The latest EU summit agreement is already unraveling as EU governments, the IMF and other observers get a chance to digest what the summit supposedly agreed on. The results of the summit were billed by the EU as Europe's "fiscal compact" to anchor fiscal discipline in Euroland.
The EU's Brussels statement provided the following points.
(1) Increased Financial Resources
From some reporting on the summits announcement, it looks like the amount of funding resources for EFSF, ECB and IMF support for weak sovereigns and the banking system has been bumped up to roughly Euro 1 trillion. The reality however is that there is only about Euro 250 billion of uncommitted lending capacity left in the EFSF, while the communique specifically mentioned the reassessment of a Euro 500 billion ceiling for the EFSF and ESM in March 2012, or three months from now.
Rescue Funding Still too Small
The European Financial Stability Facility (EFSF) was created in May 2010 to contain the Eurozone debt crisis, but has clearly not achieved its stated goal. On July 2011, Eurozone leaders agreed to enlarge the EFSF capital guarantee from Euro 440 billion to Euro 780 billion, expanding the effective lending capacity of the EFSF to Euro 440 billion. This change was ratified by all Eurozone parliments on October 13, 2011. After bailouts for Ireland and Portugal, however, the uncommitted lending capacity of the EFSF had shrunk to Euro 250 billion. The ratified agreement also removed the cash buffer held by the EFSF for any new issues and replaced it with a +65% over-guarantee by the guaranteeing countries, meaning the guarantee requires having Euro 440 billion of AAA-rated guarantor countries behind the maximum EFSF issued debt capital.
On October 27, 2011, the European Council announced an agreement to increase the effective capacity of the EFSF to Euro 1 trillion by offering insurance to purchasers of Eurozone member debt, and the creation of funds, possibly under IMF supervision, seeded with EFSF money and contributions from outside investors.
However, the effective capacity increase of the EFSF has been a non-starter, because EU countries would not only be guaranteeing all of the interest and capital raising costs of EFSF in addition to issued capital, they would also theoretically be holding an uncapped liability, and this is what Germany and its northern neighbors have the biggest problem with. In its current form, the EFSF is simply too small even compared to the size of Italy's sovereign debt of Euro 1.9 trillion.
Consequently, the combination of ECB, EFSF/ESM and IMF support leaves Euroland still well short of a solid committment to preventing further contagion, as the emerging funding support is still woefully inadequate to stop a run on Italian sovereigns or even Spanish sovereigns. The EFSF can only act after a support request is made by a Euro area member state and a "country program" has been negotiated with the EC and the IMF after the program is unanimously accepted by Euro area finance ministers and a memorandum of understanding signed. On November 2011, Euro finance ministers decided the EFSF can guarantee 20%~30% of the bonds of struggling peripheral economies. EFSF is AAA-rated by the rating agencies, making it eligible for ECB refinancing operations.
There is still no clear mandate, nor the desire for, the more aggressive use of the ECB's balance sheet as the lender of last resort for Euroland banks and sovereigns, whereas investors are looking for the ECB to provide the eventual backstop. The ECB denied market expectaions they would step up sovereign bond purchases as the key to stabilizing rising borrowing costs for weaker sovereigns. Further, the ECB has not exactly pulled out all the stops to save Euroland's Euro 23 trillion banking system. Further Germany's Bundesbank reiterated its stance that the ECB cannot take part in any form of covert funding for EMU states, even through the back-door of the IMF. Effectively the EFSF transfers the liability to repay sovereign debts from recipient countries to guarantor countries, and this is what Germany and its northern Europe neighbors have the most problem with.
The Germans have nixed the IMF funding scheme. The German Bundesbank has also nixed the supposed agreement to use the reserves of the 17 national central banks to provide Euro 200 billion of funding for the IMF to supposedly use in rescue attempts, such as for Spain or Italy, and the ECB's governor himself has said the ECB is not willing to use the IMF as a conduit for covert sovereign rescues.
While almost unnoticed by all the pomp and circumstance in Brussels, the ECB has offered additional help to the banks,
(1) Quickly lowered rates twice since Mario Draghi took the helm.
(2) Offer banks unlimited cash for three years.
(3) Lowering the eligibility of loan collateral and reducing reserve requirements from 2% to 1%.
(4) ECB can act as an agent for the EFSF in any bond purchasing operations.
