Europe’s debt woes bring up bad 2008 flashbacks
Thu, Jun 3 2010
By Emily Kaiser and Brian Love – Analysis
WASHINGTON/PARIS (Reuters) – Europe’s festering debt troubles are giving Americans bad flashbacks to 2008 when fears over what lurked on banks’ balance sheets paralyzed lending and nearly triggered a global depression.
Treasury Secretary Timothy Geithner wants more disclosure about the health of financial firms.
Several Federal Reserve officials said on Thursday they were keeping a wary eye on Europe’s problems to ensure they do not obstruct the lending vital to sustaining the recovery.
Some Wall Street analysts worry that Europe is not doing enough to prevent another credit catastrophe.
Money deposited overnight at the European Central Bank rose to a record high of 320 billion euros on Thursday, evidence that European banks are reluctant to lend even though the central bank has offered virtually unlimited short-term cash.
This all sounds a little too familiar to Bob Eisenbeis, chief monetary economist at Cumberland Advisors in Vineland, New Jersey, and a former Fed researcher.
“We fear that European policymakers may be about to make the same mistake U.S. policymakers made in 2008,” he said.
As the Fed did when U.S. banks balked at lending in 2008, the ECB is flooding markets with liquidity to try to drive down borrowing costs. Eisenbeis said the ECB should ask one critical question first: “Who is paying those higher rates and why?”
At issue is whether European banks are suffering from liquidity or solvency problems. Is it merely that volatile financial markets are blocking banks from normal funding channels, or are firms so overloaded with potentially bad debts that no one is willing to lend to them?
“When unlimited liquidity provisions are not enough, then it is a solvency crisis,” said Lena Komileva, head of G7 market economics at Tullett Prebon in London.
The United States answered the liquidity-or-solvency question by subjecting its largest banks to “stress tests” to determine whether they could withstand a worsening recession.
Many economists have urged Europe to fully disclose results of its own stress testing. The worry is if large capital holes are revealed, there won’t be money to fill them.
HALF THE PROBLEM
Spotting the difference between liquidity and solvency problems isn’t easy, and one can beget the other.
When creditors question a firm’s solvency, they refuse to lend, which can trigger a short-term cash access problem. Likewise, a bank facing a liquidity problem might be forced into fire sales to raise quick cash, driving down the value of its assets and making it insolvent.
The lesson learned from 2008 is that policymakers must attack both problems at once, with speed and force.
For the United States, that meant the Fed launched a series of emergency short-term lending programs, while Congress approved a $700 billion fund that was used to inject capital into the largest banks in hopes of spurring lending.
The second part was a political headache for then-Treasury Secretary Henry Paulson. The banks remained reluctant to lend, prompting howls of protest that Washington was bailing out fat-cat bankers while credit-starved Main Street suffered.
Raising a similar war chest in Europe could be even more difficult. Germany’s objections to bailing out its neighbors led to months of wrangling to secure European approval for a nearly $1 trillion euro stabilization fund.
Asking for a bank bailout fund on top of that would be a nonstarter because most European countries face an electorate “that just does not want to hear of further bailouts,” Tullett Prebon’s Komileva said.
While such a fund does not appear to be a pressing need, it could quickly become one if Europe’s debt troubles worsen.
Brendan Brown, London-based chief economist at Mitsubishi (UFJ) Securities International, put an 80 percent probability on a banking crisis in Spain, Greece and Portugal within the next six to 12 months.
G20 to endorse EU crisis strategy
(Reuters) – Finance chiefs of the world’s leading economies, meeting next week, are likely to deliver a strong endorsement of Europe’s efforts to resolve its debt crisis but announce no fresh policies to help it do so.
After several months in which Washington, Beijing and other governments pressed Europe to act more decisively in tackling the crisis, global policy makers now appear to feel a strategy with a reasonable chance of success is in place, and that it should be given time to work.
So finance ministers and central bank chiefs of the Group of Twenty nations, meeting in South Korea on June 4 and 5, are likely to praise Europe and present a united front on the crisis, hoping to reassure financial markets.
U.S. Treasury Secretary Timothy Geithner said in London on Wednesday that European governments had put together a “very strong program of reforms on the fiscal side and a very strong commitment on the financial side,” adding that implementing the plans was now key.
An official of a G20 government involved in preparing for the meeting said he did not think Europe or the G20 would announce any further policies for now, since steps to handle the crisis had just been revealed and were being carried out.
