Posts tagged ‘bailouts’
This week saw headlines appear about the possibility of another debt crisis in Greece. A multi-billion loan repayment to the ECB is due this summer; the European Commission and the IMF – the other two members of the “troika” governing the bailout arrangement – are divided on the scale of deficit reduction required to allow funds to be released; and in the meantime the country has just gone out on a general strike today in protest at any further “austerity”.
It feels, rather sadly, just like old times.
Yet things have changed in Greece since the pandemonium over her original bailout and debt restructuring. The governing leftist coalition, Syriza, has learned through bitter experience that it really does have no option but to comply with its creditors’ requests. And while books will doubtless continue to be written on the fiscal consolidation undergone by western countries since the Great Recession it is undeniable that Greece has been getting on with the job: the budget deficit there, as a proportion of GDP, has been falling from its 2009 peak of -15.2% at almost twice the pace at which it had grown during the course of Greece’s eurozone membership up to that point. This has had the effect of containing the national debt to GDP ratio, which while eye-wateringly high (177% for 2015) has fallen since 2014 despite the suffering brought about as a result of the Greek government’s hubris a year ago. Indeed, take out the effect of the debt restructuring in 2012 and last year’s fall in this ratio was the first since 2007.
There were also tentative signs of recuperation on the broader economic front too. The European Commission’s spring economic forecast was published on Tuesday and the expected contraction in Greek GDP this year was revised down from -0.7% to -0.3%. (Growth of +2.7% is projected for 2017.) The slow turnaround in employment might have halted for now, stuck between 24%-25% over the nine months to January, but with growth beginning to return again this should continue to tick down – and remains below the peak of 28% reached three years ago.
In the meantime, bond markets in Greece and elsewhere on the eurozone periphery are not showing any sign of panic. Ten year Greek government paper is trading down towards its lows for the year to date (just over 8% at present), well short of the over 11% reached during February’s market-wide funk. Italian and Spanish bonds have been priced around the 1.5% mark in recent weeks, just like ten year gilts.
It is worth reflecting that five short years ago – when many respected commentators were confidently predicting the demise of the euro – this was unthinkable. Greece might have been in the headlines again but there is absolutely no contagion in evidence today. Today, markets are not even bothering to try taking on Mr Draghi and his “bazooka”.
It is also worth reflecting that economic growth in the eurozone as a whole is projected at +1.6% this year and +1.7% next – a breakneck pace compared to the average rate of +0.9% over the last 15 years. And talking of headlines, it drew some attention last week when data emerged to show that the zone’s GDP had finally surpassed its pre-Great Recession peak in real terms. Numbers out last month showed its deficit falling as a percentage of GDP for the sixth consecutive year in 2015 to -2.1%, and confirmed that total debt to GDP peaked a year earlier. The unemployment rate might already have dropped back below 10% this month for the first time since April 2011.
There are political risks ahead for Europe but to say that the eurozone as a whole has moved on from the debt crisis is beginning to look like an understatement. It is to be hoped that Greece manages to continue her recuperation. If she does so the “European debt crisis” will soon be history.
This week’s Budget was, of course, highly political. The Chancellor’s £250,000 reduction in the lifetime allowance for private pensions deprived his Labour opponents of a funding source nominated for one of their policies; his single announcement on inheritance tax was nothing more than an opportunity to poke fun at the Leader of the Opposition for his tax avoidance twenty years previously; and he devoted much of his speech to refuting high-profile opposition criticism of the government’s record and intentions.
There are, however, areas of economic policy over which the Labour and Conservative parties are in total agreement. They compete to paint themselves as the true pursuers of tax avoidance, especially by maleficent multinationals. And they unite in their commitment to bashing Britain’s banks.
As is well known, a coterie of lavishly-rewarded financiers were single-handedly responsible for the credit crunch and ensuing Great Recession (forcing those Northern Rock borrowers to take out 125% mortgages, for example, and then compelling investors to purchase these assets at hideously mispriced levels from the originating banks). So the special tax on bank assets which has been running since 2010 is a great moral enterprise as well as a revenue generator, and we should all applaud the Chancellor for increasing it to bring in another £900m per year.
On the other hand, some of the Budget’s fiscal arithmetic depends on raising capital from sales of the government’s stake in Lloyds Banking Group plc. Indeed, quite a lot of the UK’s employment and economic output arises from the financial services industry. It may be some time before the next knighthood is bestowed for services to banking, but despite its present position in public esteem banking does perform a service to the country.
