Can someone explain the thinking behind the Euro bail outs?

 

          When the European political classes put their expensive spin doctors behind the need for a bail out, there were two assumptions behind  what they said. Firstly, a bail out for Ireland would stop contagion to anywhere else. Secondly, a bail out for Ireland would help solve Ireland’s problems. It is difficult to understand why they believed either of these two things.

           They already knew that a bail out for Greece to stop contagion had not worked. Barely seven months after the Greek crisis we were deep into the Irish crisis. If they watched the markets they would have known that the markets were already putting pressure on Portugal as well. As the crisis is all about a country’s ability to borrow and the price it has to pay to borrow, they should watch the government debt markets. Yesterday the price of borrowing for these countries rose again, despite the bail out.

          Prior to the Irish loan Ireland could borrow in the markets at close to 8% for ten year money. It  now has to pay  over 9%. Portugal had to pay around 6% but   now has to offer over 7%. Greece still has to pay almost 12% despite its bail out on May 2nd. Yesterday even Germany experienced rising costs to borrow, with its rate going up to 2.7% from 2.5% a few days ago. There is no evidence in these rates that bail outs appease the markets. Indeed, it looks as if one bail out just eggs the market participants on to demand a bail out for another troubled sovereign.

          These rates for Greece and Ireland imply something far worse. If you thought that these governments would pay all the interest on time and repay the amount of the loan in full when stated, and still remain in the Euro, it would be sensible to sell German bonds and buy Greek or Irish ones. You would make so much more in the same common currency with “similar” sovereign risk. Over ten years you would earn a sum greater  than 90% more of your initial  investment  in extra  income on your Greek bonds than German ones.  Clearly by a big majority investors do not expect the countries under pressure to be able to meet all their obligations in full, or they expect them to leave the Euro at some point. The defenders of the Euro have a lot of work to do to reassure people and bond markets  that Greece and Ireland will honour all their debts, so that Greece and Ireland can settle back to borrowing at something closer to German rates of interest. I hasten to add I am offering no investment advice on these matters on this site.

            So why don’t  enough people believe the loan packages for Greece and Ireland will solve their problems?  They must fear that the remedy of cuts in spending  and higher taxes will not allow the economies to grow quickly enough to curb unemployment with all the cost and waste that brings, or to allow the deficit to reduce quickly enough through more buoyant tax revenues. They must be worrying that these countries could get into a vicious circle of more cuts, less tax revenue, more cuts, less tax revenue. With interest rates as high as they are the country will find an increasing proportion  of its public spending absorbed on paying interest charges, leading to the need for further cuts in other spending to try to balance the books.

             What would work better? Leaving the Euro would be the simplest solution for distressed countries, allowing them to devalue against Germany and make themselves more competitive again more quickly without so many direct wage cuts. They would still need to control their deficits by spending curbs and growing the tax revenues, as the UK and US have to do with their own floating currencies. They would have more scope to settle the pace of these changes for themselves, and to set tax rates and regulatory burdens that were attractive to enterprise and capable of fostering the faster growth in output they need.

          The little discussed issue is why the European Central Bank chose this moment to demand a reduction in its support to Irish banks and their refinancing by the impecunious Irish state.The loan we are all being asked to contribute to is basically a loan to refinance the borrowings Irish banks have been making from the ECB. Couldn’t the ECB have carried on lending enough for a bit longer, and in  private worked out a faster and better plan for tackling the problems of the Irish banks with those banks and the Irish government?  Such a solution might not have spooked the bond markets as much as their chosen course. If they go on upsetting the  bond markets as they have been doing, they might find it makes solving their currency and debt problems more difficult, not easier. In this case, careless talk costs money. Lots of money.

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35 Comments

  1. Posted November 26, 2010 at 7:34 am | Permalink

    “Indeed, it looks as if one bail out just eggs the market participants on to demand a bail out for another troubled sovereign.”

    Exactly right. Stopping contagion with a bailout is a myth

  2. Stuart Fairney
    Posted November 26, 2010 at 7:34 am | Permalink

    In fact, the best thing the Irish could do is leave the Euro and default. Then their idiot political classes would no longer be able to borrow and the Irish economy, relieved over an over big state would be recovering in no time.

  3. lifelogic
    Posted November 26, 2010 at 7:49 am | Permalink

    No I cannot explain most of what the EU do other than by a war for power and domination. There actions always seem designed to create harm to voters and businesses and enrich the parasitic sectors and hangers on such as the parasitic industries created by their rigged markets. That and draw powers to the central EU to bureaucrats in their relentless ratchet mechanism.

