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Euro Region Leaders Statement on Resolving Crisis

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Thursday, October 27, 2011

The Eurozone summit that ended today was the fourteenth in 21 months and the markets feel that this time around the Euro leaders have found a solution and the global equity and credit markets are all rallying in unison.

The headlines were expected. Anything less than what was achieved would have been very disastrous.

As Angela Merkel put it “The world is watching Germany and Europe. They are looking to see if we are ready and able to assume our responsibilities during Europe’s worst crisis since the end of World War II,”  The announcement of the deal helped lift the euro, with investors reacting positively to the outlook for the region’s growth and single currency.

“The Eurozone has adopted a credible and ambitious response to the debt crisis,” a visibly tired French President Nicolas Sarkozy said at a news conference early in the morning in the Belgian capital.

Let us look at the achievements in the last 24 hours:

–           Europeans agreed to increase banks’ capital adequacy ratios — the amount of cash that banks must hold in reserve — up to 9 percent by June of 2012. The European Banking Authority said leading banks in 13 countries will need to come up with an additional €106.4 billion in so-called core Tier 1 capital by that date. The EBA said it based its evaluation on a sample of 70 banks across the continent. But how will the banks get all this money is a question?

–           Private-sector holders of Greek government debt will take a 50% write down on the value of their holdings. The official statement from IIF “The IIF agrees to work with Greece, euro-area authorities and the IMF to develop a concrete voluntary agreement on the firm basis of a nominal discount of 50% on notional Greek debt held by private investors” does not clarify how they are going to get it done.

–           The firepower of the European Financial Stability Facility will be increased by as much as five-fold or about €1 trillion. At present, the €440-billion fund has between €250 billion and €275 billion available after bailouts of Greece, Ireland and Portugal. The expanded EFSF may be used for credit enhancement for sovereign bonds or for setting up special purpose vehicles to finance operations. The question is where will the EUR 1 trillion in cash going to come from? The EFSF consists only of guarantees and is not a cash injection that can be used to buy the bonds. 

–           German parliament voted overwhelmingly to bar any further expansion of European bailout structures that might require a greater contribution by Germany even though they agreed to leverage the EFSF. The motion passed by German lawmakers states that the EFSF cannot be financed through the ECB and with a leveraged EFSF, the central bank will no longer need to buy bonds on the secondary market. So what happens if the EFSF cannot get the desired level of funding? Where is the backstop?

–           Signal from leaders that the European Central Bank will maintain bond purchases in the secondary market. This was really in contrast to what the Germans want. 

–           A commitment from Italy to do more to reduce its debt. Mr. Berlusconi has pledged to balance the country’s budget in 2013. But will Mr. Berlusconi be in power till then?

The question now is how will all these broad brush directions be actually implemented?

Will all the banks play ball? What about the credit-rating agencies. Can they interpret the position taken (now very public) the position taken by the European leaders really not voluntary?

How the decision was made: Euro-area leaders who called Dallara into a meeting at about midnight, forcing a break in their 10-hour summit, said that while the bond transaction will be voluntary, the decision resulted from an offer he couldn’t refuse. “It was the fiercely delivered wish by Merkel, Sarkozy, Juncker, that if a voluntary agreement with the banks was not possible, we wouldn’t resist one second to move toward a scenario of the total insolvency of Greece,” Luxembourg Prime Minister Jean-Claude Juncker told reporters. That “would have cost states a lot of money and would have ruined the banks.”

The next question is where will the EUR 1 trillion come from? The response at G20 meeting for a potential IMF solution was not encouraging. Opposing new funds for the IMF, finance ministers from the US, UK, Japan, Canada and Australia rejected the idea. Tim Geithner, US Treasury secretary said the Fund had “very substantial resources that are uncommitted”.  India, Russia and Brazil ruled out contributing to the Eurozone bailouts – though it has been reported that Chinese leaders were considering offering help. So now the European governments are trying to approach China as the main investor in the EUR 1 trillion funding.

What was very clear in the G20 meeting was that Europe needed to find their own solution to the crisis.

The agreement fell well short of offering a comprehensive solution to the financial problems facing Europe. What is very clear is that Europe, even though for its bold statements, have really not applied its resources to solve the route of the problems. There is little desire to take the steps necessary to save the structures of modern Europe. Europe needs about EUR 1.5 to 2 trillion of resources to ensure that it can withstand all risks and can help turn Europe around over time. And there are only two credible parties which can provide that degree of support in unison – ECB and Germany. But the Germans have very clearly stated in the Wednesday parliamentary vote that they will not provide any more support and using the ECB to buy the bonds is not an option. The only thing Europe has for sure is EUR 440 Million of guarantees, half of which has already been utilized.

So really .. Do we have a solution!!!! All that Europe has managed to achieve through great showmanship is as usual postpone, the pain hoping for some magic solution. As 2012 rolls in, the European sovereigns and banks have to roll over their debts who will buy their papers and at what price? The current statements only give the markets a hope which will keep the RISK – ON trade alive for a while till the markets realize that the solution is very far from the promise.

Stratfor summarizes the situation very well … “Despite failing to articulate the specifics of any credible financial resolution to Europe’s debt crisis, this was about as good of a political response as Europe could hope for given the circumstances. By alluding to — but not mandating — a restructuring, no crushing pressure has been put on the banks, yet. By not announcing the details of how the European Financial Stability Facility will be expanded, European leaders have denied critics for now the opportunity to proclaim failure. That Germany, the one country whose participation is required in any solution for Europe, is pursuing its own interests in such a brash manner does not bode well for Europe’s future.”

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Written by Sayanta Basu

October 31, 2011 at 5:05 pm

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