Over the past 24 hours or so we have seen a new proposal rise from the ashes of all the past failed ones as to how a rescue scheme for the troubled nations in the Euro zone could be financed. I do recall describing how they have gone from silly to sillier to silliest and now realise that I may have used the epithet silliest too soon! I guess it was the silliest at the time.
Will the International Monetary Fund come to Europe’s rescue?
In essence this is the starting point for the new plan. Before I outline it this means that Europe has in effect abandoned nearly all its previous types of financial engineering and frankly that is for the best as they were flawed. So we start with the idea that the IMF can be like International Rescue for the Euro zone.
We find that there is already some support for the idea as Robert Zoellick of the World Bank has said this to Bloomberg.
If the Europeans do come together with a solution,” he said, then developing countries as well as Australia, Canada and the U.S. “would be willing to back it,” “The way they would back it is through the IMF.”
Before such fantasies start to spread too far I can think of two immediate problems with this. The initial one is that the IMF has nowhere near enough funding to do this. The secondary one is that the United States has not yet fulfilled its commitments to increase its funding to the fund from the “Saving the world” 2009 meeting so an expansion of the funds assets hits a problem too.
The European Central Bank could loan the money to the IMF
Could it?
According to its treaty yes it could.
conduct all types of banking transactions in relations with third countries and international organizations, including borrowing and lending operations
So now we have a situation where the ECB could in effect create money and hand it to the IMF and this could be used to bail out Europe.
Why would it do this rather than doing it itself?
The ECB is restricted by its constitution which means that debt monetisation and outright bailouts are prohibited but it can use the ruse of lending the money to another institution.
Could the IMF then “rescue” Europe?
Not quite. The IMF could provide loans to the countries in trouble and provide support programmes for Italy and Spain. What it cannot do is support government bond markets directly. If we look at the record so far we see that this will not do the job. The evidence of the Greek Irish and Portuguese situation is that ending primary issuance does not stop the bond markets from plunging in price and yields from soaring. Just to explain this point none of these countries are issuing any government bonds at this time and only issue much shorter -term bills. So there is no new supply which theoretically should support the underlying (secondary) bond market. Unfortunately this theoretical support simply has not worked as each bond market has plunged. The best case of the three Ireland still has a ten-year bond yield of around 8%!
So the secondary bond market needs support too it would appear but the IMF cannot do this.
The IMF could give the money to the European Financial Stability Facility
Now we have a solution to the above problem as the rules of the EFSF were recently changed to permit it to intervene in secondary bond markets. Briefly those involved may have even believed in this although I wonder if they gave any thought at all to the notion that creating a false market is supposed to be illegal. So finally we have a route where the vast resources of the ECB could be employed via the IMF to the EFSF and we would finally have the “big bazooka” required. Indeed foreign nations might now be willing to join in as up until now they had been deterred by the fact that Europe was not backing its own rescue fund and had correctly smelled a rat.
Unfortunately this is another pack of cards
As ever in the Euro zone this is very complicated leading yet again to the risk of it all unravelling. However there are problems at each stage of the process.
The ECB
The danger here is that Germany says “nein” and blocks this proposal at the start.
The IMF
As the IMF only lends to countries and the EFSF is not a country then it cannot lend to it.
Also IMF lending is always “senior” which means that in any collapse or default legally it has to be paid at the front of the queue. The problem with this has been highlighted by the private sector initiative for Greece where even a heavy haircut on bonds in non-official hands does not help much because there are relatively few of them left. So here we have yet another unstable lifeboat as more IMF intervention would lead to more fears of a repeat of this which would make private investors rush for the exit. So yet again we have a rescue vehicle which in a crisis would make things worse and not better!
Another problem: There is now a limit on ECB bond purchases
It is being widely reported that the ECB has agreed a ceiling on its current bond purchases ( of Italian debt mostly but presumably more Spanish today) of 20 billion Euros a week. Unless we are going to get a surprise when this weeks figures are announced this amount has only been exceeded twice so far. These were the initial week and the week after the Securities Markets Programme began intervening in Spain and Italy.
In my opinion we have the worst of all worlds now. Those who feel that the way the programme has spread is a mistake are letting it carry on. Those who support it appear not to realise that if you state a figure markets have a horrible habit of testing it sooner or later and currently in the Euro zone it is usually the former.
My view is that this was a tactic and that it went wrong when it became a strategy in itself. It is not a strategy and the failure has has been of Europe’s politicians who needed to back it up with a concrete plan. As the discussion above demonstrates they are still searching for one some 18 months later.
More banking stress in Europe
Last night the Federal Reserve Bank of New York revealed that as part of its central bank swap lines that it had lent an extra US $395 million to the ECB on its 84 day swap line. So there is a European bank desperate for US dollars and it cannot get them through ordinary routes.
So we are left with, who was it? And why did they have to do it?
Problems in Hungary mount
Regular readers will be aware that a theme of mine is that the amount of borrowing in foreign currencies that went on in much of Eastern Europe is another front in the problems highlighted by the credit crunch. This week such problems have been evident in Hungary in particular.
For newer readers there was an enormous surge in borrowing for mortgages and business loans in both the Swiss Franc and the Euro in the previous decade. Since then the exchange rate has moved unfavourably for this as both the Euro and particularly the Swiss Franc rose. This meant that not only the level of the debt rose but so did the monthly repayments. Now think of the effect of this on the underlying economy.
Hungary’s government in effect insured mortgage borrowers against further currency losses but even this does not look like enough. This week her currency fell to a new low of 315/16 versus the Euro but has recovered on hopes that she will get more support from the IMF. So my themes today entwine and it would appear that so many need international rescue at this time. Indeed as Hungary’s politicians are showing all the competence of their Western European colleagues (they forgot to tell their own central bank they plan to go back to the IMF) I fear the worst.
Meanwhile there must be genuine suffering amongst those with mortgages denominated in Swiss Francs and Euros. Here for newer readers is a link to an article I wrote on May 24th explaining the problem.
And in another link to the rest of today’s article this also presents problems for the banks which loaned them the money. I guess students of history will already be thinking of the Austro-Hungarian empire….
Ireland
There were two moments which you can file under comedy or tragedy this week. Firstly a copy of what appears to be Ireland’s budget was found in Germany. Secondly I am grateful to the Financial Times for this transcript of a conversation between the German FAZ newspaper and the Irish Prime Minister.
First question – “Mr Irish prime minister, do you speak German?”
Answer: “I can only say good day, but my children are learning.”
