Sovereign debt bubble thread

[Sheilbh]

I shouldn't steal from the FT, but I entirely agree with this article:

The eurozone really has only days to avoid collapse

Wolfgang Munchau By Wolfgang Münchau

In virtually all the debates about the eurozone I have been engaged in, someone usually makes the point that it is only when things get bad enough, the politicians finally act – eurobond, debt monetisation, quantitative easing, whatever. I am not so sure. The argument ignores the problem of acute collective action.

Last week, the crisis reached a new qualitative stage. With the spectacular flop of the German bond auction and the alarming rise in short-term rates in Spain and Italy, the government bond market across the eurozone has ceased to function.

The banking sector, too, is broken. Important parts of the eurozone economy are cut off from credit. The eurozone is now subject to a run by global investors, and a quiet bank run among its citizens.

This massive erosion of trust has also destroyed the main plank of the rescue strategy. The European Financial Stability Facility derives its firepower from the guarantees of its shareholders. As the crisis has spread to France, Belgium, the Netherlands and Austria, the EFSF itself is affected by the contagious spread of the disease. Unless something very drastic happens, the eurozone could break up very soon.

Technically, one can solve the problem even now, but the options are becoming more limited. The eurozone needs to take three decisions very shortly, with very little potential for the usual fudges.

First, the European Central Bank must agree a backstop of some kind, either an unlimited guarantee of a maximum bond spread, a backstop to the EFSF, in addition to dramatic measures to increase short-term liquidity for the banking sector. That would take care of the immediate bankruptcy threat.

The second measure is a firm timetable for a eurozone bond. The European Commission calls it a "stability bond", surely a candidate for euphemism of the year. There are several proposals on the table. It does not matter what you call it. What matters is that it will be a joint-and-several liability of credible size. The insanity of cross-border national guarantees must come to an end. They are not a solution to the crisis. Those guarantees are now the main crisis propagator.

The third decision is a fiscal union. This would involve a partial loss of national sovereignty, and the creation of a credible institutional framework to deal with fiscal policy, and hopefully wider economic policy issues as well. The eurozone needs a treasury, properly staffed, not ad hoc co-ordination by the European Council over coffee and desert.

I am hearing that there are exploratory talks about a compromise package comprising those three elements. If the European summit could reach a deal on December 9, its next scheduled meeting, the eurozone will survive. If not, it risks a violent collapse. Even then, there is still a risk of a long recession, possibly a depression. So even if the European Council was able to agree on such an improbably ambitious agenda, its leaders would have to continue to outdo themselves for months and years to come.

How likely is such a grand deal? With each week that passes, the political and financial cost of crisis resolution becomes higher. Even last week, Angela Merkel was still ruling out eurobonds. She was furious when the European Commission produced its owns proposals last week. She had planned to separate the discussion about the crisis from that of the future architecture of the eurozone. The economic advice she has received throughout the crisis has been appalling.

Her own very public opposition to eurobonds has now become a real obstacle to a deal. I cannot quite see how the German chancellor is going to extricate herself from these self-inflicted constraints. If she had been more circumspect, she could have travelled to the summit with the proposal of the German Council of Economic Advisers, who produced a clever, albeit limited and not yet fully worked-out-plan. They are a proposing a "debt redemption" bond – another candidate for this year's top euphemism award. The idea is to have a strictly temporary eurobond, which member states would pay off over an agreed time period. At least this proposal would be in line with the more restrictive interpretation of German constitutional law.

Ms Merkel's hostility to eurobonds certainly resonates with the public. Newspapers expressed outrage at the commission's proposal. I thought both the proposal itself and its timing were rather clever. The Commission managed to change the nature of the debate. Ms Merkel can get her fiscal union, but in return she will now have to accept a eurobond. If both can be agreed, the problem is solved. It is the first intelligent official proposal I have seen in the entire crisis.

I have yet to be convinced that the European Council is capable of reaching such a substantive agreement given its past record. Of course, it will agree on something and sell it as a comprehensive package. It always does. But the halt-life of these fake packages has been getting shorter. After the last summit, the financial markets' enthusiasm over the ludicrous idea of a leveraged EFSF evaporated after less than 48 hours.

Italy's disastrous bond auction on Friday tells us time is running out. The eurozone has 10 days at most.

