Sovereign debt bubble thread

[Admiral Yi]

Suggesting that the central government is cooking the fiscal books is a pretty serious allegation.

[Sheilbh]

Suggesting that the central government is cooking the fiscal books is a pretty serious allegation.

My understanding is the system's not terribly transparent. I think the Catalan government's currently suing the central government for nearly €1billion, or 0.5%, which they claim's been wrongfully kept. But the Spanish legal system's quite slow.

Edit: And the allegations aren't from a fringe, they were made by the Catalan Economy Minister, not just some pressure group. But as I say both sides are highly politicised.

[Admiral Yi]

With the kind of provincial deficit I've been reading about, a billion euros is not going to make much difference.

[Sheilbh]

It would make a difference to Catalonia, but I don't think anyone's arguing it would be huge.

[Sheilbh]

On Catalonia:

Madrid and Catalonia clash over independence referendum

MADRID | Thu Sep 27, 2012 2:50pm EDT
(Reuters) - The parliament of Spain's powerful but heavily indebted region of Catalonia voted in favor of holding a referendum on independence on Thursday, in defiance of Madrid which said it would stop any such move towards secession.

The vote in Catalonia, responsible for a fifth of the country's economic output, was backed by 84 parliament members including those of ruling party CiU, while 25 abstained, and 21 voted against holding a referendum.

The vote was held minutes after Deputy Prime Minister Soraya Saenz de Santamaria told reporters the national government was prepared to prevent any referendum.

Catalonia brought forward regional elections to November 25 after regional leader Artur Mas' proposal to create a separate Catalan tax agency was flatly rejected by Prime Minister Mariano Rajoy, who said it went against Spain's Constitution. Mas then said he would seek a referendum on an independent Catalonia.

Mas's conservative CiU party would likely win an absolute majority in elections, polls show, strengthening the push towards independence and delivering a blow to Rajoy who has called for national unity to counter the country's economic crisis.

Independence fervour has been growing in Catalonia during the deep recession.More than half of Catalans say they want a separate state.

Catalonia's regional government says it pays 16 billion euros more to the Spanish state than it receives in transfers.

(Reporting by Julien Toyer and Fiona Ortiz; Writing by Nigel Davies; Editing by Paul Day and Jason Webb)

[Neil]

Tough choice for Brussels.  On the one hand, destroying the nation-states is an essential part of creating their superstate.  On the other hand, balkanized areas are rarely sane, stable or good for business.

[Sheilbh]

Incidentally the Germans, Dutch and Finns look like they're backing out of the European Council agreement on banking.  From the Guardian:

Spanish hopes threatened by 'shocking' statement
The European Stability Mechanism row damages the notion that the eurozone countries are capable of acting quickly
Nils Pratley
The Guardian, Wednesday 26 September 2012 20.35 BST

The plan to recapitalise banks was meant to be the easy part of the latest scheme to save the euro. Didn't everybody agree that breaking the link between weak sovereigns and weak banks was a vital and urgent step? Wasn't the central European Stability Mechanism (ESM) deemed the perfect vehicle to strengthen the balance sheets of teetering banks and thus offer a helping hand to the governments of the likes of Spain and Ireland?

Yes and yes. But now comes a powerful "no" in the form of a joint statement from the German, Dutch and Finnish finance ministries. The critical paragraph began with the words "regarding longer-term issues", a giveaway that a classic piece of foot-dragging was on the way.

The ESM, declared the trio, can only go to work on bank recapitalisations "once the single [bank] supervisory mechanism is established and its effectiveness has been determined". That latter could take years. Further, "legacy assets" should remain the responsibility of national governments. So are saying there should be no central hand-outs to cover past government-funded bailouts of banks.

The statement is a shocker. Even if there had not been riots in euroland yesterday, stock markets would have slumped on the news and bond yields in the periphery would have soared. If the will of the trio of northern objectors prevails, the €60bn (£47.8bn) needed to save the Spanish banking system will go directly on the Spanish government's books, thereby making the arithmetic of the inevitable bailout of Madrid bigger and uglier. And poor old Ireland – the one country that the austerity disciplinarians could promote as a story of recovery – would get a slap in the face.

