Sovereign debt bubble thread

[Sheilbh]

Van Rompuy looks like he should be hiding behind a wall

[Crazy_Ivan80]

a closeup of Van Rompuy.



Shaving the sideburns didn't help to make him unrecognisable...

[Sheilbh]

Incidentally today wasn't a good day for the Eurozone.  It looks like the Finns threatened to leave the Euro rather than bail anyone else out, but they've since walked that back.  This story could be a worry too:

Will Europe Really Break the Spanish Sovereign-Banking Loop?
By Charles Forelle

The signal achievement of the European Union's much-heralded summit last week was an agreement to allow the euro zone's bailout fund to rescue Spanish banks directly.

Up to that moment, the bloc's method–in Greece, Ireland and Portugal–was to lend money to the troubled government and tell it to deal with its banks. That led to the dreaded sovereign-bank loop: weak banks dragging down weak sovereigns dragging down weak banks... The summit agreement was meant to cut it.

But some comments out today are calling into question just how cleanly that loop will be severed. Our colleague Matina Stevis reports on Dow Jones Newswires that a senior EU official said today the ultimate responsibility for the banks would actually fall with Spain, and not the European Stability Mechanism. Writes Matina:

"I need to make clear what the ESM can do: the ESM is able–if one were to decide ever on such an instrument–to take an equity share in a bank. But only against full guarantee by the sovereign concerned," the official said. "What you have is that it cuts out the effect of that loan on the debt-to-GDP ratio of the sovereign. Does it still remain the risk of the sovereign or [does it go to] the ESM? It remains the risk of the sovereign."

Those comments undermine the euro zone's statement last week that it would . The statement said:

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

The statement said nothing about Spain's guaranteeing the ESM's recapitalization. We'll see how this develops, but it is an essential point.

Many in financial markets have assumed the ESM would recapitalize banks on its own–by giving them cash or high-quality bonds in return for equity stakes (or some sort of hybrid instrument, like contingent-convertible notes) in the banks. That way, the whole of the euro zone, and not just Spain, would bear the risk of the banks' rescue.

Indeed, this mutualization of responsibility has been viewed as an early step on the path to the broader risk-sharing inside the currency union that, many observers believe, is vital for its survival.

But what the senior official describes is less of a bold step and more of an exercise in accounting footwork. Yes, structuring the aid as a direct recapitalization does avoid the need for Spain to incur an actual liability to the bailout fund (and pay interest on its borrowing), but requiring that Spain indemnify the fund against losses just saddles the country with a contingent liability instead of an actual one.

Follow @charlesforelle on Twitter.

[Iormlund]

I suspect the Portuguese thing goes something like this: the government is in essence trying to levy a new tax on those months, rather than cutting their wages directly for some reason or another. Since that tax is only for public workers, the Court struck it down.

[Iormlund]

Eurozone crisis will last for 20 years


I always wondered who buys risky assets after one of these "historic" statements from the European Council. Sometimes the rally lasts for hours. Other times it lasts for days. The last one ended after less than a week; Italian and Spanish spreads are now above pre-summit levels.

The consensus among observers had been that the EU had taken an important step in the right direction by agreeing a pathway towards a banking union, but that they did not do enough on crisis resolution. I disagree with that statement. I think it was a very large step – in the wrong direction. The summit made a concrete crisis resolution decision contingent on a future decision, which will be even harder to reach, and thus even more likely to fail.

They agreed that there shall be no common bank recapitalisation until a full banking union is established. And the Bundesbank has reminded us that the latter is not possible without a political union. The logical implication is that we won't solve the crisis for the next 20 years.

What we know now is that Germany will not agree to mutualised deposit insurance. It cannot even agree to give the European Stability Mechanism a banking licence so that it can leverage itself. If Germany cannot do the minimum necessary now, why should anybody think it can agree a political union? This is less credible than the promise by an alcoholic to give up drinking in five years.

The politics of the euro rescue has crossed an important threshold in Germany. A narrow majority is still in favour of the euro, but a majority is against further rescues. A group of 160 economists, led by Hans-Werner Sinn, president of the Ifo economics institute, last week published a manifesto against a banking union. It was full of sound and fury, but the importance of this document is that it reflects a consensus view.

Angela Merkel's answer was revealing. She told them that there is nothing to worry about. The banking union was about joint supervision, she said. There will be no joint deposit insurance. She has a very different understanding of a banking union than the European Central Bank. At most, I expect this new banking union to cover the 25 largest banks, and leave those cajas and Landesbanken in national control. This is like an alcoholic who promises to drink only the better cognacs from now on.

The banking union that is required is the one Germany will not accept: central regulation and supervision, a common restructuring fund and common deposit insurance. It would take years to create. If done properly, it would require a change of national constitutions and European treaties, if only to redefine the role of the ECB. It is sheer madness to make crisis resolution contingent on the success of what would be the biggest European integration exercise in history.

