Friday, February 5, 2010

Greece, Spain, and the Euro Trojan Horse

We have written and commented on Greece and Spain as well as Iceland, Italy, Ireland, and Portugal.  This week saw a rash of sovereign debt credit default swap speculation driving the costs of CDS for Greece, Spain, and Portugal higher as well as other countries, including the United States.  The speculation is another example of the need for derivatives regulation and a transparent trading and recording market.  The fear of sovereign debt default by a European Union Euro currency nation is a wasted exercise, unless you are profiting from the same type of unregulated speculation which helped bring Bear Stearns and Lehman down and drove Merrill Lynch and Morgan Stanley into larger, more systemically dangerous relationships.

The problems in Greece and Spain are vastly different, but both are derived from the Euro.  Greece and Spain both suffer from a competitiveness gap in that their Euro exchange rate is overvalued while surplus exporting countries, like Germany, have an undervalued exchange rate.  Greece has tourism, shipping, agriculture, and banking, with an aggressive exposure to emerging Eastern Europe, as economic engines combined with an aging demographic population and falling birth rate.  The immediately prior Greek government also soured relations with the EU by supplying economic information which was not correct leaving the current Greek government with testy EU demands.  Given the lack of industrial economic growth and exports, Greece has less immediate but longer term problems.

Spain has more immediate problems.  The Euro caused negative interest rates in Spain from 2002 to 2006, which caused massive economic overheating during which Spain became the largest issuer of covered bonds in Europe driven by the mortgage market. These Cedulas are secured by mortgage loans on domestic properties issued by any Spanish bank or savings institution.  In some instances, they are participation securitizations in which the holder is entitled to only a percentage participation.  Under Spanish law, unlike the Phandbriefe in Germany, Spain undertook the largest departure from the German bond model and it is less demonstrable that investors could lay hands on the assets in the event of issuing institution insolvency.  When the current global financial crisis caused lending to cease in Spain in August of 2008, it was as if the whole financial system had seized up.  The question has become to what extent the government may have to act if the individual issuing institutions do not have the ability to make these covered bonds good in the future.  This would be a serious European problem, because, in over 200 years no Phandbriefe has ever defaulted. The financial seizure in the financial sector and the bursting of the mortgage asset bubble has created significant unemployment. Nationally, unemployment is in excess of 19% and youth unemployment (16+) is 44.5%.  The unemployment situation places a much more immediate pressure on the Spanish problem.

If Spain or Greece had their own currency, they would have more ability to apply fiscal and monetary policies to stimulate their economies and create employment. The speculative attack on their ability to issue bonds at reasonable yields is an unwarranted attack on their sovereignty, because the actual target of the attack is the Euro and is fueled by EU rules which require member nations to have only 3% debt to GDP without respect to the Euro competitiveness gap or internal national economic conditions.  Both countries should be increasing public spending to target economic growth and job creation, but they are being forced by the EU to reduce their budget deficits.  These enforced budget austerity programs are both reducing public sector wages.  This will fuel deflation.  Prior to the global financial crisis, Spain had a surplus.  The 2010 deficit estimate is 9.8% of GDP. 7.5% in 2011, 5.3% in 2012 with an austerity program which will cut $70.1 billion.  Despite the high unemployment, the people of Spain have not yet realized the fate to which the EU is consigning them.

In Greece, it is another story.  General strikes are already planned for February 10 and 24.  It is estimated that the EU enforced austerity program will accelerate the decline in Greek GDP from <1.7%>; to <7%>;.  Greek unemployment, presently 8.3%, will increase by another 300,000 as a direct result.  Does the EU really want to promote social disturbances in Greece and have them spread to Spain and then to Portugal, with its politically divided government?  Greece is raising its fuel tax.  Lower public spending, higher taxes, lower wages, and increasing unemployment are not the economic drivers the EU should be forcing on these countries.  Greece needs more budgetary control given the historical level of corruption which means spending should be efficiently targeted to spur economic growth and jobs.  Despite those deficit hawks who would drive countries into depression, public debt is not the same as private debt and it is private debt fueled by unregulated derivatives speculation which has caused this global financial crisis.  To turn our focus away from needed financial regulatory reform to an an unwarranted sovereign debt default fear which has been promoted by derivatives speculators is intolerable.  Are we to allow the derivatives speculators to become the new terrorist overlords?

There has been much gratuitous talk of bailing out Greece and how the EU will not bail out any member nation.  In fact, the legal authority exists for the EU to bail out a member nation, but it is not necessary.  All that is required is that the EU provide loans which will target economic growth and jobs and revise its monetary policies to more appropriately take into consideration the competitiveness gap of the Euro exchange and the actual internal economic conditions of each member country.  To force a debt to GDP rule down a countries throat when it needs to increase public spending is asking for economic turmoil.  To the extent, that some countries budget deficits have been inefficiently expanded by corruption or incompetence is an issue which needs to be addressed by targeted, efficient public spending.  The problem with the EU providing loans is the surplus EU countries, like Germany , who benefit from the Euro competitiveness gap, are not going to want to share in the risk.

Yet, there are European rumors that large French and German banks have significant exposure to Greek debt. Greek banks have used Greek debt as collateral on loans from (repos)  the ECB, but the ECB, at the end of 2010, will no longer accept collateral with less than an A credit rating, which Greek bonds no longer have.  Currently, there is every expectation that market pressures will continue and, perhaps, grow.  All of this makes it all the more important for the EU and ECB to quickly formulate a loan plan for targeted spending in Greece and Spain, as well as any other Euro competitiveness gap country with similar problems, such as Portugal and Italy.