More fundamentally, the row over the role of the ESM damages the already-fragile notion that the eurozone countries are capable of acting quickly. Germany and the others seem guilty of sharp practice here – they are attempting to re-write an agreement whose general meaning had seemed clear. The time to argue these points was when use of the ESM was being debated by all.

But, if that's the true picture of the state of eurozone relations, you can't blame investors for wondering what other agreements could be challenged in future. It is a terrible climate in which to negotiate the conditions of the Spanish bailout. The backdrop to those delicate talks will now be poisonous.

The Economist:

The other moral hazard
If the euro zone is to survive, Germany too must keep its promises to reform
Sep 29th 2012 | from the print edition


STITCH by stitch, Germany is unravelling the carefully knitted deal that offered the euro zone the best chance yet of overcoming its crisis. Until this week European officials dared to imagine they had got ahead of the markets with two big moves. First, the ECB declared that it will act as a lender of last resort for troubled countries like Spain (if they agree to a reform programme). And second, the euro zone pledged to create a banking union to sever the death loop between weak banks and weak sovereigns. Now that the ECB had averted the threat of the euro breaking up, others have space and time to repair its design flaws.

If only it were so easy. Protests and strikes against austerity have restarted in debtor states, and secessionism is stirring in Spain. Just as worrying, creditor states are showing every sign of going slow, and even reneging, on their promises to strengthen the euro zone. Rückfall, the German word for backsliding, is one reason the euro zone is being pushed back into an acute phase of the crisis.

Start with the conditional promise of intervention by the ECB's president, Mario Draghi. This is designed to hold down a country's borrowing costs, especially for short-dated bonds, and dispel "unfounded fears" about the future of the euro.
In his campaign to delegitimise the policy, Jens Weidmann, the Bundesbank chief, has resorted to drawing a parallel between Mr Draghi and Mephisto in Goethe's "Faust". The German government, though in favour of the ECB's scheme, is uncomfortable. It has told Spain not to ask for more help—the essential first step that would allow the ECB to act.

Worse, the Rückfall over banking union seems almost designed to rekindle the crisis. At a summit in June euro-zone leaders declared that it was "imperative to break the vicious circle between banks and sovereigns". To do so, they would create a single banking supervisor "as a matter of urgency". And once established, euro-zone rescue funds could be used directly to recapitalise troubled banks. It is no secret that the plan was meant to help Spain, by shifting some of the burden of supporting crippled banks to the euro zone—retroactively if necessary. Ireland was told it could expect similar assistance.

This bargain was done on terms that Germany has always advocated: more central control in exchange for more solidarity. But even before the European Commission this month rushed out its proposals for a banking supervisor (an offshoot of the ECB), Germany was undermining the deal. Drafts of the commission's plan included a commitment to complement the new supervisor with a euro-zone resolution authority to wind up failed banks (known as Edira), and a European bank-deposit guarantee scheme (aka, Edgar). Under German pressure, these were removed from the final version.

Many worry that, with the abortion of Edira and Edgar, the ECB will be responsible for overseeing banks but lack the means to deal with the bad ones. At the same time, Germany is fighting the commission's plan for the ECB to have authority to supervise all 6,000-plus banks in the euro zone. Berlin wants to exclude smaller banks, including its own often-troubled regional lenders.

And Germany has tried to slow down the timetable for the supervisor to start work on January 1st 2013, on the grounds that such an important task should not be rushed. Thereafter, direct bank recapitalisation should only take place once the system has shown itself to be effective. This week, Wolfgang Schäuble, the German finance minister, and his über-hawkish colleagues from the Netherlands and Finland, sought greatly to limit the scope of the commitment: direct bank recapitalisation should apply only to new problems, not "legacy assets" and should only be a "last resort", after using private capital and then national funds.

Germany knows it has to look after its own banks, so it wants to limit its liability for those of other countries. Angela Merkel, the German chancellor, has already staked much treasure on helping others. At some point, Germany may have to write off part of the loans it made to Greece. Mrs Merkel already lost her "chancellor's majority" in this summer's vote to lend Spain up to €100 billion ($129 billion) to restructure its banks. She is not rushing back to the Bundestag to ask for more money, not least because any debate would turn to the ECB and Mephisto.

