Yesterday was another bad day as the Euro crisis rolls on. Italian borrowing rates rose again, despite recent strong intervention by the European Central Bank to keep these rates down. The German Stock market, led by the banks, fell 5% . Taxpayers in the Uk lost more money again on RBS shares. Reports of the markets speak of investor worries about the state of some European bank balance sheets given the amount of sovereign debt they own, the current weakness of several Euroland country bonds, the large issue programme needed for Italian and Spanish debt, and the general slowdown in economies as confidence wanes. The decision of the UIS authorities to sue various banks for past mortgage losses did not help either.
German politics is helping disrupt the Euro. Whilst the government probably intends to carry on with bail outs and general support for the Euro scheme, delays in putting in place the European bail out fund does not help. The German authorities are probably still reluctant to allow the ECB to print and lend too much more. Markets feel too little is being done too late. As a result the EU does not get much benefit out of all the various moves it is already making.
Last week Euroland was pleased to confirm that Italy had succeeded in raising Euro 7.7 billion in the market at a rate close to 5%. Yesterday we learnt that the ECB bought more than 13 billion euros of sovereign bonds last week to bolster the markets. This may not have all been Italian, but it does make you wonder whether this is a sensible tactic. Why doesn’t Euroland simply lend the money directly to Italy, if it is so costly to create conditions in which Italy can borrow at lower rates? The ECB is expanding its holdings of sovereign bonds very rapidly, buying Euro 22 billion in the first couple of weeks of the programme. Euroland needs to fix the underlying problem, the market scepticism about the overall levels of debt incurred by some of these countries.
I have been highlighting for a long time time the folly of weak banks propping up weak sovereigns which in turn prop up weak banks. The Regulators made banks buy larger quantities of their own country’s sovereign bonds, and regarded this as safe money which helped the banks hit their cash and capital targets. Where the country itself had weak finances, this has simply set those banks up for losses as markets sell the government bonds and force the prices down. The Regulators did not include large write downs of sovereign debts in their stress tests, further undermining confidence in the process.
Now the only way out is for the weak countries to do enough to restore confidence in their own budgets and borrowing levels. Meanwhile, the blow to confidence may mean still lower growth, which in turn weakens state finances more.