    Can you JR however explain why Cameron is wasting money on a happiness index other than by stating that he is clearly mad or socialist. Will he be giving every one free happiness pills or drugs on the NHS to hit his targets?

    Or in my case prescribing a nice walk, a bit of Bach/Monteverdi, a good book and some good roast beef.

    Reply: I have not seen his justification

    • Stuart Fairney
      Posted November 26, 2010 at 9:52 am | Permalink

      Life logic, add a glass of red to that list, and perhaps the love of a beautiful woman and I think you have cracked it

      • lifelogic
        Posted November 26, 2010 at 11:28 am | Permalink

        Certainly those too.

    • APL
      Posted November 26, 2010 at 2:11 pm | Permalink

      lifelogic: “wasting money on a happiness index ”

      It’s the sort of stupid touchy feelie thing some one without a strategy would invent. It’ll come back to bite him in the arse if he is still around.

      • Denis Cooper
        Posted November 27, 2010 at 11:58 am | Permalink

        Actually there is a problem with the GDP statistic because it only measures the volume of money transactions, and therefore it can be increased simply by transferring work from an unpaid to a paid basis.

        So, as a simple invented illustration: if neighbours A and B both redecorate their own houses and tend their own gardens, then they are adding nothing to GDP through their work; if they come to an informal agreement that A who hates redecorating but likes gardening will tend both gardens, while B who hates gardening but likes redecorating will do the redecoration for both houses, then they are still adding nothing to GDP through their work; but if they come to a more formal agreement under which they pay each other for their respective work, and those payments are declared, then they will both be adding to GDP even though neither is doing any more work.

        A significant part of the growth of the GDP statistic can be attributed to people now paying others to do things which they previously did for themselves, or did for their families for love rather than for money.

        • lifelogic
          Posted November 27, 2010 at 7:49 pm | Permalink

          This is true GDP is clearly not everything. But this is no reason to waste money on a happiness index. Taxes are the big incentive to DIY. They are far too high so if we have taxes at 50% + NI and 20% VAT in the loop then it can even pay a top surgeon to do his own decoration rather than to do another operation pay tax ni and vat and pay someone else to do the decoration.

          Far more efficient for each to stick to their area of expertise but with “loop tax” (from one wage to the next persons wage) at an absurd level surgeons will continue with DIY and people will have to wait for their operations and decorators remain out of work and OPs not done.

          That is yet another reason why low tax is far more efficient and raises more taxes. Cameron is however deaf to this – too busy with his happiness index stunt.

          On similar principals he should stick to PR and give JR the job of selecting the direction of travel.

  4. norman
    Posted November 26, 2010 at 8:18 am | Permalink

    I’m sure the title of this post is rhetorical, we can all answer it. If the choices are to put a sticking plaster over the bleeding stump and hope for the best or decentralise powers from Brussels but provide an actual solution with a prospect of success it’s a no-brainer for the Eurocrats – centralise, baby, centralise! The central committee of the EU knows what’s best for every oblast.

    If the question were ‘Can someone explain the rationale behind the bail outs?’ we’d all be stumped as it’s complete and utter madness.

  5. Jose
    Posted November 26, 2010 at 8:48 am | Permalink

    Don’t you think this is more a case of ‘enough is enough’ for Germany. In the scheme of things, Greece, Ireland and Portugal are unimportant; Spain and Italy are different simply because of their size.
    Actually the best thing would be for Germany to signal its intent to leave the euro; this would reduce the value of the euro for the remaining members and save them having to do anything.
    The question is whether or not Germany wants to be seen to be ‘screwing’ the whole of the eurozone even more!

  6. Brian Tomkinson
    Posted November 26, 2010 at 8:50 am | Permalink

    In circumstances such as this, where statements are made and actions taken claiming to resolve or prevent the spread of a problem but given any thought can clearly be seen to produce the opposite effect, we are normally asked to believe that it is a “cock-up” not a conspiracy. I don’t think those involved in this current episode of how to make a crisis out of a problem are so incompetent. There is a motive behind their seeming madness; all will be revealed when it suits them to let us all in on their master plan.

    • NickW
      Posted November 26, 2010 at 9:39 am | Permalink

      Brussels wants central control of all taxation and expenditure.

      It is slowly achieving it; that was the intent behind Merkel’s comments; to force more countries to take loans and cede all financial control to Brussels.

    • Posted November 27, 2010 at 12:06 am | Permalink

      Exactly, Brian. Central banks and governments normally do everything in their power to keep this sort of thing muted – out of the headlines.

      Germany and the ECB have been doing everything but.

