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Eurozone Sovereign Debt Crisis: The European Central Bank on Thursday
returned to the bond markets to buy Portuguese debt, after a recent period of
The ECB's move was in response to a jump in Portugal’s 10-year bond yield to a
record euro period high of 7.63%. The ECB had suspended its bond-buying
programme in mid-January.
Meanwhile, in the race to succeed Jean-Claude Trichet as ECB president when
his 8-year term expires next October, Angela Merkel, the German chancellor, is
today expected to urge the former frontrunner, Axel Weber, president of the
German Bundesbank, to make way for a new central bank chief, as the heads of
government of the 17 Eurozone countries, prepare to appoint a new head of the
Eurozone's central bank.
It was reported earlier this week that Weber did not wish to seek a second term
at the Bundesbank, a move that's seen as ruling himself out of contention for
the ECB job.
In an interview with the Italian newspaper, L’Espresso, Trichet said: "A
number of fiscal policies have to be improved very significantly because they
are contributing to the creation of financial instability. We are experiencing a
crisis of some sovereign signatures in the euro area, namely in Greece and
Ireland. On the question of leaving the euro, I do not comment on absurd
He said it is clear in the eyes of the ECB that sound and rigorous national
legislation could very significantly facilitate the implementation of the
reinforced Stability and Growth Pact. "We are calling for a reinforcement of
European legislation in this domain."
Senior bondholders of European banks should take
a haircut on their investments instead of struggling banks being supported by
taxpayer bailouts, Citigroup's chief economist, Willem Buiter, said Thursday.
"As soon as the end of this year, all the European zombie banks could be
restored to health or put out of business by making senior bondholders pay
instead of the taxpayer," Buiter said, adding that state support for failing
financial institutions should be removed as soon as possible.
Citigroup was provided with the world's biggest
public banking bailout, during the financial crisis.
The Dutchman who is a former professor of economics at the London School of
Economics, has argued that up to €2trn of liquidity support may be needed for
Eurozone banks, according to
"The real question is will Ireland go it alone, which would upset its
European partners and cause market contagion throughout the EU," he said on
Thursday at the European Financial Services Conference in Brussels.
FT Video: Greek default not an option, says
ECB - - A default by Greece on its debt is
not an option, says Lorenzo Bini Smaghi,
executive board member of the European
Central Bank. He tells FT Frankfurt
bureau chief, Ralph Atkins, that EU
politicians need to do more about the
Eurozone debt crisis
Folker Hellmeyer, chief analyst at Bremer Landesbank says he concurs with the view that the Eurozone package is sufficient to contain any future crises. He tells CNBC's Rebecca Meehan, Chloe Cho and Yousef Gamal el-Din he is optimistic about seeing a resolution to Europe's debt troubles:
Danish economist, Jacob Funk Kirkegaard, from the Peterson Institute for
International Economics, a Washington DC think-tank, said in
this week: "As continued strong real economic indicators lift prospects for
recovery in the EU, and important structural reforms continue to be implemented
in the pivotal peripheral country, Spain, it is no longer a question of the
euro’s survival. (No democratic member - - economically weak or strong - - will ever
leave the euro.) Nor is there any longer a question of whether EU leaders have
the will and capacity to take the necessary painful economic reform decisions
(Prime Minister José Luis Rodríguez Zapatero of Spain illustrates this best).
There is finally no longer really a question of whether the Eurozone periphery
will achieve debt sustainability. Instead the question is precisely how, and
crucially what the core Eurozone countries want in return for providing the
necessary assistance to the periphery."
Dealing with the crisis requires a fine balancing act, said Mario Monti, president of the University Bocconi and former EU Commissioner, to CNBC. Monti added that the crisis is also leading to progress in Europe:
Also this week, economists at the London office of US investment bank, Morgan
Stanley, published an analysis and a roadmap for investors on the debt crisis.