I think this is what he means by the increased fiscal union plans:
http://online.wsj.com/article/SB10001424052970204630904577062592535969680.html?mod=WSJEurope_hpp_LEFTTopStories

In the UK the Treasury have been wargaming the break up of the Euro and I've read that the starting assumption of civil service plans now is that the Euro will break up.  I know from friends that the banks and asset management firms are making the same assumption and running the same preparations and I've got a friend working for a financial magazine who's saying the same.

Worryingly apparently Brussels hasn't been establishing contingency plans or wargames because they know they'll leak, if they're seen to prepare for a break up they make it more likely.  So if the worst does happen chances are it won't be orderly and managed.

Here's Gavyn Davies's diagram of likely options from here:

[alfred russel]

As completely dysfunctional as our government is, and as disasterous as Bush was, I have to say in regards to the US 2008 crisis and the current euro crisis:

Bush + Paulson + Bernanke + Democratic Congress (in the middle of a presidential election) > Europe

[Sheilbh]

Bush + Paulson + Bernanke + Democratic Congress (in the middle of a presidential election) > Europe

Agreed.  I've always thought that when it mattered the Bush, Paulson and Congress got it right despite politics.  It also started my suspicion of Congressional Republicans.

Here's a worry.  If the Euro fails or even if we just have ongoing stalling growth for the next year will the Fed be able to act, independently, when one party is opposed to their actions during an election campaign?

[KRonn]

Bush + Paulson + Bernanke + Democratic Congress (in the middle of a presidential election) > Europe

Agreed.  I've always thought that when it mattered the Bush, Paulson and Congress got it right despite politics.  It also started my suspicion of Congressional Republicans.

Here's a worry.  If the Euro fails or even if we just have ongoing stalling growth for the next year will the Fed be able to act, independently, when one party is opposed to their actions during an election campaign?

The Fed is independent of Congress so it should be able to act as it sees fit as far as I understand it, though that's another bone of contention with some in Congress who'd like to reign in the Fed.

[Admiral Yi]

Here's a worry.  If the Euro fails or even if we just have ongoing stalling growth for the next year will the Fed be able to act, independently, when one party is opposed to their actions during an election campaign?

Don't see why not.  Fed tenures are 5 years long so they don't coincide with elections.

[Sheilbh]

I get that in theory but have you had an election before where one party hugely opposes the actions of the Fed.  I think all Republican candidates are to a greater or lesser extent opposed to QE, for example, which the Fed may think is necessary.  There have been a lot of attacks on the Fed as an institution and Bernanke as its Chair.  Given that I'm not sure the Fed can act with the same sort of independence that it would in a non-election year even if it is being politically attacked.  So I'm looking for a comparison.

Has there been an example of an election where the actions of the Fed are both controversially and roundly opposed by one party?  I'd guess that possibly the Volker Fed was opposed by Democrats but I don't know?  Beyond that surely you'd have go to pre-Fed campaigns like Bryan?

[alfred russel]

Bush + Paulson + Bernanke + Democratic Congress (in the middle of a presidential election) > Europe

Agreed.  I've always thought that when it mattered the Bush, Paulson and Congress got it right despite politics.  It also started my suspicion of Congressional Republicans.

Here's a worry.  If the Euro fails or even if we just have ongoing stalling growth for the next year will the Fed be able to act, independently, when one party is opposed to their actions during an election campaign?

I'm not sure what the fed can do? We have already implemented ZIRP forever.

Theoretically there could be more quantitative easing, but that isn't likely to be a solution. Hopefully the creeping interest rates in the eurozone's strongest members aren't a sign of increasing inflation concerns. If they are, those concerns will probably be here soon anyway.

[alfred russel]

I get that in theory but have you had an election before where one party hugely opposes the actions of the Fed.  I think all Republican candidates are to a greater or lesser extent opposed to QE, for example, which the Fed may think is necessary.  There have been a lot of attacks on the Fed as an institution and Bernanke as its Chair.  Given that I'm not sure the Fed can act with the same sort of independence that it would in a non-election year even if it is being politically attacked.  So I'm looking for a comparison.