(2) Establishment of a New Fiscal Rule
The EBA has announced that Eurobanks are short some Euro 115 billion of funds to bolster their Tier 1 capital ratios to 9%. The Basel-based Financial Stability Board - the collective voice of the world’s monetary authorities - fears the Eurobanks could inflict a €2.4 trillion credit crunch over the coming months, just as Euroland crashes back into recession. While insisting that the capital boos target can be reached by "sales of selected assets that do not lead to a reduced flow of lending to the EU's real economy. Eurobank asset reduction will reduce credit (particularly trade credit) availability in Asia.
The ECB's moves to provide additional liquidity will help Euroland banks adding further support to the coordinated action by the world's largest central banks to ease funding conditions for banks. The U.S. Federal Reserve agreed to expand, and reduce the cost of, multilateral swap lines with five other large central banks, notably the European Central Bank, in an effort to restore access to dollar funding for European banks.
(4) OECD Warns of Global Funding Struggle
The OECD will soon publish a warning that markets and governments face an uphill struggle to fund themselves in 2012 amid extreme uncertainty over the Eurozone and global economy, as new figures reveal borrowing by industrialized governments has surged beyond USD10 trillion in 2011 and is forecast to grow further in 2012.
The OECD is warning of rollover risk, or the risk that a country may not be able to refinance or rollover its debt, forcing it to turn to the ECB in the case of the Eurozone or to seek emergency bail-outs like what happened to Greece, Ireland and Portugal. The warning effectively highlights the risk of Italy and Spain, whose rising interest rates threaten them with being shut out of private markets. The share of short-term debt issuance in the OECD area remains at 44% and much higher than before the global financial crisis in 2007/2008. This means that even AAA-rated sovereigns like France and Austra may no longer be "risk-free* credits.
The EU's Brussels statement provided the following points.
(1) Increased Financial Resources
- The European Financial Stability Facility (EFSF) leveraging will be rapidly deployed
- Introduction of the European Stability Mechanism (ESM) will be accelerated to July 2012.
- The EUR 500 billion ceiling for EFSF/ESM funding will be reassessed in March 2012.
- The EFSF will remain active in financing programs until mid-2013.
- Euro area and other Member States will consider, and confirm within 10 days, the provision of additional resources for the IMF of up to EUR 200 billion (USD 270 billion), in the form of bilateral loans.
From some reporting on the summits announcement, it looks like the amount of funding resources for EFSF, ECB and IMF support for weak sovereigns and the banking system has been bumped up to roughly Euro 1 trillion. The reality however is that there is only about Euro 250 billion of uncommitted lending capacity left in the EFSF, while the communique specifically mentioned the reassessment of a Euro 500 billion ceiling for the EFSF and ESM in March 2012, or three months from now.
Rescue Funding Still too Small
The European Financial Stability Facility (EFSF) was created in May 2010 to contain the Eurozone debt crisis, but has clearly not achieved its stated goal. On July 2011, Eurozone leaders agreed to enlarge the EFSF capital guarantee from Euro 440 billion to Euro 780 billion, expanding the effective lending capacity of the EFSF to Euro 440 billion. This change was ratified by all Eurozone parliments on October 13, 2011. After bailouts for Ireland and Portugal, however, the uncommitted lending capacity of the EFSF had shrunk to Euro 250 billion. The ratified agreement also removed the cash buffer held by the EFSF for any new issues and replaced it with a +65% over-guarantee by the guaranteeing countries, meaning the guarantee requires having Euro 440 billion of AAA-rated guarantor countries behind the maximum EFSF issued debt capital.
On October 27, 2011, the European Council announced an agreement to increase the effective capacity of the EFSF to Euro 1 trillion by offering insurance to purchasers of Eurozone member debt, and the creation of funds, possibly under IMF supervision, seeded with EFSF money and contributions from outside investors.
However, the effective capacity increase of the EFSF has been a non-starter, because EU countries would not only be guaranteeing all of the interest and capital raising costs of EFSF in addition to issued capital, they would also theoretically be holding an uncapped liability, and this is what Germany and its northern neighbors have the biggest problem with. In its current form, the EFSF is simply too small even compared to the size of Italy's sovereign debt of Euro 1.9 trillion.
Consequently, the combination of ECB, EFSF/ESM and IMF support leaves Euroland still well short of a solid committment to preventing further contagion, as the emerging funding support is still woefully inadequate to stop a run on Italian sovereigns or even Spanish sovereigns. The EFSF can only act after a support request is made by a Euro area member state and a "country program" has been negotiated with the EC and the IMF after the program is unanimously accepted by Euro area finance ministers and a memorandum of understanding signed. On November 2011, Euro finance ministers decided the EFSF can guarantee 20%~30% of the bonds of struggling peripheral economies. EFSF is AAA-rated by the rating agencies, making it eligible for ECB refinancing operations.