Economics and morality

Mario Monti, Italy's prime minister, quips that, for Germany, "economics is a branch of moral philosophy". Countries must pay for sins of commission (budget deficits) and omission (poor bank supervision). Only then can there perhaps be more European integration to avert problems in the future.

Yet there is little point in worrying about tomorrow's woes when today's crisis is unresolved. Germany is right to fret that relieving market pressure on debtors could create moral hazard and slow down badly needed reforms. Equally, though, moral hazard applies to creditors. When the pressure is off, Germany shows too little urgency about repairing the euro.

There is a cost to delay and prevarication. It is harder for countries to reform without hope that their agony will end. Germany's unwillingness to act except in the most dire moments condemns the euro zone to one acute crisis after another. In the short term Mrs Merkel may thus find herself fighting for re-election next year with the euro zone back in flames. In the longer term a chronic crisis is already creating permanent damage: prolonged economic stagnation and depression in deficit countries, loss of confidence in the credibility of governments and the future of the euro, and increasingly poisonous politics. Germany may fear the "legacy" costs of past mistakes. But it should also worry about the legacy of its hesitation and inaction.

And the doom-laden Telegraph comment page:

Europe's betrayal of Spain
By Ambrose Evans-Pritchard Economics Last updated: September 27th, 2012

We discover – yet again, you might say – that Germany, Holland, and Finland will not stand behind their solemn pledge of solidarity when push comes to shove.

Spain's premier Mariano Rajoy has been betrayed. Nobody should be entirely surprised if he and the Spanish arch-nationalists in his circle offer a condign riposte, and bring down the entire temple on the heads of the creditor powers.

He bit the bullet and agreed to the highly intrusive terms of a €100bn eurozone rescue for the Spanish banking system on a specific understanding: that the ESM bail-out fund would ultimately take over the burden by recapitalising Spain's banks directly.

This deal has been breached. Can we believe anything that the Chancellor of Germany, the prime minister of Holland, and the prime minister of Finland say from now on? The EMU rescue edifice is built on sand.

You might say Mr Rajoy had no choice. But he did. There were those whispering in his ear that Spain should instead retake control over its own monetary, exchange, and sovereign policy levers, and break out of its debt-deflation trap.

Such a course might or might not be disastrous for Spain, depending on your analysis of EMU's structural flaws, but it would certainly be disastrous for German and Dutch banks. (Given that it would cause the collapse of monetary union in the worst possible way).

The Spanish bubble was after all a joint venture. Spain was flooded with cheap capital from Germany and Holland that it could not prevent or control under the EMU system. Did the German and Dutch regulators recognise the danger, or try to stop the excesses? Not really. They were complicit.

The ECB's uber-loose money (to help Germany when it was in slump) led to negative real interest rates for Spain – minus 2pc for years – that fuelled a massive credit boom. Policy was far too lax for a fast-growing Tiger economy.

Did the Spanish make big mistakes? Of course. But the ECB and the European Commission did not make that critique at the relevant moment. They too were smoking weed.

Be that as it may, Mr Rajoy now learns that the AAA trio will not permit direct recapitalisation of the Spain's "legacy" banks by the ESM, even after the new European bank regulator is up and running.

The burden will fall entirely on Spain, or so it seems. Spain must raise €60bn in fresh debt on the capital markets to plug the hole, or nearer €150bn if City sceptics are right.

The accord signed by EMU leaders in June is crystal clear, as the European Commission remind the Northern powers yesterday. The purpose was to break the "vicious circle" between banks and sovereign states.

EURO AREA SUMMIT STATEMENT
- 29 June 2012 -
• We affirm that it is imperative to break the vicious circle between banks and sovereigns. The Commission will present Proposals on the basis of Article 127(6) for a single supervisory mechanism shortly. We ask the Council to consider these Proposals as a matter of urgency by the end of 2012. When an effective single supervisory mechanism is established, involving the ECB, for banks in the euro area the ESM could, following a regular decision, have the possibility to recapitalize banks directly. This would rely on appropriate conditionality, including compliance with state aid rules, which should be institution specific, sector-specific or economy-wide and would be formalised in a Memorandum of Understanding. The Eurogroup will examine the situation of the Irish financial sector with the view of further improving the sustainability of the well-performing adjustment programme. Similar cases will be treated equally.
• We urge the rapid conclusion of the Memorandum of Understanding attached to the financial support to Spain for recapitalisation of its banking sector. We reaffirm that the financial assistance will be provided by the EFSF until the ESM becomes available, and that it will then be transferred to the ESM, without gaining seniority status.