Has there been an example of an election where the actions of the Fed are both controversially and roundly opposed by one party?  I'd guess that possibly the Volker Fed was opposed by Democrats but I don't know?  Beyond that surely you'd have go to pre-Fed campaigns like Bryan?

Bush I against Clinton. Bitching about the fed isn't new. I wouldn't worry about it, especially when the ECB was raising rates a few months ago.

[Sheilbh]

Bush I against Clinton. Bitching about the fed isn't new. I wouldn't worry about it, especially when the ECB was raising rates a few months ago.

The ECB's cutting rates again.  The rate rises were pretty heavily criticised.

[alfred russel]

Bush I against Clinton. Bitching about the fed isn't new. I wouldn't worry about it, especially when the ECB was raising rates a few months ago.

The ECB's cutting rates again.  The rate rises were pretty heavily criticised.

As they should have been. They were very stupid.

[Admiral Yi]

Bush I against Clinton. Bitching about the fed isn't new.

I don't remember any bitching about the Fed back then.

Anything's possible Shelf, but Fed chairman confirmations tend to be about the most uncontroversial activity Washington engages in.  I'm pretty sure no nominee has ever been denied.

[Sheilbh]

Anything's possible Shelf, but Fed chairman confirmations tend to be about the most uncontroversial activity Washington engages in.  I'm pretty sure no nominee has ever been denied.

I don't mean anything like that.  Rather would the Fed feel constrained in what action it can take if it's become a political issue during an election campaign?  I'm wondering if there's any examples.

[Zanza]

What it should have done was contain the contagion at an early stage, before it spread to those two, by allaying investor doubt in return for tangible and strong structural reforms.

Germany doesn't believe there would be tangible and strong structural reforms without market pressures. And the containment of contagion is questionable too as the markets would have called that bluff. It's not particularly hard to notice that Germany can't do anything about Italy's debt without being the next in line itself.

[Zanza]

Everything Germany's agreed to so far in every summit has been the bare minimum necessary, for the previous summit.

Another interpretation is that it was the maximum it could agree on without being ripped apart by internal political divisions.

Every time commentators say there's a need for very decisive large-scale intervention and we get a statement that says that's happened and then two or three days later everyone realises that's not really the case. 

Our commentators are much more divided upon the issue than the ones in the English press.

Well Ireland had serious cuts and tax rises for at least two years before they were bailed out.  I think Spain and Portugal had some austerity measures prior to getting into trouble (much like France has over the past year).

France was in trouble over the past year as there have been constant doubts about its AAA rating etc. No idea about Spain and Portugal. Ireland actually did what was necessary and is now on a path to growth again.

Having said that I think everyone supports Merkel in using this opportunity to get governments to pass reforms and  she wants treaty changes to institute fiscal oversight, to ratify the EFSF and so on.  All of which is good but I do worry that it just won't work.  I can't see the Irish agreeing in a referendum, the UK will use the reopening of treaties as an excuse to try and renegotiate membership, I can't imagine that the Eurosceptic right in Finland or the Netherlands will be keen either.

Everyone supports and it will not pass? So if there is no political will in Ireland or Finland, Merkel gets blamed?

So far I think we're very lucky there's not been an anti-German backlash in one of these countries.

Read the news. There has been.

[Sheilbh]

Edging towards a solution?  God willing:

The euro crisis
Could this be the plan?

Nov 28th 2011, 15:48 by R.A. | WASHINGTON

THERE is an inescapable sense that the euro zone is accelerating toward an uncertain and terrible end. At the Financial Times, Wolfgang Münchau writes that the euro zone has but days to save itself. At Bloomberg, Peter Boone and Simon Johnson say that the beginning of the single currency's end is upon us. And of course, The Economist continues to warn of the rising possibility of a break-up, and explains how one might occur, in the latest print edition. Everywhere one looks, there are portents of doom.

Except, that is, in the markets. Equities are soaring today, perhaps as a result of technical factors like short-covering but perhaps, some suggest, on hopes that the euro zone is finally rising to the challenge facing it. From whence cometh this hope?

