Today's quote: "If there is no deal on Friday, there will be no second chance." French President Nicholas Sarkozy
1--Italy; where the road ends in this crisis, pragmatic capitalism
Excerpt: It’s still uncertain if this week’s summit will finally resolve the Eurozone sovereign debt crisis, but early reports certainly leave some doubts. If it should turn out that EMU leaders are not ready to fire a bazooka then the first quarter of next year will almost certainly fore the issue.
As Credit Agricole recently noted (see the chart below), the debt issuance calendar in early 2012 is heavy. But it’s particularly heavy for Italy. As we all know by now, Italy is where the road ends in this crisis. If Italy defaults the EMU as we know it will never be the same. In 2012 Italy has total debt redemptions of almost $300B. In the first 4 months of the year Italy has redemptions of $115B. This is going to kick the EMU crisis into overdrive early next year. If we don’t hear a sustainable and permanent fix later this week then prepare yourselves for early next year. This crisis is almost certain to reach a new crisis peak as EMU debt redemptions force the issue.
2--Soros: World Financial System on Brink of Collapse, WSJ
Excerpt: The world financial system not only isn’t functioning, it’s on the brink of collapse, according to investor George Soros....
The current global financial system is in a “self-reinforcing process of disintegration,” Mr. Soros warned, and “the consequences could be quite disastrous. You have to do what you can to stop it developing in that direction.”
While the economic and fiscal woes of the developed world remain critical, Mr. Soros said his recent travels gave him a sense of optimism about Africa and the Arab world.
“A lot of positive things are happening,” he said. “I see Africa together with the Arab Spring as areas of progress. The Arab Spring was a revolutionary development.”
However, he noted, Hungary’s 1956 revolution changed the political atmosphere but didn’t bear fruit until 1989.
“You can’t expect immediate success but what is happening will have a lasting impact,” he said.
3--ECB cuts rates as France, Germany press for EU deal, Reuters
Excerpt: The European Central Bank acted to soften a looming recession and avert a credit crunch in the debt-plagued euro zone by cutting interest rates on Thursday as European Union leaders prepared for a crucial summit.
The ECB cut its main rate by a quarter-point to a record low 1.0 percent as anxiety over the worsening sovereign debt crisis drowned out concern about above-target inflation.
ECB President Mario Draghi was expected to announce further action to support teetering banks with longer term credit at a news conference at 1330 GMT. He has signaled the central bank may act more decisively if an EU summit on Friday agrees to move towards fiscal union in the euro area.
European Commission Jose Manuel Barroso appealed to European leaders holding their eighth crisis summit of the year to put aside sharp differences to support their common currency.
"The summit that we are going to tonight in Brussels is indeed a crucial one," Barroso said at a meeting of European conservative party leaders in the French port city of Marseille, using words reminiscent of late U.S. President John F. Kennedy.
4--Draghi Presents ECB Plan to Avert Credit Crunch, Bloomberg
Excerpt: European Central Bank President Mario Draghi coupled an interest rate cut with a pledge to offer banks unlimited cash for three years as officials try to head off a looming recession and leaders meet in Brussels to hammer out a solution to the debt crisis.
The Frankfurt-based ECB cut its benchmark rate by a quarter percentage point to 1 percent, matching a record low. It introduced new three-year loans for banks and loosened the collateral criteria it imposes when lending by making credit claims such as bank loans eligible and reducing the rating threshold on asset-backed securities.
The measures “should ensure enhanced access of the banking sector to liquidity,” Draghi told reporters in Frankfurt today after chairing a meeting of the ECB’s Governing Council.
The decisions highlight how the central bank is focused on reviving bank lending rather than increasing its government bond purchases to defeat the sovereign debt crisis. Europe’s leaders begin talks in Brussels today to craft another solution for the turmoil, a week after Draghi pushed them to deliver a “fiscal compact” he hinted the ECB may be willing to help support in financial markets.
