Wal Street Journal Europe
October 3, 2011
by Irwin Stelzer
A mosaic consists of bits that, taken alone, don't mean much: put those individual tesserae, or tiles, together, and you can have a work of art. So, too, with the news about the latest turn in the euro-zone crisis. We all know the picture that has been painted on a broad canvas. German Chancellor Angela Merkel can be seen persuading a bare majority of members of her coalition to support an increase to €211 billion ($282.47 billion) from €123 billion in the guarantees Germany will provide the €440 billion European Financial Stability Facility (EFSF), and allow it to buy bonds, recapitalize banks and issue liquidity loans. Note: no cash will change hands.
In the background are euro-zone powers-that-be, sitting around a table planning to solve the problem created by too much sovereign debt by issuing still more debt, whether in the form of a eurobond (no to that, says Ms. Merkel), leveraging up the size of the EFSF from a puny €440 billion to several trillion euros (you remember leveraging from the good old days right before the bank bailouts in the U.S.), or increasing the borrowing activities of the European Central Bank. Again, no cash, no new equity, even though the International Monetary Fund estimates that there are about €3 trillion in outstanding bonds issued by countries that are now regarded as credit risks, and that euro-zone banks face about €300 billion in losses from write-downs of sovereign debt.
The picture is deliberately blurred by its creators, as their plans to heap debt upon debt must be executed in such a complex way that voters won't realize that they have transferred still more wealth to Club Med. Even if cash doesn't move, by taking on the contingent liability of making good on any EFSF losses, countries will have lowered their credit ratings, and will have to pay more to borrow—a cost no less real even though hidden from the sight of most voters.
So much for the large canvas. On to the tiles that make up the even more revealing mosaic. It turns out that almost exactly two months ago Jean-Claude Trichet and Mario Draghi, the present and future heads of the ECB, dropped a line to Italian Prime Minister Silvio Berlusconi linking the willingness of the ECB to continue buying Italian bonds—then yielding an unsustainable 6.2% on the 10-years—to specific economic and budget reforms. Mr. Berlusconi had responded to cries of "Go home" from his parliamentarians by saying they had created a problem for him, since he had twenty homes and didn't know which one they had in mind. Apparently, the postman knew where to find the prime minister, and didn't have to ring twice before delivering the ECB's message—one of the tiles in a mosaic that is shaping up to depict a profound shift of power from national governments to euro-zone institutions. Mr. Berlusconi did pretty much as the ECB duo directed.
Another set of tiles fills in the picture of euro-zone leaders refusing to face the need to pay down debt. Europe's banks can be seen struggling as the markets refuse to make traditional debt funding available on reasonable terms. Instead of issuing unsecured debt, they have been relying on borrowing backed by specific assets that the lender can take in the event of the issuers' bankruptcy. Unfortunately for them, still more tiles form a sketch of regulators, seen in the background frowning on such balance-sheet "encumbrances," while financial architects sit about creating devices such as an exchange of assets with insurers in return for government debt, which then can be used as collateral to borrow from the central bank. Barclays Capital reckons that the yield on European banks' senior unsecured bonds is now 3.5 percentage points above safe government debt—above the 3.2 percentage-point peak reached after Lehman Brothers went down.
Two final sets of tiles that complete the picture were added in Greece and Spain. No surprise that one comes from the nation that created amazing mosaics hundreds of years B.C.
Euro-zone officials with the task of auditing the books of George Papandreou's government prior to releasing the next tranche of bailout funds—€8 billion needed to meet payrolls and keep the state functioning—were barred from access to the building containing the needed data. Meanwhile, the Greek parliament, even faced with the prospect of running out of cash to pay public-sector workers, can be seen refusing to pass promised legislation that would put 30,000 of those workers into a reserve status at 60% of their normal pay.
In Spain, squabbling policy makers complete the portrait of politicians resisting the austerity medicine prescribed by the wealthy North. They reversed their decision to sell 30% of Loterías y Apuestas del Estado, which runs the state Christmas lottery. The market's valuation, €17 billion, fell short of the €21 billion originally expected, and—perhaps more important—Cristóbal Montoro, slated to be budget minister if, as expected, the opposition Popular Party wins the November elections, opposes the Socialist government's plan to "mis-sell … the state's inheritance. These privatizations must stop." Pity the poor socialists, foiled in their efforts to privatize parts of Spain's economy by the conservative opposition.
There is the completed mosaic. Overly indebted nations and banks piling on more debt to avoid coming up with equity, a super-state coming into view, angry debtors and taxpayers unhappy about paying with austerity and credit ratings to allow banks to write down—by only 20%—bonds that are selling in the market at 50% of their original value—a light trim instead of a crew cut, especially fashionable in France. Not a pretty picture.
Irwin Stelzer is a Senior Fellow and Director of Economic Policy Studies for the Hudson Institute. He is also the U.S. economist and political columnist for The Sunday Times (London) and The Courier Mail (Australia), a columnist for The New York Post, and an honorary fellow of the Centre for Socio-Legal Studies for Wolfson College at Oxford University. He is the founder and former president of National Economic Research Associates and a consultant to several U.S. and United Kingdom industries on a variety of commercial and policy issues. He has a doctorate in economics from Cornell University and has taught at institutions such as Cornell, the University of Connecticut, New York University, and Nuffield College, Oxford.
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