Markets appear to see the prospect of salvation in reports of a new policy approach from Angela Merkel and Nicolas Sarkozy. The two are said to be putting together a framework for a rapid move toward greater fiscal integration. Such a plan would likely entail oversight of member-state budgets—and a corresponding loss of sovereignty—with the understanding that such ties would facilitate the way toward sovereign risk-sharing, as through euro bonds. The prospect of fiscal submission to the will of the euro zone's big powers is unlikely to appeal to peripheral countries, but many have already accepted some degree of oversight in exchange for emergency assistance, and the alternatives are likely to be far worse. To get around the need to go through a lengthy and uncertain treaty-change procedure, the plan may be drawn up along the lines of the Schengen agreement on geographic mobility. Countries may be able to sign on on a voluntary basis; it will not be an all or nothing approach. Given the scale of the current debt crisis, mutualisation of fiscal responsibilities won't fix the mess. The main hope for the plan is clearly that a major step toward better fiscal institutions will encourage the European Central Bank to substantially step up its intervention in bond markets.

The approach has several of the ingredients necessary to resolve the crisis, and it isn't crazy to think that it might represent the beginnings of a workable end-game. Yet significant question markets remain. One concerns timing. The euro-zone crisis is galloping forward. Can enough euro-zone governments arrive at an agreement before critical thresholds are reached? Can and will the ECB hold the single currency together for long enough?

Then of course, there are the pesky details. One supposes that peripheral economies may bite the bullet and sign on. To what, however, are Germany and France actually willing to agree? And Finland and the Netherlands? Is this actually going to be fiscal integration with bite? Even if one assumes that the relevant parties are prepared to throw themselves headlong into true fiscal integration, will that convince the ECB to dramatically increase its interventions? Hang-ups about fiscal institutions aren't the only thing deterring the central bank from broader action, remember; Bundesbank officials are also worried about the statutory limits on the ECB's behaviour. Without explicit orders from governments to act as lender-of-last-resort, the ECB may keep its role limited.

It also seems like greater levels of bond purchases aren't enough to save the situation. The ECB has been buying large amounts of debt, to little avail. Markets are looking for guarantees. Without an explicit promise from the ECB that it will stand behind member-state debt, markets will continue to take ECB buying as little more than an opportunity to dump risky bonds. A lot of moving parts have to move in just the right way for a plan like this to work.

Meanwhile, the backdrop against which this drama is taking place is growing ever more foreboding. The OECD declared today that the euro zone is likely in recession. Its latest projections for growth in 2012 are truly dismal—and probably overoptimistic. Real output may contract in France and Germany over the next year. Italy and Spain also face recession, and Portugal and Greece are looking at very deep contractions. Moody's warned today that all of Europe's sovereign ratings are at risk and that multiple defaults can't be ruled out. It is seen as good news that in an auction of 10-year debt this morning, Belgian yields rose to just 5.7%.

Hope is not yet dead. But markets will soon turn sceptical again as they wait for details to materialise. Unless euro-zone leaders can deliver the goods and fast, it won't be long—mere days, perhaps—before panic is once again ripping the single currency apart.

Those OECD estimates are scary.  They probably are overoptimistic (given past OECD projections) but they also assume a reasonable outcome to the Euro.  Their guess of what could happen if things fall apart is a depression and that could well be overoptimistic.

Another interpretation is that it was the maximum it could agree on without being ripped apart by internal political divisions.

I would note that her ability to go a bit further always seems a bit greater immediately after regional elections.

I think British and American governments had to risk that when trying to save the financial sector.  There's a time when politicians actually have to lead not follow opinion and I think Merkel's failing on that ground.  As Wolf says of the ECB, that it's in danger of going down in history as a magnificently orthodox central bank, I think Merkel's the political equivalent.  In ordinary times her instincts would be fine but I think there's a need for bold, unorthodox action.

As it stands I think if Europe fails it will be, above all, Merkel's fault which would be a damning failure for a successor (in office and party) of Adenauer. 

Incidentally on past Chancellors I've been wondering how Schroeder's perceived?  Given how much people are linking Germany's recent economic success with the Hartz agenda is his time in office being re-evaluated, or not so much?

Our commentators are much more divided upon the issue than the ones in the English press.

I don't just mean the press though.  Though you're right there's a consensus from the Guardian to the Economist on that.  Even the Telegraph spends half its time relishing the end of the EU and the other, saner half, fretting about whether it'll be safe in the end.  But it's more than the press I mean people like Stephen King, who's head economist of HSBC, economists and asset managers who are commenting.