The ECB also cut banks’ reserve ratios to 1 percent from 2 percent and will stop fine tuning operations at the end of each reserve maintenance period, Draghi said. The 36-month loans will be conducted as a fixed rate with full allotment, Draghi said.
European Union chiefs will meet for dinner at 7.30 p.m. to devise a fifth “comprehensive” solution in 19 months for a crisis which has left Germany and France, the euro’s lynchpins, facing the threat of losing their AAA rating from Standard & Poor’s....
Lender of Last Resort
Euro-area governments have to repay more than 1.1 trillion euros ($1.5 trillion) of long- and short-term debt in 2012, with about 519 billion euros of Italian, French and German debt maturing in the first half alone, data compiled by Bloomberg show.
Weidmann, 43, has said the ECB can’t become a lender of last resort for euro-area governments because that would exceed its mandate and erode its independence. He has backing from German Chancellor Angela Merkel, who fought off French entreaties for the ECB to do more.
5--The Price of a Haircut, by Steve Landsburg, economist's view
Excerpt: Yesterday I had the pleasure of attending a very good talk by Yale’s Gary Gorton on the origins of the financial crisis.
Gorton’s story is that this was a bank run, not substantially different from the bank runs that have always plagued capitalist economies. In this case, the run took place in the repo market, which is an unregulated (and largely unmonitored)... The repo market serves large institutions (e.g. Fidelity Investments or state governments) with a lot of cash on hand that they want to stash in an interest-bearing account for a day or two. So Fidelity deposits, say, a half-billion dollars at, say, Bear Stearns, just as you might deposit five hundred dollars at your local bank. One difference, though, is that your account at your local bank is insured, whereas Fidelity’s account at Bear Stearns is not — so Fidelity, unlike you, demands collateral for its deposit. Bear Stearns complies by handing over a half-billion dollars worth of bonds, of which Fidelity takes physical possession. The next morning, Fidelity withdraws its money and returns the bonds.
The problem comes in when rumors begin to spread that some bonds might be riskier than they appear, and Fidelity starts to worry that maybe Bear Stearns is picking particularly risky bonds to hand over. Therefore Fidelity demands more than a half-billion in bonds to guarantee its half-billion dollar deposit. If there’s, say, a 10% discrepancy between the deposit and the collateral, we say that Bear Stearns has taken a half-billion dollar haircut.
Because Bear Stearns has a fixed quantity of bonds on hand, and because all of its depositors are demanding haircuts, Bear Stearns can now accept fewer deposits than before. This means that Bear Stearns has less cash on hand. This makes depositors even more worried about the security of their deposits, which means they demand larger haircuts. The effects snowball until Bear Stearns collapses. ...
So what should we do about all this? Gorton, along with his colleague Andrew Metrick, argues that the repo market, like any banking market, is inherently susceptible to runs and therefore ought to be regulated. In this case, the regulations should focus on insuring the availability of sufficient high-quality collateral to keep depositors calm. Gorton observes that the existing policy responses to the crisis (e.g. the Dodd-Frank bill) do pretty much nothing to address this fundamental need. The Gordon/Metrick paper contains some specific proposals, which unfortunately Gorton never got to in yesterday’s talk. ...
6--Draghi Pushes to Unfreeze Credit as Bond-Buy Talk Damped, Bloomberg
Excerpt: European Central Bank President Mario Draghi cut interest rates and offered banks unlimited cash for three years while steering clear of any signal the ECB will buy more bonds to stem the region’s debt crisis.
The Frankfurt-based ECB today reduced its benchmark rate by a quarter percentage point to 1 percent, matching a record low. It pledged for the first time to offer banks unlimited cash for three years and loosened the collateral rules it imposes when lending to financial institutions.
The measures “should ensure enhanced access of the banking sector to liquidity,” Draghi told reporters in Frankfurt today after chairing a meeting of the ECB’s Governing Council.