The G20 meeting is likely to emphasize that Europe will implement its plan and that markets are expected to stabilize, said the official, who declined to be named.
Early this month G20 governments were clearly worried that some European countries might not be able to summon the political will to confront their public debt problems.
U.S. President Barack Obama spoke personally to Spanish Prime Minister Jose Luis Rodriguez Zapatero to urge him to implement budget reforms. G20 officials held conference calls to discuss European policy.
Since then, Europe has come up with a two-pronged strategy. One prong is a string of national austerity schemes designed to bring state budget deficits and public debt down to safe ratios of gross domestic product in the next few years.
The most heavily indebted states on the periphery of the euro zone, Greece, Portugal, Spain and Italy, have announced austerity drives this month. Even France, a stronger country, has acted, announcing an intention to enshrine deficit-cutting in its constitution.
The other prong is emergency liquidity support from rich nations to give time for austerity steps to work; this ensures countries retain access to financing even if they lose the ability to fund themselves in the debt market, as Greece has.
In addition to a 110 billion euro bailout of Greece, European nations are creating a financial safety net for indebted countries that along with support from the International Monetary Fund could total 750 billion euros — three-quarters of the total public debt of Greece, Portugal, Ireland and Spain.
Markets are only partially reassured by this strategy, as shown by continued strains in the euro zone’s interbank money market. There are doubts over some governments’ will to stick to austerity over the long term, and over rich states’ willingness to fund indebted countries for as long as necessary.
A minority of analysts thinks austerity steps in Greece and perhaps other states cannot work since the countries are fundamentally insolvent, making eventual debt restructuring inevitable, Reuters polls show. Germany’s push for an orderly insolvency process for indebted euro zone states aims to handle this contingency.
But senior European officials have said publicly that markets are too fragile for a country to risk restructuring its debt at present without triggering a wider financial crisis.
Also, the G20 worries that Europe’s austerity policies could slow the recovery of the global economy from recession; G20 officials said this would be a major topic of discussion at next week’s meeting. Any debt restructuring in Europe could deliver a fresh blow to growth by hurting commercial banks.
So for now, the G20 appears content to throw its weight behind Europe’s effort to insulate itself from the markets with emergency loans while trying to work through its debt.
A senior U.S. monetary official, St. Louis Federal Reserve President James Bullard, seemed to endorse this approach on a visit to Stockholm on Thursday, saying Europe had “bought time” for its governments.
“If there is some kind of restructuring out there in the future, it will be down the road, probably several years at this point,” Bullard said.
Another official from a G20 government said the group was likely to deliver a message of unity and solidarity with Europe at next week’s meeting.
That by itself could help to reassure the markets, which were thrown into turmoil last week when Germany shattered an emerging global consensus on financial market regulation and unilaterally banned some forms of short-selling.
Convincing investors that the G20 was still moving toward agreement on financial regulation, and that it was at least trying to coordinate fiscal policies to protect economic growth, could reduce market instability.
“They can provide a strong signal to global markets that they mean it politically when they say they want to coordinate policy,” said Pier Carlo Padoan, chief economist at the Organization for Economic Co-operation and Development.
“A collective effort and a collective political investment from the G20 would benefit everybody.”
In April 2009, a show of unity by G20 leaders at a summit in London marked the start of markets’ recovery from the global financial crisis and may have contributed to the return of confidence. Next week’s meeting, and a G20 leaders’ summit in Toronto in late June, could conceivably have a similar effect in the European debt crisis.
Analysts believe G20 governments and central banks have a number of policy options in reserve if the crisis worsens. One is for the U.S. Federal Reserve to cut the rate it charges the European Central Bank for the dollar swaps which it revived this month to ease tensions in Europe’s money market.
Use of the swaps by commercial banks has been modest, which some traders have blamed on their price. But Bullard said this week that he believed the swaps were little used because financial strains were less serious than those in late 2008.
Another option, if weakness of the euro does too much damage to confidence in euro zone assets, would be concerted intervention by major G20 central banks to support the currency.
But so far, ECB officials have not even started issuing verbal warnings about excessive currency weakness, and they are aware that the euro’s drop to four-year lows is helping sustain economic growth in the zone.
If financial conditions deteriorate further, the ECB has options including another cut in record-low official interest rates and a massive expansion of its purchases of government bonds. But these are radical steps that could be seen as signs of panic by markets, so the central bank is expected to hold them in reserve for the foreseeable future.
(Editing by Andrew Torchia)