Europe: What's happening and what's not
The basic situation this Wednesday morning, with markets yo-yoing and default insurance costs for major banks astronomic, is as follows:
1) Greece remains on the edge of default. Its revised budget deficit numbers on 3 October (8.5% deficit in 2011) were expected, but they mean any disbursement of the 8bn euro tranche by the Troika has to be done using the fig leaf of "we have plans to close the gap next year").
2) Italy's problems are equally strategic: its rating was downgraded last night by Moody's, citing three reasons:
a. Stress in the eurozone because of Greece
b. Low growth
c. Implementation risks due to political uncertainties - viz, the country is ruled by what traders in the City of London technically term "a muppet".
3) Dexia, the Belgian bank that has lent out money to the tune of 150% of Belgian GDP, is in trouble: it is set to be broken up, today or tomorrow, and its toxic debts placed in a "bad bank", similar to what happened with Northern Rock, which will then be quarantined by the French and Belgian governments.
4) The EU finance ministers met yesterday. They discussed a big recapitalisation plan for the EU banks - yes, those very banks that passed all the stress tests designed by the EU. However, there is a gap between what is needed to happen and what is actually happening. The French - whose banks are most exposed to Greece - are not prepared to move yet.
5) The International Monetary Fund has just waded in calling for the very thing the EU leaders are still mulling over: an urgent bank recapitalisation plan.
6) What are the obstacles?
a. First, the EFSF is not yet ratified. They need it to be ratified by Malta and the Netherlands.
b. Second, the EFSF is not big enough: the discussions at the IMF two weekends ago centred around the idea of a $2tn expansion of the Facility using "leverage". However, everybody immediately rowed back from this and there is some frustration in IMF, European Commission and UK government circles about the lack of specificity and urgency of such proposals (the German government is openly against).
7) What are the variables?
a. There is clearly a danger of a third European credit crunch. This graph of credit insurance costs for major European banks is signalling we may be in bigger trouble than 2008.
b. As in 2008 the form of the crunch is not simply "banks not lending to banks" but non-EU banks taking their money out of the EU banking system. There is circumstantial, anecdotal and direct briefing evidence that this is going on - though not yet critical.
c. There is also the danger of a bank run in any of the countries where savers might believe the government is not going to guarantee all their deposits: hence the move to guarantee by Belgium yesterday. Obviously the Greek government cannot bail out its own banks, and there has been a slow leakage of deposits out of the banks there - 12% in the year to August.
d. The Greek political situation: Greek politicians - cast adrift from any contact with their electors - are busily signing up to all kinds of job cuts and new taxes, but it's doubtful that they can execute this.
e. The sovereign debt crisis is also ticking away in the corner: Moody's warned it may downgrade other countries soon, which will raise the cost of borrowing for them and for their banks.
8) What is the fundamental problem? The problem is there are actually three problems - each interlinked but with separate "laws of motion":
a. There is the sovereign debt problem of busted countries - Greece, Portugal and Ireland
b. There is distress in the banking system both for banks exposed to a potential Greek default and the more long-term fear of a euro breakup
c. Growth is declining, in part because of the uncertainty, in part because the global round of stimulus after 2008 has run out.
d. The IMF and US government believe there is a fourth problem: that austerity measures are exacerbating problems a-thru-c.
9) Is there a circuit breaker? It is certainly one of those moments where we need one. But it should be remembered that, at a similar moment in 1933, the world powers failed to find one, despite Keynes famous warning that: "Our plan must be spectacular, so as to change the grey complexion of men's minds. It must apply to all countries and to all simultaneously." The result was Depression.
10) What market people believe needs to happen is a solution similar to the US TARP in 2008 - where part nationalisation, the quarantining of bad loans on the government's balance sheet, combined with $700bn spent buying bad debts stabilised the US banks until the two big ones had to be part nationalised a few weeks later.
11) The form this will probably take in Europe is that France, Germany and Benelux refinance their own banks, while the EFSF, in current or expanded form, gets pumped into the Italian banks and the Spanish cajas. You would have to combine this with some immediate market suppressive measures: like banning short selling, banning credit default swaps or introducing an immediate Tobin Tax for countries prepared to sign up (say my sources).
12) In all circumstances, most EU politicians are coming round to some form of Greek default and the failure to disburse the 8bn euros looks more and more like the EU leaving itself the option of using this tranche to trigger the event, if it can get to the end of next week with some kind of Tarp plan in place.
13) But make no mistake: whenever the markets plunge it is because traders are taking a seasoned and reasonably well-informed view that the politicians are going to fail; that events will overwhelm them, and that there'll be disorderly defaults/exits from the eurozone. And as I have said before, a southern-European exit from the eurozone takes down north European banks that look quite healthy on sovereign exposure.