Tag Archives: greek debt

ECB monetizing or not ?

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>   
>   (email exchange)
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>   On Thu, Apr 15, 2010 at 3:29 PM, John wrote:
>   
>   Warren, I can’t tell from this article if the European Central Bank is
>   issuing new currency in exchange for national government bonds or not?
>   

This in fact is a very good article.

Yes, the ECB is funding its banks, and yes, they do accept the securities of the member nations as collateral.

However that funding is full recourse. If the bonds default the banks that own the securities take the loss.

The reason a bank funds its securities and other assets at the Central Bank is price. Banks fund themselves where they
are charged the lowest rates. And the Central Bank, the ECB in this case, sets the interbank lending rate by offering funds at its
target interest rate, as well as by paying something near it’s target rate on excess funds in the banking system. That is, through its various ‘intervention mechanisms’ the ECB effectively provides a bid and an offer for interbank funds.

In the banking system, however, loans ‘create’ deposits as a matter of accounting, so the total ‘available funds’ are always equal to the total funding needs of the banking system, plus or minus what are called ‘operating factors’ which are relatively small. These include changes in cash in circulation, uncleared checks, changes in various gov. account balances, etc.

This all means the banking system as a whole needs little if any net funding from the ECB. However, any one bank might need substantial funding from the ECB should other banks be keeping excess funds at the ECB. So what is happening is that banks who are having difficulty funding themselves at competitive rates immediately use the ECB for funding by posting ‘acceptable collateral’ to fund at that lower rate.

One reason a bank can’t get ‘competitive funding’ in the market place is its inability to attract depositors, generally due to risk perceptions. While bank deposits are insured, they are insured only by the national govts, which means Greek bank deposits are insured by Greece. So as Greek and other national govt. solvency comes into question, depositors tend to avoid those institutions, which drives them to fund at the ECB. (actually via their national cb’s who have accounts at the ECB, which is functionally the same as funding at the ECB)

As with most of today’s banking systems, liabilities are generally available in virtually unlimited quantities, and therefore regulation falls entirely on bank assets and capital considerations. As long as national govt securities are considered ‘qualifying assets’ and banks are allowed to secure funding via insured deposits of one form or another and the return on equity is competitive there is no numerical limit to how much the banking system can finance.

So in that sense the EU is in fact financially supporting unlimited credit expansion of the national govts. They know this, but don’t like it, as the moral hazard issue is extreme. Left alone, it becomes a race to the bottom where the national govt with the most deficit spending ‘wins’ in real terms even as the value of the euro falls towards 0. When the national govts were making ‘good faith efforts’ to contain deficits, allowing counter cyclical increases through ‘automatic stabilizers’ and not proactive increases, it all held together. However what Greece and others appear to have done is ‘call the bluff’ with outsize and growing deficits and debt to gdp levels, threatening the start (continuation?) of this ‘race to the bottom’ if they are allowed to continue.

The question then becomes how to limit the banking system’s ability to finance unlimited national govt. deficit spending. Hence talk of Greek securities not being accepted at the ECB. Other limits include the threat of downgraded bonds forcing banks to write down their capital and threaten their solvency. And once the banking system reaches ‘hard limits’ to what they can fund a system that’s already/necessarily a form ‘ponzi’ faces a collapse.

The other problem is that when the euro was on the way up due to portfolio shifts out of the dollar, many of those buyers of euro had to own national govt paper, as their is nothing equiv. to US Treasury securities or JGB’s, for example. That helped fund the national govs at lower rates during that period. That portfolio shifting has largely come to an end, making national govt funding more problematic.

The weakening euro and rising oil prices raises the risk of ‘inflation’ flooding in through the import and export channels. With a weak economy and national govt credit worthiness particularly sensitive to rising interest rates, the ECB may find itself in a bind, as it will tend to favor rate hikes as prices firm, yet recognize rate hikes could cause a financial collapse. And should a govt like Greece be allowed to default the next realization could be that Greek depositors will take losses, and, therefore, the entire euro deposit insurance lose credibility, causing depositors to take their funds elsewhere. But where? To national govt. or corporate debt? The problem is there is nowhere to go but actual cash, which has been happening. Selling euro for dollars and other currencies is also happening, weakening the euro, but that doesn’t reduce the quantity of euro deposits, even as it drives the currency down, though the ‘value’ of total deposits does decrease as the currency falls.

It’s all getting very ugly as it all threatens the value of the euro. The only scenario that theoretically helps the value of the euro is a national govt default, which does eliminate the euro denominated financial assets of that nation, but of course can trigger a euro wide deflationary debt collapse. The ‘support’ scenarios all weaken the euro as they support the expansion of euro denominated financial assets, to the point of triggering the inflationary ‘race to the bottom’ of accelerating debt expansion.

Bottom line, it’s all an ‘unstable equilibrium’ as we used to say in engineering classes 40 years ago, that could accelerate in either direction. My proposal for annual ECB distributions to member nations on a per capita basis reverses those dynamics, but it’s not even a distant consideration.

Where are ‘market forces’ taking the euro? Low enough to increase net exports sufficiently to supply the needed net euro financial assets to the euro zone, which will come from a drop in net financial assets of the rest of world net importing from the euro zone. This, too, can be a long, ugly ride.

As a final note, the IMF gets its euros from the euro zone, so using the IMF changes nothing.

Comments welcome!

The Next Global Problem: Portugal

By Peter Boone and Simon Johnson

Peter Boone is chairman of the charity Effective Intervention and a research associate at the Center for Economic Performance at the London School of Economics. He is also a principal in Salute Capital Management Ltd. Simon Johnson, the former chief economist at the International Monetary Fund, is the co-author of 13 Bankers.

April 15 (NYT) — The bailout of Greece, while still not fully consummated, has brought an eerie calm in European financial markets.

It is, for sure, a huge bailout by historical standards. With the planned addition of International Monetary Fund money, the Greeks will receive 18 percent of their gross domestic product in one year at preferential interest rates. This equals 4,000 euros per person, and will be spent in roughly 11 months.

Despite this eye-popping sum, the bailout does nothing to resolve the many problems that persist. Indeed, it probably makes the euro zone a much more dangerous place for the next few years.

Next on the radar will be Portugal. This nation has largely missed the spotlight, if only because Greece spiraled downward. But both are economically on the verge of bankruptcy, and they each look far riskier than Argentina did back in 2001 when it succumbed to default.

Portugal spent too much over the last several years, building its debt up to 78 percent of G.D.P. at the end of 2009 (compared with Greece’s 114 percent of G.D.P. and Argentina’s 62 percent of G.D.P. at default). The debt has been largely financed by foreigners, and as with Greece, the country has not paid interest outright, but instead refinances its interest payments each year by issuing new debt. By 2012 Portugal’s debt-to-G.D.P. ratio should reach 108 percent of G.D.P. if the country meets its planned budget deficit targets. At some point financial markets will simply refuse to finance this Ponzi game.

The main problem that Portugal faces, like Greece, Ireland and Spain, is that it is stuck with a highly overvalued exchange rate when it is in need of far-reaching fiscal adjustment.

For example, just to keep its debt stock constant and pay annual interest on debt at an optimistic 5 percent interest rate, the country would need to run a primary surplus of 5.4 percent of G.D.P. by 2012. With a planned primary deficit of 5.2 percent of G.D.P. this year (i.e., a budget surplus, excluding interest payments), it needs roughly 10 percent of G.D.P. in fiscal tightening.

It is nearly impossible to do this in a fixed exchange-rate regime — i.e., the euro zone — without vast unemployment. The government can expect several years of high unemployment and tough politics, even if it is to extract itself from this mess.

Neither Greek nor Portuguese political leaders are prepared to make the needed cuts. The Greeks have announced minor budget changes, and are now holding out for their 45 billion euro package while implicitly threatening a messy default on the rest of Europe if they do not get what they want — and when they want it.

The Portuguese are not even discussing serious cuts. In their 2010 budget, they plan a budget deficit of 8.3 percent of G.D.P., roughly equal to the 2009 budget deficit (9.4 percent). They are waiting and hoping that they may grow out of this mess — but such growth could come only from an amazing global economic boom.

While these nations delay, the European Union with its bailout programs — assisted by Jean-Claude Trichet’s European Central Bank — provides financing. The governments issue bonds; European commercial banks buy them and then deposit these at the European Central Bank as collateral for freshly printed money. The bank has become the silent facilitator of profligate spending in the euro zone.

Last week the European Central Bank had a chance to dismantle this doom machine when the board of governors announced new rules for determining what debts could be used as collateral at the central bank.