Unfortunately the British government’s record in rescuing financial institutions compares poorly to that of the USA, for example, where the subprime mortgage market kicked things off back in 2007. In another piece of news earlier this month we saw Mr Osborne raise £500m from selling the latest slice of the UK’s stake in Lloyds. The total raised from such sales to date now amounts to £8.5bn, which may seem impressive. But the size of the Lloyds bailout was £20bn. The government still owns 23% of the bank, a stake worth about £13.2bn at the time of writing. Over the Atlantic, the US Treasury had got out of its $45bn bailout of Citigroup entirely by mid-2011, making a $13bn profit on the original amount and further gains on charging for a default protection facility which was never used. Similarly, while the US government still owns mortgage securitization behemoths Fannie Mae and Freddie Mac, which received a combined bailout of over $187bn in 2008 and still face problems, it has received back more than this amount in dividends from both companies. The UK government still owns 62% of RBS, has not sold any shares and has not received a penny back from its £46bn bailout.
RBS, of course, was not assisted by its various financial and managerial idiosyncrasies in the years preceding the crisis. But policies such as the bank levy have not helped. The great purchase protection insurance compensation bonanza – which has seen RBS alone pay out billions over the last four years – has not helped either. And the crisis-period support afforded by the Bank of England lacked the breadth and scale of the several emergency lending programmes of the Federal Reserve and slew of measures taken by the US Treasury under its Troubled Asset Relief Program.
Predictably, all this has reflected poorly on the very balance sheets whose tax rate the Chancellor has just raised. While the Big Four US banks have seen their provisions for losses on loans fall steadily since mid-2010 to about a third of their peak level, combined loss reserves at Barclays, Lloyds and RBS only started to fall a year later and are still at almost 60% of their peak.
The share of the UK’s economic activity accounted for by financial services remains relatively high, at 8%. But it has been falling slightly over the past five years. It is unfortunate, to say the least, that public policy has contributed to this effect.
There is of course an election looming. But it looks as though whatever government takes charge the banking sector can expect more of the same. That is bad for the UK economy. And even in the aftermath of the crash bank shares still make up 12.6% of the value of the FTSE 100. The American approach certainly had its flaws but it has indisputably produced a better outcome and outlook for the financial sector and for US taxpayers than our own.
“Nice banking system you got there. Be a shame if something … happened to it.”
Obviously this paraphrases the lengthy talks which took place earlier this month between the Cypriot government and the Troika – the biggest, most powerful and most ruthless gang of organised cross-border lenders in the world. But it is the case that the Troika’s three bosses (the European Commission, ECB and IMF) have their desperate borrower firmly by its heart and mind. Impertinent Cyprus initially tried to stop the Troika taking a cut of its bank deposits, voting it down in its little parliament on Tuesday. So Cyprus was given the chance to vote again (and get it right this time, or else). We shall see, probably tonight, whether Cypriot lawmakers give up some of their bank deposits in return for being allowed to keep the system as a whole propped up by Troika lending.
The idea of a government-sponsored bank raid might have seemed outlandish a few years ago. What is truly fascinating about the events of recent days, however, is the equanimity which has met them. Like the reaction to the elections in Italy we wrote about last week this surely has something to tell us about the current level of market confidence.
After all, we have been somewhere very similar before. Almost two years ago, scary demands from lenders were emerging about something called “private sector involvement” (PSI) – the idea that holders of Greek bonds should share the pain of bailing the country out with European taxpayers. Initially a German idea, it was approved by Merkozy (remember them?) and in due course officially adopted as part of the restructuring arrangements for Greek sovereign debt last year.
At the time, PSI caused chaos. As this blog observed on 8 July 2011, for example:
… Markets were blindsided on Tuesday by the decision of Moody’s, the credit rating company, to junk Portugal. Confidence was creeping back in after Athens took its austerity medicine, securing the release of emergency funds – and then, wham! – a cent off the euro, a down day for equities and a two point jump in Portugal’s 10 year yield.
From Moody’s full statement it is clear that their main concern is the possibility that private sector creditors may be expected to incur losses in a hypothetical future renegotiation of Portugal’s bailout. This concern arises from the possibility that such private sector losses will form part of the renegotiation of the bailout of Greece.
It really was pandemonium: no one knew what was going to happen, and almost everyone was panicking.
This time the background is the same. Deposit-holders have taken the place of bondholders; a dangerous precedent is being set; there is the risk of cross-border contagion in the eurozone and elsewhere; the whole plan was an unexpected surprise. But this time the panic is missing. Peripheral eurozone bond yields have not shot higher, equity markets are not materially weaker and the euro is about where it was a week ago.