Hours before European leaders meet in Brussels, Draghi kept the onus on them to solve the two-year debt crisis by repeating his call for a “fiscal compact” and denying he had hinted the ECB would automatically support such an initiative with more bond purchases.
Draghi’s comments roiled markets, with stocks and the euro rising on the bank-lending measures before falling after he damped speculation that more bond purchases are imminent. The euro sank more than 1 percent and traded at $1.3336 at 3:41 p.m. in Frankfurt.
“All euro-area governments urgently need to do their utmost” to deliver fiscal sustainability, he said. Draghi, who said on Dec. 1 that “other elements” could follow a push toward a fiscal union, said he was “kind of surprised” that the remarks were viewed as a suggestion the ECB would intensify bond purchases....
Speaking at the same time in the French port of Marseille, German Chancellor Angela Merkel played down investor hopes by saying there will be no “big-bang” solution for Europe’s woes at the summit, which starts at 7:30 p.m. in Brussels. The meeting will be “one stop” along the way to ending them, she said.
With the ECB’s focus on jolting banks into lending, Draghi made it easier for them to borrow cash from the central bank. Credit claims such as bank loans will become eligible as collateral and he also reduced the rating threshold on asset- backed securities.
7--ECB cool on more bond buying, lending to IMF, Reuters
Excerpt: The European Central Bank doused on Thursday hopes it will aggressively ramp up its bond-buying program and allow the euro zone to lend money to IMF so it can help fight the euro zone debt crisis.
ECB President Mario Draghi said new forecasts from the central bank showed the currency bloc's GDP could contract by as much as 0.4 percent next year although it could also grow by as much as 1.0 percent.
But he played down expectations the central bank would dramatically increase its debt crisis-fighting measures and revealed the vote to cut rates was not unanimous.
"The outlook remains subject to high uncertainty and substantial downside risks," Draghi told a news conference after the ECB cut interest rates back to a record low of 1 percent.
The move came hours before a high-stakes EU summit which will aim to agree on a plan to defuse the crisis, with France and Germany pushing for rule changes to stricter budget discipline in the bloc.
The ECB, which euro zone officials say has been closely involved in drafting plans for tighter fiscal integration in the bloc, has pressed governments to toughen their budget rules.
Draghi said last week further actions could follow if European leaders agreed on tighter budget controls.
ECB watchers took that to mean the central bank would step up its purchases of the bonds of struggling euro zone members but he firmly played down that interpretation.
"I was surprised by the implicit meaning that was given (to my comments last week)," he said.
"A new fiscal compact, comprising a fundamental restatement of the fiscal rules together with the fiscal commitments that euro area governments have made, is the most important precondition for restoring the normal functioning of financial markets."....
With euro zone leaders desperate to build a firewall around their debt-ridden members, another idea that has been floated is for euro zone central banks to lend to the International Monetary Fund so it could take a more prominent role.
"It's legally complex. The spirit of the treaty is that one cannot channel money in a way to circumvent the treaty provisions," Draghi said. "If the IMF were to use this money exclusively to buy bonds in the euro area, we think it's not compatible with the treaty."....
Pressure is getting ever more intense on the central bank to avert a euro zone meltdown.
A senior euro zone source said hours before the start of the EU summit that a proposal to give the euro zone's permanent bailout fund, the European Stability Mechanism, a banking license -- which could allow it to access ECB funds, boosting its firepower -- had been rejected.
The ECB had been uncomfortable about the idea but the jettisoning of another proposal that could have put a firewall around euro zone debt strugglers puts it ever more firmly in the spotlight to act directly.
8--'A Strong Signal Is All that Can Be Expected', Der Speigel
Excerpt: "The euro won't survive if Germany continues to have export surpluses and the southern Europeans continue to accrue gigantic trade deficits because they purchase more from other countries than they can afford."