Some anticipated the central bank might plan to tighten the rules gradually, thereby preventing the Greek government from issuing too many new bonds that could be financed at the bank. But the bank did not do that. In fact, the bank’s governors did the opposite: they made it even easier for Greece, Portugal and any other nation to borrow in 2011 and beyond. Indeed, under the new lax rules you need only to convince one rating agency (and we all know how easy that is) that your debt is not junk in order to get financing from the European Central Bank.

Today, despite the clear dangers and huge debts, all three rating agencies are surely scared to take the politically charged step of declaring that Greek debt is junk. They are similarly afraid to touch Portugal.

So what next for Portugal?

Pity the serious Portuguese politician who argues that fiscal probity calls for early belt-tightening. The European Union, the European Central Bank and the Greeks have all proven that the euro zone nations have no threshold for pain, and European Union money will be there for anyone who wants it. The Portuguese politicians can do nothing but wait for the situation to get worse, and then demand their bailout package, too. No doubt Greece will be back next year for more. And the nations that “foolishly” already started their austerity, such as Ireland and Italy, must surely be wondering whether they too should take the less austere path.

There seems to be no logic in the system, but perhaps there is a logical outcome.

Europe will eventually grow tired of bailing out its weaker countries. The Germans will probably pull that plug first. The longer we wait to see fiscal probity established, at the European Central Bank and the European Union, and within each nation, the more debt will be built up, and the more dangerous the situation will get.

When the plug is finally pulled, at least one nation will end up in a painful default; unfortunately, the way we are heading, the problems could be even more widespread.

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GS on GREECE – INITIAL IMPRESSIONS AND MARKET

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This remains the tricky part, seems:

Several key issues remain outstanding, however:

1. The budgetary and reform milestones which need to be cleared in order for Greece to receive funding have yet to be hammered out with the lenders. The statement suggests that discussions will start tomorrow and may last weeks, potentially resulting in market volatility if there are disagreements.

2. Availability and drawdown conditions have yet to be decided. Specifically, the one reached over the weekend is a political agreement and each EMU government will now need to go seek legislative approval in Parliament. Related open questions include: Where will the loans rank with respect to other existing Greek debt? Where will these loans show up in the lenders’ books (i.e., will they increase the deficit and debt)? Will they require extra funding in the capital markets?

3. Most importantly, as Erik Nielsen has commented in a note this afternoon, the issue of medium term debt sustainability remains open. It will depend on measures and reforms put in place by the Greek authorities, the response of domestic activity, and the external economic environment.

Best Regards. FUG
Francesco U. Garzarelli

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Euro finance ministers to agree on Greek aid: source

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Without an interest rate and a credible quantity pledged, the agreement is grossly deficient.

The way Greece obtains funding is by offering ever higher rates until there is a taker.

So let’s say they offer securities at 5%, then 6, then 7, then 10, then 15, then 20 with no takers. How high do they go before they tell the EU group they have failed to obtain funding?
And then what rate does the EU charge them if they agree?

The process makes no sense.

The way to do it is for the EU group to offer funding at some rate, giving Greece some amount of time to try to find a better rate.

Euro finance ministers to agree on Greek aid: source

By Jan Strupczewski

March 13 (Reuters) — Euro zone finance ministers are likely to agree on Monday on a mechanism for aiding Greece financially, if it is required, but will leave out any sums until Athens asks for them, an EU source said on Saturday.

Policymakers have been debating possible financial support for the heavily-indebted European Union member state for more than a month, but have provided only words of support. Germany, key to any deal, has resisted appeals to promise aid.

British newspaper The Guardian on Saturday quoted sources as saying Monday’s meeting of the currency zone’s 16 finance ministers would agree to make aid of up to 25 billion euros available.

But a senior EU source with knowledge of preparations for Monday’s meeting told Reuters no numbers were likely at this stage.

“I think we should be able to agree on principles of a euro area facility for coordinated assistance. The European Commission and the Eurogroup task force would have the mandate to finalize the work,” the source said.

“It would be the principles and parameters of a facility or mechanism, which then could be activated if needed and requested.

He said no figure had been agreed.

“You would have a framework mechanism and you would have blank spaces for the numbers because there has been no request (from Greece) yet,” the source said.

Greece has announced steps to reduce its budget deficit this year to 8.7 percent of GDP from 12.7 percent in 2009, triggering street protests and strikes but also reducing market concern over whether the country would be able to service its debt.

That helped Athens sell its bonds with ease on debt markets earlier this month, but policymakers are still searching for ways of making its cost of borrowing — still far above that of other Europeans — more sustainable.

They are also concerned that the problems in Greece could undermine confidence in the euro and spread to other heavily indebted eurozone countries such as Portugal or Spain.

CUTBACKS

The EU source said that among the instruments considered to help Greece were both bilateral loans and loan guarantees.

“The preparations have been done under the Eurogroup by member states and the Commission. The Commission has done much of the technical work,” the source said.

“The aim of the exercise so far has been to do the technical preparations, so that the political decision could be possible on Monday. Germany holds the key at the moment.”

Polls show that public opinion in Europe’s biggest economy Germany is strongly opposed to bailing out Greece, which has for years provided unreliable statistics about the true size of its deficit and debt, breaking EU budget rules.

In a move that is likely to alleviate German concerns about spending money on Greece, the Commission has said it would soon make a proposal for stronger economic cooperation between euro zone countries and tighter surveillance of their performance.

French Economy Minister Christine Lagarde told the Wall Street Journal she believed Greece’s austerity moves were behind the improvement in its situation on markets and negated the need for a bailout.

“”There is no such thing as a bailout plan which would have been approved, agreed or otherwise, because there is no need for such a thing,” she said.

But she added that “technical experts” at the EU have been working on a contingency plan, so that if the need arose “all we would have to do is press the button.”

The Guardian quoted a senior official at the European, the EU executive, official as saying the euro zone members had agreed on “coordinated bilateral contributions” in the form of loans or loan guarantees if Athens was unable to refinance its debts and called on the EU for help.

The agreement has been tailored to avoid breaking the rules governing the operation of the euro currency which bar a bailout for a country on the brink of bankruptcy, and to avoid a challenge by Germany’s supreme court, the official said.

A German ministry spokesman said he could not believe the newspaper’s report on the bailout plan was correct.

“We are not aware that this is being planned,” he said, adding that Greece had not requested any aid. “Greece is implementing its (savings) program and we expect that it will manage it alone.”

(Additional reporting by Tim Pearce in London, Pete Harrison in Brussels and Volker Warkentin in Berlin, Writing by Sarah Marsh and Jan Strupczewski; Editing by Patrick Graham)

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The Eurozone Solution For Greece Is A Very “Clever Bluff”?

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The Eurozone Solution For Greece Is A Very “Clever Bluff”?

The Guardian is today reporting that, after weeks of crisis, the Eurozone has agreed to what appears to be a multibillion-euro assistance package for Greece that will be finalized on Monday. Member states have apparently agreed on “coordinated bilateral contributions” in the form of loans or loan guarantees to Greece, but only if Athens finds that it is unable to refinance its soaring debt and asks for help. Other sources said the aid could total €25bn (£22.6bn) to meet funding needs estimated in European capitals that Greece could need up to €55bn by the end of this year.

Once again, however, since funding is a function of interest rates, this proposal has the appearance of a very “clever bluff”. It says nothing about how high interest rates for Greece would have to go before the Greek government is somehow declared unable to refinance, and asks for additional help. The member nations probably structured the loan package and terms this way hoping to try to draw in lenders who would rely on this member nation as a back stop when making their investment decisions. However, if this ploy fails, Greek rates will go sky high in an attempt to refinance, and as Greece asks for more help, the spike in rates will make it all the more difficult for the entire Eurozone monetary system to function. Additionally, the prerequisite austerity measures will subtract aggregate demand in Greece and the rest of the Eurozone, and, to some extent, the rest of the world as well.

I have a very different proposal. It is designed to be fair to all, and not a relief package for any one member nation. It is also designed to not add nor subtract from aggregate demand, and also provide an effective enforcement tool for any measures the Eurozone wishes to introduce.

My proposal is for the ECB to distribute 1 trillion euro annually to the national governments on a per capita basis. The per capita criteria means that it is neither a targeted bailout nor a reward for bad behavior. This distribution would immediately adjust national government debt ratios downward which eases credit fears without triggering additional national government spending. This serves to dramatically ease credit tensions and thereby foster normal functioning of the credit markets for the national government debt issues.

The 1 trillion euro distribution would not add to aggregate demand or inflation, as member nation spending and tax policy are in any case restricted by the Maastricht criteria. Furthermore, making this distribution an annual event greatly enhances enforcement of EU rules, as the penalty for non compliance can be the withholding of annual payments. This is vastly more effective than the current arrangement of fines and penalties for non compliance, which have proven themselves unenforceable as a practical matter.

There are no operational obstacles to the crediting of the accounts of the national governments by the ECB. What would likely be required is approval by the finance ministers. I see no reason why any would object, as this proposal serves to both reduce national debt levels of all member nations and at the same time tighten the control of the European Union over national government finances.

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Eurozone buying time

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Looks like behind the scenes they may be getting their banks to fund Greece and, by extension, any other national govt. this which will buy time, though longer term it depreciates the currency, which they may want to happen as well.

As long as the banks can carry their eurozone bonds at par and book the interest as earnings and fund themselves based on implied govt guarantees there is no operational limit to how long they can continue.

The limits would be the extent to which the banking laws restrict this practice, and the political tolerance for any inflation that may get imported through the fx window should the euro continue to fall.

The other problem is the downward pressure on aggregate demand of the prerequisite ‘fiscal consolidation’ is likely to result in increased social unrest as living conditions further deteriorate.

And this could be accelerated if the fiscal consolidation were to include reductions of transfer payments.

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self imposed constraints vs external constraints

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I don’t think anyone thinks it would not make any difference to Greece if it was dealing in it’s own currency with the same types of self imposed constraints the US has rather than its current externally composed constraints.

US has legal obligations to pay and self imposed constraints aren’t a valid excuse for not paying.

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Germany Said to Consider Greek Aid Beyond Loan

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[Skip to the end]

They have to be very careful as all the national govts are subject to a liquidity crisis.

If all the national govts had started with zero debt when they formed the union, the markets never would have let them get beyond maybe 20% debt to GDP.

(Note that Lux never did have its own currency and never did get that high.)

Instead they came in at the 60-100+ debt to GDP ratios they got to when they had their own currencies when it didn’t matter for liquidity/funding purposes, as with their own currencies liquidity and solvency wasn’t an issue, and whether they knew it or not their deficits were simply offsetting the economys’ nominal savings desires at the then current exchange rates.

So all (except Lux) came into the new single currency with highly problematic debt ratios, and a ‘promise’ of bringing them down. This promise had enough credibility to get them through, but markets are telling us the recession has cast serious doubts on the current institutional structure being able to bring its debts down and get itself out of ponzi.

Germany lending to Greece does not reduce the overall debt to GDP of the Eurozone. In fact arguably the introduction of ‘moral hazard’ issues make it worse as there’s a reasonable chance with this kind of implied umbrella Greece and others will feel they’ve called the union’s bluff and not adjust their finances accordingly. And, worse yet, markets are coming to understand that fiscal austerity can backfire and cause deficits to increase as it causes the economies weaken further, making it a lose-lose scenario.

So yes, the announcement of aid beyond loans will buy some time, but without sufficient real growth driven either by exports or domestic credit expansion (which is also not sustainable longer term) all the same issues will probably return.

And one of the reasons for the weak euro has been that their deficits have gotten large enough to make euro financial assets sufficiently ‘more plentiful’ to weaken the currency. This kind of help doesn’t change that.

And it could be that one of their goals is a policy that weakens the euro in an attempt to improve exports, while at the same time not triggering a liquidity crisis. Seems like an impossible tightrope to try to walk.

The easiest/safest way to do that is for the ECB to buy fx, but their ideology doesn’t allow that.

>   
>   (email exchange)
>   
>   On Wed, Feb 10, 2010 at 6:14 AM, Dave wrote:
>   
>   Bunds off almost a point on this story
>   Curve bear steepening
>   
>   DV
>   

Germany Said to Consider Greek Aid Beyond Loan Guarantees
2010-02-10 10:10:02.560 GMT

By Brian Parkin

Feb. 10 (Bloomberg) — German Finance Minister Wolfgang Schaeuble told lawmakers that options for helping Greece extended beyond loan guarantees, said an official who attended a briefing today at the Parliament in Berlin.

Officials were told that European Union rules on aid were more flexible than the government originally thought, according to the lawmaker who spoke on the condition of anonymity because the discussions were confidential.

Lawmakers were briefed on the legal aspects of an EU member state providing financial help for another and were told to digest the information quickly, the lawmaker said. The German parliament must back any move to help Greece, he said.


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