  7. Amanda
    Posted November 26, 2010 at 8:53 am | Permalink

    Thank you for this explanation. As usual, it is clear, well written, and does help one to understand things.

    PS – to the gentleman walking with Bach in his mind and roast beef waiting at home – you are not alone, except my choice is Vaughan Williams .

    • APL
      Posted November 26, 2010 at 2:13 pm | Permalink

      I’ll put a word in for Elgar.

      • lifelogic
        Posted November 26, 2010 at 9:27 pm | Permalink

        I nearly put Vaughan Williams & Elgar too but could not spell “Vaughan” and it was getting too long a list.

  8. Jonathan Woolf
    Posted November 26, 2010 at 9:37 am | Permalink

    As you imply, the answer is that the markets have done a few simple calculations and now reckon the chances of Greece and Ireland defaulting are close to 100%. Greece’s public accounts have repeatedly been revised to show less revenues and more debt, and the true picture will continue to get worse. If Greece were a corporate entity, it would be in administration already as a total basket case.

    The Irish banks now cannot get funding other than from the ECB at below market rates and the Irish state, forced to give full guarantees of Irish bank liabilities 2 years ago by the ECB, is now being overwhelmed by those banks’ insolvent balance sheets.

    Piling more debt onto either government in the long-term is not a solution. A true friend to Ireland would have offered an alternative route and facilitated default and departure from the Euro. As Douglas Carswell has pointed out, look at Argentina for the answer.

    Ireland is only going to grow again when its economy and living standards have been crushed to the point at which it is cost competitive with Germany and other Euro countries. It will be considerably poorer and will have a considerably smaller economy and population by that time. The same goes for Greece. The human cost is a tragedy and it is shocking to see what devestation the EU elite are prepared to inflict on smaller member states to maintain their “dream” of a federal US of E. Sadly for us, the main beneficiaries in Irish politics look likely to be Sinn Fein.

    • Kenneth
      Posted November 26, 2010 at 3:25 pm | Permalink

      The human cost – you’re absolutely right.

  9. Denis Cooper
    Posted November 26, 2010 at 9:52 am | Permalink

    Maybe the ECB is getting edgy about its exposure to Ireland because it’s becoming slightly nervous about its own position.

    I recently read this claim:

    http://www.openeurope.org.uk/media-centre/summary.aspx?id=1239

    “… the ECB is more leveraged than the average hedge fund. He said the ECB is leveraged 21 times, and the Eurosystem 24 times, while the average hedge fund is only leveraged three to four times. He added, “A fall in assets of 4.2% would wipe out the reserves of the ECB balance sheet, which begs the question: who will then bail out the ECB?” He further said that if the ECB applied mark-to-market accounting, it would already be insolvent.”

    The obvious answer to that question, “who will then bail out the ECB?”, is that the national central banks would have to supply additional capital.

    http://www.ecb.int/ecb/orga/capital/html/index.en.html

    “The capital of the ECB comes from the national central banks (NCBs) of all EU Member States. It amounts to €5,760,652,402.58. The NCBs’ shares in this capital are calculated using a key which reflects the respective country’s share in the total population and gross domestic product of the EU – in equal weightings.”

    There are two tables, showing the subscriptions from euro and non-euro area national central banks respectively.

    Being outside the euro the present set contribution from the Bank of England is minimal, only €59 million, but nonetheless that might open the door for the UK to be dragged into helping to bail out the ECB on a much larger scale.

    Reply: The Fed and the Bank of England have also become very highly leveraged. All the time they can print money or seek state support all is well, subject of course to a little inflation.

  10. Mark, Edinburgh
    Posted November 26, 2010 at 10:07 am | Permalink

    A few no doubt naive thoughts on your two questions.

    1. Why now?

    Cock up theory says the ECB had a panic fit because there were signs of a run on the Irish banks which might have taken them to 50% plus of ESB liquidity. Conspiracy theory says the Germans had to do it now to determine the agenda in advance of the next round of Eurozone finance policy meetings.

    2. Why are we joining in?

    Cock up says it was always the Treasury policy to do this because at least this way we got some Eurozone cash to underwrite RBS and Lloyds without too much fuss, but actually the Treasury was weak and we could have achieved this anyway without participating. Conspiracy says the bilateral will give us important future political leverage over the Republic and maybe gets us some of the assets in UK back on the cheap through collateral. Obviously I’d hoped for conspriracy but Lenihan’s “more mature relationship” comment unfortunately perhaps suggests we are being weak on the terms – although I suppose low interest rate with a break clause and strong collateral could square the circles?