The Germans, Dutch and Finns (in particular) say they were bounced into this deal. It would not surprise if they were outmanoeuvred by Italy's Mario Monti, and if too-clever-by-half Council officials tweaked the language at the last minute. But this was the accord.

It was a key foundation of the global market rally of the last two months. The Nordics have now ripped it up. Investors in Asia and the Middle East might justifiably conclude that the Chancellor of Germany is blowing smoke in their eyes, that Germany will not in fact "save the euro". Eurozone rhetoric is a sham.

So we are back to crisis.

I have no idea what Spain will do, but emotions are running high and the country – in the words of Confidencial this morning – risks "disintegrating". We watch and wait to see whether the Basque revolt or the Catalan revolt will detonate first, and whether the Spanish will really use "all means" to hold the union together.

The newspapers ABC and La Razon both called on the government to deploy " the arms of the state" to stop Catalonia holding an independence referendum.

It is as if the Daily Telegraph were to call for coercion to stop Scottish independence. Imagine the response in Scotland.
Mr Rajoy's authority is collapsing. Some 84pc of Spaniards have lost confidence in his leadership. The current course is becoming hopeless.

Today he will announce a fresh round of austerity measures to meet EU targets that cannot be met, adhering to reactionary strategy of "internal devaluation" imposed by Germany that is destroying his country.

And now he has just been betrayed by the German bloc anyway. Es el colmo. If he were to request full sovereign rescue, he would most likely be shafted again. Who can blame him for dragging his feet?

The temptation to tell the Germans and Dutch to go to Hell – and to pull the pin on their banking systems – must be growing mightily. Desperate men do desperate things.

[MadImmortalMan]

You're supposed to be waiting until after the election you bastards.

[Iormlund]

Maybe we should hold an auction to decide the timing of the rescue. Who would pay more, the Dems or the GOP? 

[alfred russel]

Maybe we should hold an auction to decide the timing of the rescue. Who would pay more, the Dems or the GOP? 

The GOP would probably pay a lot of money--but only for Europe to collapse into anarchy asap and before the election. So I don't know if their bids would be credible.

[Zanza]

That was always how it was presented by Merkel, so I don't see any change in German policy.

We affirm that it is imperative to break the vicious circle between banks and sovereigns. The Commission will present Proposals on the basis of Article 127(6) for a single supervisory mechanism shortly. We ask the Council to consider these Proposals as a matter of urgency by the end of 2012. When an effective single supervisory mechanism is established, involving the ECB, for banks in the euro area the ESM could, following a regular decision, have the possibility to recapitalize banks directly. This would rely on appropriate conditionality, including compliance with state aid rules, which should be institution specific, sector-specific or economy-wide and would be formalised in a Memorandum of Understanding.

To suggest that's some kind of decision is laughable. It clearly states that the decision will be made later and is at best some kind of expression of intent. It's not making any committments, so there is nothing the Dutch, Finnish and German prime ministers can even go back on. They are just detailling what their policy proposals are regarding this.

[Zanza]

You're supposed to be waiting until after the election you bastards.

The next relevant election is only in September 2013. 

[Admiral Yi]

That was always how it was presented by Merkel, so I don't see any change in German policy.

I'm usually the first to leap to the creditor nations' defense, but in this case what I think is worrying is the language in one of Shelf's articles about setting up the bank supervision and "making sure that it's doing the job well" before authorizing joint recapitalizations.  That's a formula for inaction.

On the creditor side, of course winding up failed banks should be the sole responsibility of the host country.  Winding up a failed bank involves money out of pocket, not the provision of liqudity.

[Zanza]

I'm usually the first to leap to the creditor nations' defense, but in this case what I think is worrying is the language in one of Shelf's articles about setting up the bank supervision and "making sure that it's doing the job well" before authorizing joint recapitalizations.  That's a formula for inaction.

As I said, not a change in German policy. 

[Sheilbh]

That was always how it was presented by Merkel, so I don't see any change in German policy.

I disagree.
June -

We affirm that it is imperative to break the vicious circle between banks and sovereigns.

September -

direct bank recapitalisation by the ESM should take place based on an approach that adheres to the basic order of first using private capital, then national public capital and only as a last resort the ESM.

June -

The Commission will present Proposals on the basis of Article 127(6) for a single supervisory mechanism shortly. We ask the Council to consider these Proposals as a matter of urgency by the end of 2012.

September -

We agreed that it is important to achieve rapid progress on this issue, but it cannot happen at a cost of the quality of the new supervision.

June -

We affirm our strong commitment to do what is necessary to ensure the financial stability of the euro area, in particular by using the existing EFSF/ESM instruments in a flexible and efficient manner in order to stabilise markets for Member States respecting their Country Specific Recommendations and their other commitments including their respective timelines, under the European Semester, the Stability and Growth Pact and the Macroeconomic Imbalances Procedure

September -

the recapitalisation should always occur using estimated real economic values

June -

The Eurogroup will examine the situation of the Irish financial sector with the view of further improving the sustainability of the well-performing adjustment programme. Similar cases will be treated equally.

September -

the ESM can take direct responsibility of problems that occur under the new supervision, but legacy assets should be under the responsibility of national authorities

In each of those cases there's backsliding at best and contradiction at worst.  The condition that there be a banking supervisor in place before the ESM could directly recapitalise was pushed for by Germany, who are now objecting most strongly to the Commission's proposals and wanting it weakened (according to reports in the FT).  I think the way this has been reported in the Anglo-Saxon (and Irish press) and elsewhere I believe suggests that if this has been the position, it's certainly not been clear over the summer. 

Here's some briefing from the Commission:

"There are a couple of countries that are trying to backtrack but I don't think they will be able to muster the force to succeed," the official said, referring to Finland and the Netherlands.

"'Legacy' problems is a newcomer to the debate. It is one more case of this habit of walking away from decisions taken."

Publicly the Commission downplayed it - saying it's simply a negotiating position over the technicalities:

Eurozone leaders "agreed on 29 June that the future European Stability Mechanism should have the possibility to recapitalise banks directly once the new supervision mechanism is in place," European Commission spokesman Olivier Bailly said Wednesday.

"This is, as far as we are concerned, the position of the (eurozone) member states," Bailly said.

To suggest that's some kind of decision is laughable. It clearly states that the decision will be made later and is at best some kind of expression of intent. It's not making any committments, so there is nothing the Dutch, Finnish and German prime ministers can even go back on. They are just detailling what their policy proposals are regarding this.

Sort of.  That's how all European Council summit statements read, but it's an unusually urgent Council decision, it ends 'We task the Eurogroup to implement these decisions by 9 July 2012.'  They did handing it over to the Commission to draft the rules, which will then have to be agreed - but the principle and timescale were agreed and Germany, the Netherlands and Finland want to resile from both.

I should say I think there'll be a sense of schadenfreude in Whitehall because Germany sounds almost British    Every government we've had moans.  First they think they did okay during the Council.  Then the Commission starts presenting proposals.  Suddenly it dawns on them that they've agreed to something rather more far-reaching than they suspected.

Incidentally I'm not sure what this supervisor would be able to achieve?  It would miss the problems in the regional banks, it would miss the Spanish crisis for example - and the systemic risks that came from that.  It looks like it might be able to spot the Irish or Slovenian problems - but may not be able to solve them.

Meanwhile Spain and France presented their budgets - the French looks quite canny.  The reaction to Spain seems to be that they are basically taking many of the same steps as Ireland in 2009 - and their stress test wasn't very credible (the adverse scenario projects a smaller banking bailout than in Ireland).  Add in Rajoy's denials and it looks like Cowen all over again. 

At least my distant cousin won't go on national TV an hour before Ireland accepts a bailout to say that the government hasn't asked for a bailout