With interest rates on 10-year government bonds over 6 per cent, neither Italy nor Spain can sustain their membership in the eurozone. This is what Mario Monti and Mariano Rajoy should have made clear to Angela Merkel at the summit. They should have told her that their governments would make preparations for a withdrawal from the eurozone if there was no change in policy. A resolution requires either a eurozone bond – or some other form of debt mutualisation –in both the public and private sectors, and ECB bond purchases. Germany does not accept the former. The ECB does not accept the latter.

If something is neither sustainable nor self-correcting, there are only two courses of action left. The first is to wait patiently until the situation breaks down. This is the strategy pursued by the European Council – and by alcoholics. The alternative is to start making preparations – and be careful not to trigger a breakdown in the process. It is hard to envisage an exit without breaching hundreds of national and European laws. This is why nobody is doing it. One would have to use a force majeure defence. One cannot prepare for such an event. It took a decade to create the euro. It will take more than a long weekend to undo it. A collapse would constitute the biggest economic shock of our age. But among a list of bad breakup choices, some are a better than others. I will write about these in a future column.

Back in November, I wrote that the European Council had ten days to save the euro. If they had laid the groundwork for a banking and a fiscal union back then, they might now be in a position to agree an effective crisis resolution strategy – consisting of bank recapitalisation and bond purchases. They did not do it then. And they are not in a position to solve the crisis now.

The message I took away from the summit is that the eurozone will not resolve the crisis. In that sense, it was indeed a "historic" meeting.

[Martinus]

paternalism means, in both theory and practice, that citizens are -to a degree- children of the state.
That might be practical, but eventually a block for further cultural development. Just like it was pretty practical to have the Church install a yoke on the barbaric savages of the dark ages, but became quite the limiting factor for further development.

This can be largely mitigated by what is called "soft paternalism", though.

[MadImmortalMan]

Spanish 10-year is at 7.08% right now.

[Iormlund]

France has joined the club of negative borrowing costs.

[Duque de Bragança]

France has joined the club of negative borrowing costs.

Flanby über alles! 

[citizen k]

Krugman taken to woodshed by Pedro Schwartz:

http://www.youtube.com/watch?v=EX55BH97quk&feature=player_embedded

[Crazy_Ivan80]

Krugman taken to woodshed by Pedro Schwartz:

http://www.youtube.com/watch?v=EX55BH97quk&feature=player_embedded

the following is from someone I know who was there

Madrid, 4th of July 2012. Question for Mr. Paul Krugman: "You seem to focus on the question what macro-economic policy we need to get out of the crisis, but you do not adress the more fundamental question what policies have lead us here. If you would do so, I think you would have to conclude that it was Keynesian policies - creating inflation to combat unemployment - who got us in this mess in the first place. Why do you think the measures you propose will have a different effect this time?

Nervous answer: "All data point in that direction".

My reply: "But surely, Mr. Krugman, you must know that the way in which data is validated as evidence is subject to a certain methodological theory too. I am sure you are familiar with the critique of the Austrian School of Economics, which claims that the cardinal data required for Keynesian equilibrium calculus can only be generated in a free market, in which only ordinal valuations take place, rendering the whole theory of aggregate demand as a tool of government intervention and central planning useless. How do you defend your methodological assumptions about economic reality?"

Annoyed answer: "Excuse me. I promised to be home for dinner".

Paul Krugman, Nobel Prize Winner 2008

[The Minsky Moment]

Re Krugman - I'm not going to slog through a two hour video.

But the Q&A cited by Ivan does not impress.

The first question is based entirely on false premises.  Neither fiscal deficits nor inflation caused the present mess - fiscal deficits have been a symptom not a cause, and inflation has been notoriously non-existent.  I very much doubt that Krugman's response to that question was "nervous" unless the delivery (alongside the content) caused him to be concerned about the questioner's sanity.

The second question, though phrased as a critique of "Keynsian equilibrium calculus," actually is a critique that has nothing to do with Keynes or Keynsianism. The questioner appears to have read old writings in the Austrian school criticising the British marginalists (especially Alfred Marshall) and Walras for their reliance on axioms of cardinal utility.  This has nothing to do Keynes - the General Theory doesn't rely on any formal utility model at all, and the mainstream adaptations of Keynsianism to develop equilibrium models are all based (like their neo-classical counterparts) on ordinally-based axioms of preferences.  In short, the question suggests that the person asking is either a quack or someone who autodidactially read some articles on mises.org without really understanding them.  Either way, Krugman's response would be appropriate.

[Admiral Yi]

Neither fiscal deficits nor inflation caused the present mess - fiscal deficits have been a symptom not a cause

What in the world are you talking about?

[The Minsky Moment]

Neither fiscal deficits nor inflation caused the present mess - fiscal deficits have been a symptom not a cause

What in the world are you talking about?

What I assume the questioner was asking about - the European economic crisis, c. 2008 - present.

[Admiral Yi]

What I assume the questioner was asking about - the European economic crisis, c. 2008 - present.

Ho ho.

So fiscal deficits are not the cause of rising sovereign yields?  Was that, as rumored, a Jewish conspiracy?