  11. GJ Wyatt
    Posted November 26, 2010 at 10:20 am | Permalink

    The thinking behind these baleful bail-outs? Isn’t every crisis an opportunity for europhiliacs? Bail-outs tie the givers and receivers more tightly together and, ominously, “we’re all in this together”. Preventing countries from devaluing to become competitive lashes them to the mast of the sinking vessel. The thinking is more eu-than-asia.

    • GJ Wyatt
      Posted November 26, 2010 at 10:26 am | Permalink

      p.s.
      Yesterday Ken Clarke on QT was still in thrall to Europe, no regrets! For an ex-chancellor to still only see the transaction cost benefits of a single currency and not the macroeconomic imbalances it has created before his very eyes is astonishing. I am led to conclude that his own successful chancellorship had less to do with him and more to do with the conditions he inherited from Norman Lamont’s “Black Wednesday”.

  12. oldtimer
    Posted November 26, 2010 at 10:20 am | Permalink

    Perhaps there is little or no thinking behind the bailouts. Alternatively there is conflicting thinking between the national (Merkel defending the interests of German taxpayers and banks) and the federal (Brussels bureaucrats defending the Euro project). These are not compatible. The bond market knows this. My conclusion is that the bailouts are not so much an expression of thinking as of panic.

  13. Acorn
    Posted November 26, 2010 at 10:34 am | Permalink

    Interesting to see what is happening in Iceland. Back in those heady days of 2005, you would get 74 Króna to the Euro. At the end of 2009 you could get 183 Króna. It is still at 152. Iceland is still paying 7% for overnight money; that’s a lot better than it was.

    The Iceland Central Bank has taken over monetary and fiscal policy. The government can’t issue debt unless the central bank says so. Sound like a future model for the Eurosystem? The ECB will command the size of Euro States budget deficits and, directly regulate cash and capital requirements; you mark my words.

    “If you’re Irish come into the parlour, there’s a welcome there for you”. Sod that Paddy, get yourself a single ticket on a 747.

  14. Mark
    Posted November 26, 2010 at 11:20 am | Permalink

    Surely it is clear: Irish external debt was $2,131bn at end Q2 2010, of which over $1.6 trillion is accounted for by the banking and shadow banking sectors. Halifax reported the value of Ireland’s ~2million+ homes as being €531bn at the peak of their property bubble, since when prices have fallen by over 50%.

    The bailouts the ECB was giving to the Irish financial sector were clearly not backed by adequate collateral, and given the size of the implicit guarantee they panicked because they realised that Ireland alone has the potential to torpedo the Euro and create a systemic pan European crisis. Like Gerry Adams, the crisis hasn’t gone away you know. In fact, the ECB have simply drawn attention to their lack of Emperor’s clothes.

  15. EJT
    Posted November 26, 2010 at 11:34 am | Permalink

    “Explain the thinking ? “. Easy. Spread the contigation so that eventual failure is EU-wide systemic. Euro ( then worth half a peanut, but hey..) survives. Simples.

  16. A.Sedgwick
    Posted November 26, 2010 at 11:56 am | Permalink

    Just as I read pollution in Asia is responsible for an alleged decrease in global warming – assumption burn coal and save the planet – so the invasion of the common sense snatchers in Brussels remains unabated. The Euro was always doomed to economic failure. It’s only chance of survival was a full political and fiscal union of Euroland – never going to happen given Europe’s entrenched history over the past millenium. Our so called Eurosceptic leaders are finding it hard/impossible to grasp the inevitable retreat from the Euro and the EU so what chance do the continental EU (cronies -ed) have of coming to terms with the demise of their empire building.
    Anyone who invests in Euro bonds even at 9% interest would be braver than me when bond default is being muted. The whole Euro saga is a dog’s dinner, a rat’s nest and the only way out for the weak economies is exit, revert to their own currencies, devalue and get on with life.

  17. edgeplate
    Posted November 26, 2010 at 2:35 pm | Permalink

    This doesn’t make any sense unless you consider the political aspects of what the Euro is about.

    It’s a contest between a political objective and the markets. The markets will win because the Euro has structural flaws. It was a an essentially political project launched without firm enough political foundations to support it. Merkel’s comments show that she thinks politics should be able to trump the markets. They tried that in the Eastern Bloc and failed.

    Merkel and friends are losing and doubling up each time and eventually I guess they’ll chance the lot on a do or die gamble.

    As for the ins and outs and the timing, it’s easy to assume these people know what they are doing and aren’t in a state of panic.

    My worry is that this government and the last haven’t shown the mettle to limit our involvement with the predictable mess that’s unfolding.

