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George Papandreou (back to camera), Greek prime minister, José Luis Rodríguez Zapatero, Spanish prime minister and Pedro Passos Coelho, the new prime minister of Portugal, at the EU summit, Brussels, June 23, 2011.
This is a commentary from
CheckRisk, a UK company
which provides pre-investment market risk analysis for to investors.
The most recent EU
“hope” has come from the possibility of a so-called voluntary reprofiling of
debt. It is not clear, however, that the ECB and EU have thought through the
consequences of voluntary reprofiling of sovereign debt for countries such as
Ireland and Greece. In fact there are many
unintended consequences to such a move which could be much more dangerous and
costly than accepting an outright default, according to CheckRisk, the research
and advisory service.
It is clear that
the ECB and EU are struggling with the possibility of a complete debt
collapse in Greece. So far the solution has been to pile more debt onto
Greece, but delaying the inevitable is not a long-term solution. The central
problem is that a solvency issue cannot be treated with liquidity solutions.
Only debt reduction can solve a bankruptcy problem, which means someone has
to take a loss. We have written at length on the transfer of risk from the
private sector to government, and the current move toward a soft solution in
Europe is symptomatic of a misunderstanding and naivety with regard to the
risk of such actions, warns CheckRisk founder Nick Bullman.
What the EU
and ECB would like to achieve, before August, is a restructuring that avoids
the terminology of default being attached to it. This, as far as the EU and
ECB is concerned, is a solution because it allows more time for Greece to
make far reaching austerity measures and for the economy to recover through
the stimulus of further loans. Whilst this is unrealistic, it is the
position that Europe wishes to take. Given that funds are already stretched
at the European Financial Stability Bond level, there are €450bn available
for bailouts but Greece might use at least €150bn of this fund and thus
leave it very underfunded for Portugal, Ireland and Spain which are lurching
toward the same fate.
member states have given to the EFSB (European Financial Stability Board) are also problematic. The ECB, is
therefore, understandably defending the castle wall with regard to the term
default. The ECB has unique access to the details of sovereign finances and
the trouble they are in, but more importantly the ECB is acutely aware of
the problems at individual bank level. Proof of this may be found in the
European Bank Authority (EBA) , which was set up by the ECB and EU to
conduct financial service company stress tests. The EBA is currently
conducting stress tests that will be published in July, notably the
possibility of a Greek sovereign default is excluded in the testing
standards. It is not surprising that two banks, Allied Irish Bank and Bank
of Ireland have both needed additional funding despite passing the last
round of EBA stress tests a year ago, when such loose tests are applied.
The EU and ECB
are under the utopian delusion that because an investor accepts a voluntary
change that no default has occurred. But we believe this is fundamentally a
poor and incorrect interpretation that has massive risk consequences for the
credit default swap market (insurance) for bonds.
from the semantics it is very clear that Greece is bankrupt and that no
matter what austerity measures are introduced the burden of debt is just too
great. The Greeks are being asked to endure greater pain, not because it
will lead to a solution, but more because they must suffer to protect the
core banking system of Europe. France and Germany are likely to extract the
same sacrifice from Ireland and is here that geopolitics will clash with
It is unlikely
that the average Greek will be up to the challenge. This week’s
parliamentary vote of confidence in Greece is not really relevant. The vote
to watch is the passing of austerity measures and then the implementation of
them. It is also unlikely that the Irish will relish such a role. The denial
of creative destruction, by the EU, the ECB and government intervention has
cut capitalism dead in its tracks. The inability to allow debt to be
written down by accepting that losses must be incurred is putting the
existence of the euro on the line and is a massive bet which is, for those
that understand risk, not worth taking when compared with the cost of
letting Greece go.
Greek Euro Exit Not the Answer: Economist: "The fact of the matter is that some historical processes are irreversible; the euro, like it or not, is one of those," Barry Eichengreen, professor of economics and political science at the University of California, Berkeley told CNBC Thursday. "Greece is going to have to figure out other ways, with the help of Europe, of restoring its competitiveness," he added:
other unintended consequences to present EU policy actions. The insurance
industry, particularly the US insurance industry, owns massive liabilities
in the bond insurance market. Credit default swaps insure against the
default of the debtor to the benefit of the creditor or lender. European
banks, when they invested in Eurozone debt will have in many cases insured
against default by buying credit default swaps (CDS) for this insurance to
be triggered a default event must occur. The ECB are determined to avoid
default at any cost for this reason. It would force a payout of CDS
insurance and a write down of outstanding debt. Again this kind of market
manipulation has consequences. If a bank, for example, loses money in a bond
but cannot trigger the CDS insurance, then their position is unprotected.
Unhedged is the proper terminology. The only choice in such a circumstance
is to sell the bonds, which would cause interest rates to spike higher for
the weaker nations. The alternative is to allow the market to work and
insurance protection to be called on, the EU are hesitating because of fear
of contagion. But ultimately until the debt is written down, bond market
funding access for Ireland and others will remain closed as the risk of
investment with no insurance is simply too high.
The loss of
sovereignty that the austerity measures imply will be hard to accept by the
Greeks and southern Europeans. The Irish too will not easily trade their
economic freedom for a greater European ideal; Ireland is not Greece; but
debt does not distinguish between nationalities. Ireland is more likely to
come out of the crisis in better shape to handle the future, but at what
expense in the present? The concept of perpetual economic bondage is not
easily discussed but is becoming a reality under the current construct. It
is easier to understand why this pressure is being exerted when one
considers the exposure of the German, French and British banks to the debt
of Greece, Ireland, Portugal and Spain.
solutions, the most likely, perhaps inevitable, outcome is that France,
Germany and the stronger northern European countries break away and form a
northern block euro. The weaker southern countries, including Ireland would,
with the sponsorship of the northern block revert to their own currencies in
the form of a euro punt, euro drachma, and so on. These currencies would be
pegged to the northern block euro, but with very wide convergence zones
allowing them initially to devalue and eventually, when their fiscal houses
are in order, to rejoin. This appears a radical solution but in reality is
the cleanest way to stimulate growth. Without such a radical step the euro
is doomed. The debt burden is simply too large and will be exposed by the
market on a continuous basis. The choices are of a two-decade, maybe longer,
Japan style economic stagnation, or a realization of the reality now.
to brace itself against the coming storm. The key is to renegotiate the
bailout terms and include debt forgiveness in the package. The Irish need to
decide early what their fate will be, the current Irish Government has
performed reasonably well in its first 100 days – however the mountain that
has to be climbed to recovery is steep. Clarity of purpose, clarity in
negotiations with EU partners, an export driven recovery and an
entrepreneurial spirit are the elements that just may differentiate Ireland
from the other struggling Eurozone economies.