By the end of March, European policy-makers will present
broad-ranging reforms to contain the crisis. The MS economists say that
in mapping out the different policy options discussed among European
policy-makers, notably in the context of the reform of the European Financial
Stability Facility (EFSF), they present an analytical framework to help assess
the effectiveness of the measures that will eventually be announced.
The key distinction in this framework is between measures that only
provide additional liquidity and those that help to improve solvency directly.
The economists say the former can easily be implemented, because they
do not involve any immediate costs. The latter is more difficult to restore,
because it involves foregoing income or consumption immediately: either the
borrower through austerity measures, structural reforms or asset sales; or the
creditor by writing off part of the debt, lowering the interest charged or
extending the maturity.
As long as emergency liquidity is available from the EFSF or other
sources, countries will only default on their debt if they believe that it is in
their best interest. Restructuring is a particular concern for the
Eurozone because its member states are considered between an emerging market
government borrowing in foreign currency and a developed country with its own
national currency. Yet the cost of defaulting is considerably higher
for a Eurozone country than it is for an emerging market government.
At the same time, the benefits of defaulting are also considerably smaller.
While even remote prospects of some form of default are rather disconcerting
events for bond investors, markets systematically overprice such risks.
"We cannot rule out an involuntary debt restructuring in the euro area in the
coming years. But we believe that the risks are more than adequately priced
into government bond markets," MS says.
The restructuring hurdle in the
Eurozone is higher than many
investors appreciate. Calls for a default on the debt in the
Eurozone periphery tend to be based on a partial analysis, which just focuses
on debt sustainability, but does not look at the consequences of debt
restructuring across the whole capital structure to grasp the costs and benefits
that a rational government will take into account in its decisions.
The economists say the impact of a sovereign debt restructuring on the
sector remains uncertain. However, it is vital for investors to
consider the impact of such a debt restructuring, especially a compulsory one,
on the different layers of the bank capital structure. Together with
initiatives towards bank resolution legislation and the ESM (European Stability
Mechanism, which will take effect from 2013) making private
sector involvement compulsory in future debt restructuring, even senior
unsecured bank debt has become less safe an asset.
Key Investment Implications
1. Peripheral government bonds have experienced a deterioration of some of
their ‘institutional' and ‘behavioural' characteristics. Investors looking for
low risk, low return investments that usually characterize government bonds
could continue to exclude peripherals from their portfolios, as they no longer
exhibit such characteristics. Such peripheral government-issued bonds
will have to cheapen sufficiently to make them attractive within a broader
asset-allocation context (e.g., versus credit such as IG & HY corporate
bonds, equities, commodities, etc).
2. With country risk back as a main driver of investment decisions and
portfolio performance, MS thinks that Eurozone bond markets will
continue to exhibit wide spreads, differently sloped yield curves and varying
volatility. And, to the extent that portfolio managers' mandates get
changed to a greater extent towards AAA securities, this will further limit
peripherals' financing possibilities and potentially create difficulties in Eurozone financial markets.
3. Implementing an EMU (European
Monetary System) -- wide fiscal transfer mechanism that provides for
bailouts of countries in trouble by the economically stronger Eurozone members
would certainly help to solve the current sovereign crisis near term. However,
such a move to a ‘transfer union' creates the long-term risk of a
political backlash in the countries shouldering the bill, which might ultimately
even lead to EMU break-up. Clearly, leaving the euro would involve
serious political and economic costs for the seceding country (or group of
4. The combination of even a remote prospect of EMU break-up and the severe
sovereign debt crisis in the Eurozone have brought the country factor back with
a vengeance when it comes to portfolio performance - - both in equities and in
fixed income. In the MS view, country allocation decisions will remain
very relevant going forwards over and above sector allocation, duration
decisions and credit quality. In addition, any future rally in the
exchange rate will likely be capped by these uncertain but remote prospects of
European Central Bank president, Jean-Claude Trichet, on the health of the Eurozone: