Europe latest bailout scheme is as flawed as its predecessors and Hungary badly needs help

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 danger here is that Germany says “nein” and blocks this proposal at the start.


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….


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.”

This entry was posted in Economy, Euro zone Crisis, General Economics, Quantitative Easing and Extraordinary Monetary Measures, Yield. Bookmark the permalink.
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  • Bkester

    I don’t know much about the operations of the IMF but I’m under the (possibly mistaken) impression that the organisation almost always demands currency devaluation as part of a rescue package with a view to improving competitiveness.  I’ll be interested to see how this will be achieved in Greece, Portugal, Spain etc.

  • JW

    Shaun, do you not think its worth digging below the ‘national debt’ issue to find who is actually driving these changes in bond values? Is it not likely that MF Global was but the tip of an iceberg? That the very same ( mainly US institutions) that brought us the US mortgage scam are doing exactly the same thing with a new ‘sub-prime’ ie EZ bonds? The initial banking debt has been added to already high national debt everywhere in the western world. The next stage is the complete socialisation of this debt by monetisation ( inflation), already well under way in US and UK. However in EZ there has been two additional factors. Firstly the brokers/traders can play the repo and CDS game ( exactly as they did with sub-prime mortgages); and secondly Germany refuses to monetise the debt. Its no wonder the US is getting nervous, its no longer AIG sitting with the CDS exposure its now Goldman and JP Morgan.
    The actions of NY FED you identified are a symptom of credit lines etc on the brink again just like 07/08. When she goes this time there are no government bail-outs available, all used up. It probably needs to happen , but its going to be very ugly.

  • Anonymous

    Shaun – forgive the ignorance, but what part if any do the IMF Special Drawing Rights have within the context of the incredible plan (?) you have outlined? 

  • Anonymous

    Estonia is an example of how an internal devaluation can be done. Helps that Estonia’s politicians are relatively honest. Estonia’s PM took a 20% pay cut. This makes austerity  easier to tolerate.

  • JW

    Estonia has the kroon, not in the EZ. Besides , if you are one of the unemployed ( high teens) or left the country ( estimated at 20%) you might have a different view. Estonia currently has lost about 25% of GDP since 2007. This is certainly an ‘example’, but not a very nice one for many involved. Still the Finnish and Swedish Banks are happy as are their ‘vendor’ exporters, debts paid. So IMF work done to spec.

  • Anonymous

    Estonia joined the eurozone 1 Jan 2011.

    Due to convergence criteria Estonia could not allow the Kroon to devalue and had to use an internal devaluation. Yes this has been a painful readjustment, please tell me your less painful solution.

     A devalued currency has a similar effect on real wages. Sterling has devalued 20% against the euro compared to 2007 and just look at how much more expensive food and petrol are.

    Spain’s unemployment is over 20% and Greek unemployment is nearing 20%. The Eurozone’s extend and pretend is not nice for those involved. And they are still sinking where Estonia is improving.

  • JW

    Apologies for missing the 1 Jan date.
    However I don’t understand the logic of your last two sentences.
    As the kroon has been pegged to the Euro for some time, the ‘pain’ is little to do with currency convergence but much more to do with the inbalance of the economy.
    The loss of people and GDP were inflicted by the IMF rebalancing to save the creditors in Sweden and Finland. It may have been triggered by the global credit problems in 2007 but was inflicted to a great degree to ensure overseas debts were paid.
    So yes, the pain was magnified because they couldn’t devalue their currency. The question remains, which is better, or rather less worse? And for which part of the population? The same issues face Greece and Portugal.

  • Anonymous

    Hi JW

    You are asking a few questions in one go I think but let me pick out a couple of points and answer them.

    1. The collapse of MF Global is an issue on many fronts. Organisations so close to central banks used to be closely supervised by them and it was called the “eyebrows of the Governor of the Bank of England” in the UK some years ago. So yet again the new system has shown a clear flaw.

    For me there is the issue of “client money” as I worked in futures/options departments and we believed that such money was held in segregated accounts which were untouchable. It is clear that they were not untouchable at MF Global which is another system failure. For those that are unaware of what took place it would appear that segregated accounts were indeed dipped into and used.

    It also challenges the broking industry as if clients funds can be dipped into then not many will be willing to leave money with them….

    2. I think that the NY Federal Reserve is still there with its fx liquidity swaps and I would not be surprised if they are called on in major amounts again before this crisis is over.