Part of the explanation may lie in practicalities. Punishing Greek bondholders was a larger-scale and more arbitrary exercise than going after Cypriot banks. Cyprus is a country half the size of Wales with a population of 1.1m. It has GDP of about €18bn, and less than $1bn in gold and foreign exchange reserves. And yet it has €68bn of bank deposits, about a third of which are estimated to be of Russian origin.
This latter estimate is necessarily imprecise. The attraction of Cyprus as a banking centre lay in a combination of many things: low tax rates, an accommodating approach to offshore investment, a common law heritage which recognises the validity of trusts – and strict rules on banking secrecy. Suspicions of money laundering improprieties were raised months ago and led to an investigation of money laundering controls as a precondition of the Troika’s bailout.
Nonetheless, whatever one thinks of the properness of Cypriot banking, the sanguine response to the confiscation of bank deposits in a eurozone country is noteworthy, and especially so in the context of PSI and the reactions to it at the time.
This year’s positive start was strengthened again today by better-than-expected data on US employment. Markets have continued to shrug off the messy political situation in Italy and the UK downgrade a couple of weeks ago. For the time being at least, sentiment is taking the relative robustness of America as its example and putting the problems of Europe to one side.
We have been here before. Almost exactly a year ago we saw good data from the US on the one hand and a sovereign default from Greece on the other. At the time this blog asked: who will win the tug of war: the US, or Europe?
The answer – eventually – was the US. Greek elections last spring plunged markets into a familiar state of uncertainty, but 2012 as a whole passed without various long-awaited disasters and constructively for risk assets overall. Part of the reason for this is of course that time is a healer (as well as an essential ingredient in the transmission mechanisms of monetary policy).
In any event it seems an apposite moment to consider a few of the anniversaries we’re passing this March.
First of all, 2007. It was at the beginning of this year that movements in something called the ABX index began to draw the attention of a few structured credit professionals. This index – then a new product – tracks the prices of sub-prime mortgage-backed securities. Coupled with occasional news of fraud and other problems in the origination market, it was telling a select crowd of market pariticipants that something was going very wrong. It was a forerunner of a huge slew of CDO and other ratings downgrades in the summer which would begin to widen interest in the subject of American mortgages.
2008. By the spring of this year, some smaller banks were being bailed out (Northern Rock, Bear Stearns), confidence was sagging, recession was dawning and stock markets had begun to suspect that something was amiss. Plenty of complacency still lingered though: oil was rising to new records, RBS was still rated Aa1 and Chancellor Darling announced in his budget speech that “the British economy will continue to grow through this year and beyond.”
2009. In March this year we were all doomed. Unprecedented crisis, leading to unprecedented recession, had brought about unprecedented debt and everyone by this stage was feeling a level of pessimism which was utterly without precedent. Those few banks which had not been nationalized had stopped lending. Ratings company staff had gone into hiding. Iceland had gone bust. Stock markets had collapsed through the floor. And then the recession ended, confidence returned and the MSCI World Index ended the year 27% up.
2010. For most of the year’s early months, optimism persisted. We knew that various countries were on the verge of posting eye-wateringly abysmal budget deficits for the previous year, but the recession was over! Recovery was on the way! Then the ratings companies, who had suddenly become rather less obliging, began to suggest that it wasn’t just little out-of-the-way places like Iceland that were vulnerable to default after all. Shortly after Easter, S&P junked Greece and the first eurozone bailout programme was born.
And now, here we are. It has been an interesting few years. Not wishing to read too much into it, but it is the same markets and observers who were so slow to spot that something was wrong in the first place that have been equally cautious in more recent times of entertaining the idea that things also go right.
The same tug of war we wrote about a year ago is still being played out. The further we get from the financial crisis and its historic events, the closer the contest gets to being decided – in favour of one side or the other.
That, at least, is one prevalent view: whatever summits are convened and decisions made, Portugal, Italy, Greece and Spain will leave the eurozone. There are many who think that this is a great idea. In the long run, so they say, devaluation will improve competitiveness and thereby increase growth and employment.
Of course we know what happens to all of us in the long run. And the short run consequences are not likely to be pleasant – indeed, can be terrifying. In Iceland only four years ago, for example, the currency became unsaleable for a period and panic set in over the availability of (mostly imported) food.
There are reasons not to be quite so enthusiastic about the idea closer to home too. In the economic sense at least, Britain is not an island. There are real concerns about the effect on our own prospects that deeper uncertainty on the Continent would have.
Furthermore, there is no reason to suppose that bond markets – the most likely mechanism for triggering another sovereign bailout – would stop at chasing away the PIGS. When financing for Italy looked in greatest jeopardy last November, bond yields in France came under pressure too: ten year French bonds rose from a spread of 0.3% above their German equivalents to almost 2%. To many at the time this seemed the natural way for the crisis to spread.