"Both camps will have to change their policies, including Germany. Of course the southern Europeans need to modernize their economic models, cutting monopolies down to size and paying closer attention to wage costs while at the same time investing in export companies. At the same time, Germany needs to consider what its economic model for a functioning currency union would look like. The answer isn't simple because Germany isn't just competing with its own euro partners, but also with booming Asian states."
"The Germans should increase wages to a greater degree than in recent years in order to aid the rest of the euro zone. … If Germans were also more courageous, they would also establish more service companies, which have been hindered by bureaucracy. Doing so would reduce the country's fixation on exports to drive the economy. Such ideas might sound strange and provocative at the moment, but it is important that Germany begins a rethink and develop proposals. Because if Germany simply continues to celebrate itself as the world's export champion, the currency union will be crushed by its very weight."
9--Blame the ECB, CEPR
Excerpt: The circumstances under which the financial markets brought about a run first on the debt of Greece, Ireland and Portugal, and more recently on the debt of Italy and Spain were created by the policies pursued by the European Central Bank (ECB) and Mario Draghi and his predecessor Jean Claude Trichet.
The ECB has run a policy that is focused on containing inflation and forcing governments to reduce their deficits. It could have instead run a policy that placed its primary emphasis on promoting growth. It also could have played the role of lender of last resort. It was a quite deliberate policy decision by the ECB to impose a fiscal straightjacket on the heavily indebted countries of Europe. (Its policies have made this debt burden much worse.)
It is understandable that Draghi and the ECB would like to pretend that the problems facing Greece, Italy and other countries in the euro zone are simply the result of the market imposing its discipline. However, this is not true. They are responsible for the difficulties facing these countries.
10--Citi: Euro Breakup Would Result in Years of Global Depression, WSJ
Excerpt: A break-up of the Euro Area would be rather like the movie ‘War of the Roses’ version of a divorce: disruptive, destructive and without any winners. A break-up of the 17-member state Euro Area, even a partial one involving the exit of one or more fiscally and competitively weak countries, would be chaotic. A full or comprehensive break-up, with the Euro Area splintering into a Greater DM zone and around 10 national currencies would create financial and economic pandemonium. It would not be a planned, orderly, gradual unwinding of existing political, economic and legal commitments and obligations.
It took seven years of careful preparation and planning to launch the then 11-nation Euro Area in 1999. Exchange rates of the 11 candidate national currencies converged smoothly to the irrevocable euro conversion rates agreed among the member states well in advance. Even the fiscally weak and uncompetitive Euro Area candidates had, under pressure to meet the Maastricht criteria for euro area membership, engaged in years of fiscal austerity, inflation convergence and domestic cost control prior to entry. Although we now know that there was extensive fiddling of the national data used to verify fiscal compliance with the Euro Area membership criteria, even the most egregious corner-cutters made serious efforts to comply. The creation of the euro was not accompanied by sharp and unexpected last-minute currency revaluations.
In contrast, exit, partial or full, would likely be precipitated by disorderly sovereign defaults in the fiscally weak and uncompetitive member states, whose currencies would weaken dramatically and whose banks would fail. If Spain and Italy were to exit, there would be a collapse of systemically important financial institutions throughout the European Union and North America and years of global depression. Even if the likelihood of an eventual exit or break-up were to be assessed accurately by the markets – something for which there is preciously little evidence – the timing of any exit or break-up is bound to come as an unexpected and deeply disruptive event....
A disorderly sovereign default and EA exit by Greece alone is manageable. Greece accounts for only 2.2 percent of EA GDP and 4 percent of EA public debt. However, a disorderly sovereign default and EA exit by Italy would bring down much of the European banking sector. Disorderly sovereign defaults and EA exits by all five periphery states – an event to which I attach a probability of no more than 5 percent, would drag down not just the European banking system, but the north Atlantic financial system and the internationally exposed parts of the rest of the global banking system as well. The resulting global financial crisis would trigger a global depression that would last for years, with GDP falling by more than 10 percent and unemployment in the West reaching 20 percent or more. Emerging markets would be dragged down too.