Much has been made of the IMF providing money to Greece as the preferred process and the IMF has indicated it would be willing to work with Greece, but Greece has not approached the IMF.  In as much as these problems in Greece and Spain have been at least partially caused by the Euro, I do not see the EU wanting the IMF to help Greece.  Additionally, the EU and the ECB need to face up to the need of the Euro to be responsive to the economic conditions of the member nations and the need to address the Euro competitiveness gap.  The EU has studied the possibility of issuing EU bonds since at least 2000 and this current situation is just the reason the EU and ECB should quickly develop an EU bond program and begin issuing EU bonds.

If EU member nations using the Euro are not able to apply fiscal and monetary policy, because they no longer have a national currency, then the EU and the ECB need to develop the monetary policy tools to allow their member nations to apply appropriate fiscal policies to best serve their citizens.

The possibility of default is speculative hoopla and deficit hawk destructiveness.  While deficits need to be controlled,  targeted public spending grows an economy and the withdrawal of public spending constricts an economy.  At the present time, Greece and Spain need targeted spending and financial regulatory reform.  Default is not a plausible option given the domino effect.

Note:  I am aware that the EU currency is spelled euro and not capitalized, but I have chosen to capitalize it to emphasize that it is a currency of 16 nations and, as such, it faces the problems a global currency would have to resolve.


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9 comments:

  1. The same argument would apply to a California or a Texas wouldn't it? Do you think that would still be the road to happiness?

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  2. Very good piece. The author makes the excellent point that those who cry the loudest about sovereign debt (deficit hawks) are the same people who favor unregulated wild speculation and leverage which actualy caused the global meltdown.

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  3. The fear of a sovereign debt default is quite warranted. The rules have always been clear: if you join the euro, you will have to be able to withstand a downturn without breaching the deficit and debt limits. Greece chose to flaunt the prescriptions of that rule... and currently pays the price. Another set of loans will not lessen the burden of the already existing debt and the still looming pension payments.

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  4. Just a formal thing. The german word "Phandebriefe" is correctly spelled "Pfandbriefe".

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  5. Comment posted by MG 9:25 AM edited to remove link to his blog (this was evidently his post today)and with respect to his "systemic risk implications" reference the link was to the zerohedge flow charting dominoes link in my post. I welcome all comments, but I do not make any comments on other blogs. Mg's comment, as posted, was a link to his blog only.

    His comments:
    Sovereign debts: markets for lemons and Ponzi schemes

    The Greek debt crisis prompts an interesting question: are sovereign debt markets, markets for lemons?

    In the case of Greece there is more than just some information asymmetries as national accounts were fudged. Greece is also rattled by some 'hidden debt' controversy.

    Since foreign banks own some 70% of Greek debt, it appears clear that "market structures helped overcome information asymmetries and sustained the development of Greece sovereign debt", under very peculiar conditions.

    Leading banks known for their reputation helped Greece to place bonds abroad granting it favourable borrowing terms in the euro-zone. They sustained the development of the Greek sovereign debt and now they may be victims of their own underwriting of Greek debt.
    The Greek conspiracy theory is interesting. It would appear that bailing out of Greece has the same level of moral hazard and systemic risk implications for the financial markets of Lehman and AIG crisis.

    Is history repeating itself as the financial crisis is not over?

    Bail out Greece to save its banking counterparts and avoid snowball effects in the financial markets, including the famous Credit Default Swap one?

    I still contend that the roll over of sovereign and public debt is a kind of Ponzi scheme not simple hysteria. When enough of government debt clients look to sell or place, at the same time, their bonds and some of their apparently well-performing sovereign assets, also to help offset other losses, the scam collapse and a country may risk the default (via self fulfilling prophecy as well).

    Moreover the dumping of government bonds makes the cost of any adjustment higher for a country as fiscal deficit increases just for the higher interest rate to be paid on the debt.

    Who are going to buy all governments' securities and continue to lend to governments?

    links within body:

    hidden debt
    http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/7140233/Greece-rattled-by-hidden-debt-controversy.html

    market structures
    http://www.princeton.edu/~pcglobal/conferences/globdem/papers/Bonds_and_Brands14.pdf

    Credit default Swap one
    http://ftalphaville.ft.com/blog/2010/01/29/137341/whos-selling-greek-cds/

    simple hysteria
    http://baselinescenario.com/2009/11/20/government-debt-hysteria/

    Greek conspiracy
    http://www.ft.com/cms/s/0/da5c40da-1283-11df-a611-00144feab49a.html?nclick_check=1

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  6. I appreciate the Phandbriefe correction. I thought I had double checked it, but it got past me and is now corrected.

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  7. Removing a selected link makes it more curious!
    Plus it assumes on your part that the reader has no critical thinking to discern the fallacy of any rebuttal of any issue legitemately raised.

    Now I am more than curious to know what was the reason it was removed b/c you don't give fact based reasons on issue in question other than 'it was link to his blog'

    Let me make up my own opinion of that!

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  8. On the contrary, the comment as posted was a link to a post on his blog only and only a link.

    I have provided the entire text (from that link) which the commenter purposefully did not post as a comment.

    It is very bad etiquette to make a self-serving link to one's own blog.

    I never leave comments on other blogs and, if I have something to communicate to another blogger, I communicate directly with them.

    This area is for comments, not advertising trips.

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  9. The Greek government is in this mess, precisely because carefully targeted public spending is beyond its ability. Greeks will not accept outside limits on their government spending, and French and German taxpayers will not accept a blank check to the drunken sailor Greek government (apologies to drunken sailors). Greece will eventually default on its debt, and the other governments of the Euro area will then have to assess whether to bail out their respective banks who will be in line to take that hit. But the bailout will be to those banks, and not the Greek government. It might not happen this year, but it will happen sooner than people think, because no government without a printing press can borrow forever. And when Greece joined the Euro, they gave up their printing press.

    Bottom line, debt that cannot be repaid will not be repaid.

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