There is still no clear mandate, nor the desire for, the more aggressive use of the ECB's balance sheet as the lender of last resort for Euroland banks and sovereigns, whereas investors are looking for the ECB to provide the eventual backstop. The ECB denied market expectaions they would step up sovereign bond purchases as the key to stabilizing rising borrowing costs for weaker sovereigns. Further, the ECB has not exactly pulled out all the stops to save Euroland's Euro 23 trillion banking system. Further Germany's Bundesbank reiterated its stance that the ECB cannot take part in any form of covert funding for EMU states, even through the back-door of the IMF. Effectively the EFSF transfers the liability to repay sovereign debts from recipient countries to guarantor countries, and this is what Germany and its northern Europe neighbors have the most problem with.
The Germans have nixed the IMF funding scheme. The German Bundesbank has also nixed the supposed agreement to use the reserves of the 17 national central banks to provide Euro 200 billion of funding for the IMF to supposedly use in rescue attempts, such as for Spain or Italy, and the ECB's governor himself has said the ECB is not willing to use the IMF as a conduit for covert sovereign rescues.
While almost unnoticed by all the pomp and circumstance in Brussels, the ECB has offered additional help to the banks,
(1) Quickly lowered rates twice since Mario Draghi took the helm.
(2) Offer banks unlimited cash for three years.
(3) Lowering the eligibility of loan collateral and reducing reserve requirements from 2% to 1%.
(4) ECB can act as an agent for the EFSF in any bond purchasing operations.
(2) Establishment of a New Fiscal Rule
- Member states in "excessive deficit" will need to submit an economic partnership program detailing structural reforms to redress excessive deficits to the EU Commission and Council, who will monitor progress in these programs.
- Member States in breach of a 3% debt ceiling will face automatic sanctions unless a qualified majority of Member States oppose.
- A promise to work on further deepening fiscal integration.
What was immediately picked up on by observers was the gap between rhetoric and reality in the summit announcements. Firstly, the agreement involves no Euro treaty changes. The fiscal compact has worthy long-term goals, but cannot solve the Eurozone's balance of payments imbalances. There is no roadmap for redressing the 30% exchange rate misalignment between North and South that has evolved over fifteen years, leaving half Europe in a ruinous trap and unable to earn their way in EMU. Secondly, the agreement sets off a new round of potentially contentious ratifications across the member states in the first half of 2012, to sign off the ESM treaty and to approval the intergovernmental agreement after the March European Council. Germany's Bundestag president demands the summit package undergo scrutiny by Germany's constitutional court.
(3) EBA Pushes Ahead with Plans to Force Euroland Banks to Meet 9% Core Capital Requirement
The EBA has announced that Eurobanks are short some Euro 115 billion of funds to bolster their Tier 1 capital ratios to 9%. The Basel-based Financial Stability Board - the collective voice of the world’s monetary authorities - fears the Eurobanks could inflict a €2.4 trillion credit crunch over the coming months, just as Euroland crashes back into recession. While insisting that the capital boos target can be reached by "sales of selected assets that do not lead to a reduced flow of lending to the EU's real economy. Eurobank asset reduction will reduce credit (particularly trade credit) availability in Asia.
The ECB's moves to provide additional liquidity will help Euroland banks adding further support to the coordinated action by the world's largest central banks to ease funding conditions for banks. The U.S. Federal Reserve agreed to expand, and reduce the cost of, multilateral swap lines with five other large central banks, notably the European Central Bank, in an effort to restore access to dollar funding for European banks.
(4) OECD Warns of Global Funding Struggle
The OECD will soon publish a warning that markets and governments face an uphill struggle to fund themselves in 2012 amid extreme uncertainty over the Eurozone and global economy, as new figures reveal borrowing by industrialized governments has surged beyond USD10 trillion in 2011 and is forecast to grow further in 2012.
The OECD is warning of rollover risk, or the risk that a country may not be able to refinance or rollover its debt, forcing it to turn to the ECB in the case of the Eurozone or to seek emergency bail-outs like what happened to Greece, Ireland and Portugal. The warning effectively highlights the risk of Italy and Spain, whose rising interest rates threaten them with being shut out of private markets. The share of short-term debt issuance in the OECD area remains at 44% and much higher than before the global financial crisis in 2007/2008. This means that even AAA-rated sovereigns like France and Austra may no longer be "risk-free* credits.