Why do I get the uneasy feeling it's all going to come crashing down in the next few weeks. Haven't found any positives on Europe this morning. Makes our problems in the US seem easier to deal with.
Europe teetering on the brink
Slippery slope starts with Greece, continent goes downhill from there
By: Satyajit Das
Posted: 09/17/2011 1:00 AM
A full scale credit crash may be ahead.
Fact 1 -- The European debt crisis has taken a turn for the worse.
There is a serious risk that even the half-baked bailout plan announced on July 21 cannot be implemented.
The sticking point is a demand for collateral for the second bailout package. Finland demanded and got 500 million euros in cash as security against their 1.4 billion euro share of the second bailout package. Hearing of the ill-advised side deal between Greece and the Finns, Austria, the Netherlands and Slovakia also are demanding collateral, arguing that their banks were less exposed to Greece than their counterparts in Germany and France, entitling them to special treatment.
Of course, Greece, which does not have two euros to rub together, doesn't have this collateral and would need to borrow it. If it provides collateral then there is the legal risk that it triggers default on other outstanding debt.
Compounding the problem is Greece's fall in GDP was worse than forecast, even before the latest austerity measures become effective. The Greek economy has shrunk by about 15 per cent since the crisis began. Two-year borrowing costs for Greece are over 50 per cent -- pawnbroker levels.
The next instalment of Greece's first bailout package is due to be released at the end September. Some members of the International Monetary Fund are expressing misgivings about further assistance to Greece, in the light of its seeming inability to meet its end of the bargain.
A disorderly unwind of the Greek debt problem cannot be ruled out. Ireland and Portugal remain in difficulty. Spain and Italy also remain embattled with only European Central Bank purchases of their bonds keeping their interest rates down. Concern about the effect of these bailouts on France and Germany is also intensifying.
Concerns about U.S. and Japanese government debt are also increasing.
Fact 2 -- Problems with banks have re-emerged.
Banks globally, especially European banks, are seen as increasingly vulnerable to European debt problems. The total exposure of the global banking system to Greece, Ireland, Portugal, Spain and Italy is over $2 trillion. French and Germany banks have large exposures.
If there are defaults, then these banks will need capital, most likely from their sovereigns. Former French Finance Minister and now IMF head Christine Lagarde has called for mandatory recapitalization of European banks, but under acute pressure from European leaders that may not happen.
As the sovereigns are increasingly themselves under pressure, their ability to support the banking system is unclear. The pressure is evident in the share prices of French banks; Societe Generale's share price has fallen by nearly 50 per cent in a relatively short period of time.
In the U.S., concerns about Bank of America have emerged, with analysts suggesting that it requires significant infusions of capital. BA's decision to issue $5 billion in preference shares at distressed prices to Warren Buffett's Berkshire Hathaway, confirmed as the market's lender of last resort, was not a statement of strength but weakness. BA's woes confirm that problems in the banking system exist globally, not only in Europe.
Fact 3 -- Money markets are seizing up.
Banks and financial institutions are finding it increasingly difficult to raise funds. Costs have risen sharply.
Spanish and Italian banks have limited access to international commercial funding. Like Greek, Irish and Portuguese banks, they are heavily reliant on funding from local investors and central banks, including the ECB.
American money-market funds, which manage around $1.6 trillion, historically invested around 40-45 per cent ($600-700 billion) with European financial institutions. Over the last few months, the money market funds have reduced their exposure to European entities, especially Spanish and Italian banks. The funds have also decreased the term of their loans to the European entities that they are willing deal with to as little as seven days at a time, in an effort to limit risk.
As a result, non-financial institutions are finding finance less readily available and more expensive. Anecdotal evidence suggest that businesses are having difficulty financing normal commercial transactions, recalling the credit problems of late 2008-early-2009.
Fact 4 ---- The broader economic environment is deteriorating.
The global economic recovery is stalling. The risk of a recession or minimal growth is significant. Germany, China and India, which have contributed the bulk of global growth since 2008, are showing signs of slowing. The effects of the excessive credit expansion in China and India are showing up in bank bad debts.
Then there are pernicious feedback loops. Tighter money market conditions feed into lower growth, increasing the problems of government finances. Falling tax revenues and rising expenditures push up budget deficits, requiring greater borrowing. Lower growth feeds into greater business failures that increase banks' bad debts, feeding further tightening in lending conditions and the cost of finance.
The rapid and marked deterioration in economic and financial conditions means that the risk of a serious disruption is significant.
If markets seize up again, then "this time it will be different." There might just not be enough money to bail out everyone and every country that may need rescuing.
Government policy options are restricted because of excessive debt levels and the reluctance of investors to finance indebted sovereigns. Interest rates in most developed countries are low or zero, restricting the ability to stimulate the economy by cutting borrowing cost. Unconventional monetary strategies -- namely printing money or quantitative easing -- have been tried with limited success. Further doses may not be effective.
There are also disagreements among policy makers about the necessary actions. In Europe, there are sharp divisions between politicians and bureaucrats. The recent resignation of Jurgen Stark, the chief economist at the ECB, is seen as symptomatic of these disagreements.
The global economy may muddle through, but a second credit crash is now distinctly possible. |