    • EJT
      Posted November 26, 2010 at 6:51 pm | Permalink

      “They tried that in the Eastern Bloc and failed. ”

      Eventually. They held it together for decades, though. Don’t underestimate the insanity of what Brussels will attempt. When they say that a breakup of the euro is unthinkable, for them it is, and their actions will reflect this.

  18. Kenneth
    Posted November 26, 2010 at 3:20 pm | Permalink

    Even if the Irish budget is passed there is a general election looming so the uncertainty will continue.

    It seems the bond markets are much more in tune with European democracy than the eu quango.

    When governments fall and new governments start to say “can’t pay, won’t pay” under the force of an angry electorate, the game will be up.

    The eu quango is paying the price for hiding from democracy.

  19. alan jutson
    Posted November 26, 2010 at 5:36 pm | Permalink

    Why is the EU funding bailouts ?

    Simple.

    When they loan or underwrite the money, they then get some control of the economy of that Country.

    Is it worth it ?.

    Not in Financial terms, but for Political ideology, they think it is.

    The more Countries they can bail out, the more they control from the Centre.

    Will it succeed ?

    Not if the Markets bet against it all.

  20. Mike G
    Posted November 27, 2010 at 8:52 am | Permalink

    I think bail-outs are pure theatre. Ireland will suffer a deflationary collapse if those austerity measures are actually implemented, and I can’t believe that even European politicos are so arrogant as not to be acutely aware of the legendary Irish propensity for civil dissent.

    Is Merkel destabilising the Euro in preparation for a German Euro exit??

    This will rescue the remaining Eurozone at a stroke with a surviving Euro at below $1, and will allow Germany to continue/expand its reflation without triggering inflation. The Irish can deal with their banks simply by modifying the guarantees to deposits only (bonds already trade at high default risk). It will also rescue countries like Latvia with huge Euro-denominated debts. Even France is happy with restored competitivness and a new position as the head of the eurozone (better the reign in the gutter….)

    Germany has the ablity to forcibly restructure its banks, and demonstrate those bondholder haircuts. German exporters can cope with a higher exchange rate, which is moderated by “preparing” the Euro first, and by those haircuts.

    The very first individual country to exit the Euro would take down the whole European (and probably UK) banking system by setting off unstoppable bank runs. A German exit is a bit like all other countries exiting simultaneously.

    I think we are in for an interesting time.

    Mike

  21. Ed the Shred
    Posted November 27, 2010 at 9:19 am | Permalink

    I’m not sure leaving the Euro would be the simplest solution John.

    Yes, sure the NEP (New Eire Pound) would devalue against the Euro, however Eire will still be shackled by its enormous Euro debt, which will have increased, relative to NEP, via the self same devaluation.

    One way Eire could solve that problem is to remove itself from the Euro AND force a haircut on its lenders by the anticipated devaluation amount. So, this way Eire walks out of the woods leaving the scary monsters in the shadows.

    Those shadows are the lenders, most of whom are European based banks, funds (e.g. pension funds) and other similar institutions which are weakened significantly by the forced haircut, necessitating help from central EU authorities (like the ECB).

    Back to square one, except Eire is now walking in the sunshine and the daisies, soon to be followed by Portugal ……

    Nope, the solution is to devalue all of the Euro, which can only achieved by Germany leaving the Euro and creating the NDM.

    But such an act would be seen in the same way as the Sudetenland annexation, now politically impossible.

    Yep, the Eur project was always seen by a significant minority of people as intrinsically nutty, and so it has come to pass. Sadly most of the tears have yet to be shed.

    Ed

    • edgeplate
      Posted November 27, 2010 at 8:54 pm | Permalink

      “Yes, sure the NEP (New Eire Pound) would devalue against the Euro, however Eire will still be shackled by its enormous Euro debt, which will have increased, relative to NEP, via the self same devaluation.”

      That assumes that the Euro would go from strength to strength if the Irish were to leave. However, the crisis doesn’t concern only the Irish, there’s also Portugal, Spain, Greece and Italy in the framc at least, all adding up to an unstable Euro. Let’s face it, in anything like its current form, the Euro is a mass of contradictions.

      In any case Ireland could default. No one would want to lend them huge funds without much thought any more, but since that’s the way this thing started, how is that a bad thing?

  22. Ed the Shred
    Posted November 28, 2010 at 8:29 am | Permalink

    Edgeplate,

    Precisely, that is why later in my post, I said “soon to be followed by Portugal ……”. There is no implied assumption that the Euro would “go from strength to strength”, exactly the opposite in fact. “Sadly most of the tears have yet to be shed.”

    Ed

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