The problem is that while Greece is a relatively small economy, France and Italy are giants. In absolute terms, the national debt of Greece is substantial, having risen to over €350bn by the end of last year. But for Italy and France, the numbers are over ten times bigger at more than €3.6trn. Writing down the value of debt on that scale – along the lines that Greece did this year – could really lead to “contagion”. To put the number into context, it is (on Bloomberg tracking) hundreds of billions bigger than the total writedowns suffered and capital injections required as a result of the financial crisis by all financial institutions, worldwide.
Sticking with the numbers for now, many seem not to realise that it would be nigh impossible to bail such large economies out. Between them they have around €420bn of bond and money market debt to refinance by the end of the year – and that doesn’t include the amount required to fund their budget deficits or support existing bailouts. Add in 2013 and that number almost doubles.
At the present time there isn’t much in the way of €800bn hanging off the world’s trees. The IMF’s entire gold reserves, for example, would cover payments until about the end of October – assuming that they could sell the full 2,800 tonnes at the current price. Couple this with the whole of the Fund’s emergency lending capacity – US$750bn – and you still wouldn’t quite make it to the end of next year, even assuming they would be able to raise all this from their member countries (including the $178bn supposed to be provided by various members of the European Union).
Alternatively, there are a couple of countries that have foreign currency reserve assets big enough to cover the amount – literally a couple: China and Japan. Even if the Chinese were willing to help it’s likely that they would insist on unwelcome lending criteria (they have previously insisted on more competitive trading terms with Europe and security over infrastructure, for example). And in Japan the cash isn’t really spare. They have their own debt problems, having run budget deficits every year since 1992 – in fact, a bill approved this week will see the nation’s sales tax double to 10% in an effort to contain the problem.
Which brings us from the PIGS to the elephant in the room: sovereign debt problems are not confined to Europe. In Britain our banks have about US$300bn of exposure to France – over 12% of UK GDP. We could well become another domino to fall. And as the city of Stockton, California’s decision to file for bankruptcy protection this week reminded us (the tenth municipal bankruptcy in the last four years), the US is not immune either.
So, while it must be possible that the PIGS might fly – anything is possible – it is not desirable, no matter what some say. Not least because, when it comes to sovereign debt, there are plenty of pigs beyond the Mediterranean.
“Marathon runners often say that a marathon gets especially tough and strenuous after about 35 kilometers,” Merkel told lower-house lawmakers in Berlin today … “But they also say you can last the whole course if you’re aware of the magnitude of the task from the start.”
Nowhere has her analogy proved more apt than in the country which originated the concept: Greece. And while it received negligible attention, the Greeks this week reached another milestone on their long slog towards recovery.
Amid significant popular dissatisfaction, which on Wednesday saw the seventh general strike of the year, the leader of Greece’s main opposition party gave a written commitment to the EU Commission, the Eurogroup, the ECB and the IMF that he would support the budgetary measures sought by caretaker prime minister Papademos. As a result, release of the EU component of the nation’s bailout money – thrown into jeopardy by former PM Papandreou’s referendum call – was agreed on Tuesday night. The IMF is due to approve its €2.2bn share of the €8bn aid tranche by Monday. By January, details of the debt swap with private sector creditors are due to be agreed. The exchange is projected to practically halve Greece’s deficit to 5.4% for 2012.
This amounts to quite a lot of news, but of course the Greeks aren’t the only ones who have been moving on. The bear consensus has moved on too. Concerns over Greece have in the market’s mind long been superseded. The solvency of Italy and Spain has been challenged, as well as that of France. Incredibly, there were even confused reports of a “failed” bund issue in Germany too.
Since then, coordinated action by central banks on Wednesday to improve liquidity in the European banking system has calmed nerves and sent stock markets soaring. And only yesterday, successful bond auctions in France and Spain did the same for government debt. Eurozone bond yields have fallen back substantially over the last couple of days (including, crucially, in Italy.)
Europe’s marathon is far from complete. A disappointing EU summit next week, or any number of left field events could plunge us all back into funk and gloom once again. But it is worth reminding ourselves that despite the pitch of fear and associated confidence effects, disaster has yet to strike. And it is just about possible that while the consensus worries about other things (and indeed everything), an exchange of Greek debt is successfully agreed, Greece and the other bailout countries make further progress towards solvency, other eurozone nations go on happily funding themselves with no outside assistance and the global recovery struggles resolutely on.
Like a marathon, this “muddle-through” scenario could prove protracted and painful. But there’s one thing it still doesn’t appear to be, even after the positive market moves this week: priced in.