiveness of a limited rescue fund.
While the stakes are high, expectations are dim. It took three months for comparatively modest crisis measures announced in July to be approved by all 17 euro area governments.
Some experts have already dismissed Wednesday’s meeting as a prelude to the Group of 20 summit in early November, when the world’s most powerful leaders will gather in Cannes, France. “We have no confidence at all that the various proposed strategies will provide any effective fix for Europe’s ills,” said Ian Gordon, an analyst at investment bank Evolution Securities in London.
The main issue for Greece is the role the private sector could play in restructuring Greece’s debt.
Calls have been growing for banks and investors to voluntarily accept larger writedowns, or haircuts, on the value of Greek government bonds. Under a July agreement, bondholders had agreed to a 21% reduction. But the latest estimates suggest that writedowns of 50% or more will be necessary.
It won’t be easy. Analysts say talks with the Institute of International Finance, which represents the interests of banks that hold Greek debt, have been challenging. IIF president Charles Dallara said “there are limits” to what the private sector will tolerate as voluntarily, warning that any “unilateral actions would be tantamount to default.”
Analysts said the writedowns must be voluntary because an involuntary haircut could trigger credit default swaps, which act as insurance policies on bonds. The fear is that reducing the amount of money Greece owes will prompt other debt-burdened nations to seek a similar deal. But economists say there is no way for Greece to get out of debt without some concessions from creditors.
European banks need to raise capital reserves to withstand a default by Greece or another euro area government. The tab could total as much as €200 billion. The big question: where will the money come from?
EU politicians, including German Chancellor Angela Merkel and French President Nicolas Sarkozy, have said banks should first try to raise capital from private investors before seeking government aid. But market participants are skittish about investing in European banks. In addition, some banks have had trouble raising money to fund short-term needs, and have been elying on temporary liquidity measures from the ECB.
Banks that cannot raise money in capital markets should be recapitalized by member state governments, politicians say.
The European Financial Stability Facility, a €440 billion fund that was recently empowered to intervene in sovereign debt markets and lend money to governments that need to boost bank capital, is widely seen as inadequate. However, increasing the amount of money the EFSF controls has been ruled out by EU nations.
There has been talk of combining the EFSF, which will be phased out in 2013, with a replacement called the European Financial Stability Mechanism. Leaders are also considering a new vehicle to attract private capital from sources, such as emerging market sovereign wealth funds. The IMF may also contribute more money, analysts say.
But the talks have so far mainly revolved around ways to enhance or “leverage” the existing EFSF to get more miles out of its relatively limited resources. The fund has already committed loans to Ireland and Portugal. It is also expected to back a second bailout for Greece, originally expected to total €109 billion.
In addition to providing loans, the fund has been authorized to lend money to governments that need to inject capital into banks. It also has the power to buy bonds directly from investors. The EFSF is seen as a potential replacement for the ECB as the buyer of last resort for the debt of nations such as Italy and Spain, which are struggling to secure affordable funding.
There have been several theories about how to boost the fund’s firepower but analysts say a bond insurance scheme is the most likely outcome. The plan is to use what money the fund has left after all of its other commitments to provide a partial guarantee on newly issued government bonds. The goal is to jumpstart the market for sovereign debt by giving investors some confidence that they won’t lose all of their money.
The need for a large and credible rescue fund is urgent as worries about Italy grow. Italy, the eurozone’s third largest economy, has one of the largest bond markets in the world, worth an estimated €2 trillion. While Italy is in much better shape than Greece, the Italian economy has been ailing for years and the nation has debts equal to about 150% of its economic output.