  • Anonymous

    Hi Ray

    SDRs are an area which is little understood and they operate in something of a grey area which suits our political leaders for obvious reasons.

    They are the IMF’s version of a currency although I do not know if any shop accepts them!

    As of yesterday one SDR was worth US $1.56922 although it is now defined against 5 currencies and not just the dollar. For US readers there has been inflation here as it used to be worth only one dollar.

    From the IMF website

    “The SDR is an international reserve asset, created by the IMF in 1969 to supplement its member countries’ official reserves. Its value is based on a basket of four key international currencies, and SDRs can be exchanged for freely usable currencies. With a general SDR allocation that took effect on August 28 and a special allocation on September 9, 2009, the amount of SDRs increased from SDR 21.4 billion to around SDR 204 billion ”

    So they have US $320 billion and there we get our answer. Maybe a role but nowhere near enough to bail out even Italy let alone any others.

    Care may be needed with the IMF ‘s arithmetic too as there are five not four currencies in the SDR basket (It gets around this by arguing that the other 4 are valued in US dollars).

    Oh and if you take the mainstream media view that there is no risk in all of this then there is the question what is it all backed by? If it is backed then there must be a risk….

  • Anonymous

    Shaun – thank you for your response that clarifies my thinking. Seems to me there’s a huge amount of “funny money” circulating and almost all of it is most certainly NOT risk-free!!

  • Anonymous

    1 : Convergence criteria required Estonia to keep the Kroon / Euro exchange rate near constant. This meant the economic readjustment could not be obscured by devaluation. You take a hefty pay cut and be glad you still have a job.

    2 : A currency devaluation would have a similar effect. While you do not get a 20% pay cut, 20% price increases on goods will lower your purchasing power.

    3 : I think the Spanish and Greeks are suffering similarly harsh drops in income and rises in unemployment. Estonia is not unique.

    4 : The Estonians are seeing progress with their suffering, where the euro bailout austerity causes Greece suffering without progress.

  • Anonymous

    If the client money accounts have been “dipped into” then the responsible parties should face prosecution …..

  • Mr_Kowalski555

    America’s best economist interviewed by a rather obnoxious BBC radio gal trying to pin him as an evil speculator– but there are some of his predictions going forward:

  • JW

    ‘The Estonians’ who are benefiting a small percentage of the remaining population. The same is true in Ireland. The ‘economic indicators’ may be looking slightly better, but that disguises the suffering of the vast majority of the population. You are correct  in that Greek, Spanish and Italians will be added to the sacrifice on the altar of IMF ‘progress’.
    Wonderful! 90% of the population ( at least) who had nothing whatsoever to do with the decisions taken in their name end up paying for the mess for years to come. Welcome to the 3rd world.

  • Anonymous

    Hi Mr.K

    Thank you I particularly enjoyed the “German Pope Italian head of the ECB line”….

    I think that Sarah Montague (who presents Radio four’s Today programme over here) misunderstood the purpose of the programme which was to ask hard questions and not to act “hard”. Accordingly she missed the chance to ask difficult questions of  a man who actually answered the questions he was asked only for her to often talk over him.

  • Sean Fernyhough

    Financial innovation causing problems in Hungary.  It is simple and boring to say it but you need to settle your liabilities/ meet your commitments in the same currency you receive your income in.  The Hungarian government is now spending money – it probably hasn’t got – guaranteeeing borrowers who have bought (and probably been sold) a product that is, if not a ticking time bomb, then a improvised roadside devise ready to blow up as their finances walk past it. 

  • ExpatInBG

     These countries are in crisis because their politicians mismanaged and overspent. I think the remaining options are
    Bad : Austerity

    Worse : IMF recovery program

    Worst : Economic disintegration, currency collapse, starvation and riots.

    What solutions can you suggest ?

  • JW

    Germany has done pretty well from the Euro, especially with ECB helping them out with ‘German-centric’ policies earlier.
    Overall the EZ isn’t in too bad a shape, so its time for some ‘transfers’.
    Either Germany has to provide direct state transfers or it has to allow monetary expansion and the risk of inflation.
    Its too easy to lump the PIIGS together and say they all mismanaged/overspent. Greece is a basket case, but there are many more complicated reasons for the others. Until its property market blew up , financed largely from external banks, Spain’s economy was doing OK, indeed better than Germany on some measures ( remember Germany has over 80% debt, its not a paragon of virtue!).