ECB into the Breach?

Various Eurosceptics are piping up this morning, and no wonder.

Unfortunately some of the interesting stuff is behind the FT’s magnificently unstable subscription firewall, which, in an attack of paranoia, or megalomania, has decided today, as it occasionally does, to deny access to everything, even the free bits, subscriber or not. It is like something off the DiscWorld. Thank goodness it can only wall off the FT, not the entire internet, but I bet it wants to.

I might post again if the FT techies manage to tame it, but for the moment it is going to have to be a diet of Ambrose and Johnson&Boone, amplifying my post earlier today.

The money quote from Johnson and Boone is this one, on the little problem with promising a bailout plan for 2013 when the bailout needs to happen in 2010:

“Given the vulnerability of so many eurozone countries, it appears that Merkel does not understand the immediate implications of her plan. The Germans and other Europeans insist that they will provide new official financing to insolvent countries, thus keeping current bondholders whole, while simultaneously creating a new regime after 2013 under which all this debt could be easily restructured. But, as European Central Bank President Jean-Claude Trichet likes to point out, market participants are good at thinking backwards: if they can see where a Ponzi-type scheme ends, everything unravels.”


Ambrose has some more numbers that show why Portugal really, really shouldn’t be attracting attention to itself right now (see my earlier post today):

Portugal is in worse shape than Ireland. Total debt is 330pc of GDP. The current account deficit is near 12pc of GDP (while Ireland is moving into surplus). Portuguese banks rely on foreign wholesale funding to cover 40pc of assets.

The country has been trapped in perma-slump with an over-valued currency for almost a decade. Successive waves of austerity have failed to make a lasting dent on the fiscal deficit, yet have been enough to sap the authority of the ruling socialists and revive the far-Left.

Not sure how Ambrose gets to 330% of GDP as the debt number (the usual one is ~100%), but it’s the 40% wholesale foreign funding number that caught my eye. For comparison, it was a ~30% wholesale funding ratio that turned our Northern Rock from an apparently overcapitalized bank, in July 2007, to a run victim and basket case three months later, once the CP markets seized up properly. With HBOS, a much bigger mortgage bank, a 20% funding ratio merely meant that the liquidity problem took longer to turn up, and when it did, it was huge. Indeed, the problem of rolling over that debt still haunts us. So – 40% reliance on flighty foreign wholesale funding? That could turn into a credit crunch in the twinkling of an eye, even if it has been tolerated by markets for a decade.

It is hard to see how Portugal could avoid being sucked into the vortex alongside Ireland. Europe and the IMF would then face a cumulative bail-out bill of €200bn or so. That stretches the EFSF to its credible limits.

One sees that the Euro interest rate that was far too low for Ireland, and sparked the property bubble there, has been far too high for Portugal, providing a decade-long example of failed austerity policies that no-one’s paid much attention to. Oh well, at least the Euro interest rate has been just right for Germany and France…

As usual with AEP it just gets better from there..Spain:

The focus would shift instantly to Spain, where economic growth stalled to zero in the third quarter, car sales fell 38pc in October, a 5pc cut in public wages has yet to bite, and roughly 1m unsold homes are still hanging over the property market. The problem is not the Spanish state as such: the Achilles Heel is corporate debt of 137pc of GDP, and the sums owed to foreign creditors that must be rolled over each quarter.


It is far from clear what would happen if Italy was forced to provide its share of a triple bail-out for Ireland, Portugal and Spain. Italy’s public debt is already near danger point at 115pc of GDP. It is also the third-largest debt in the world after that of Japan and the US. French banks alone have $476bn of exposure to Italian debt (BIS data).

While Italy has kept a tight rein on spending, it is not in good health. Growth has stalled; industrial output fell 2.1pc in September; and the Berlusconi government is disintegrating. Four ministers are expected to resign on Monday.

That’s enough more than enough apocalypse, methinks. As we just saw with Ireland, sometimes doom gets delayed. Point is,

It is clear by now that IMF-style austerity and debt-deflation is not a workable policy for the high-debt states of peripheral Europe, since it cannot be offset by the IMF cure of devaluation. The collapse of tax revenues has caused fiscal deficits to remain stubbornly high. The real debt burden has risen further.

So where to turn? The ECB, Ambrose thinks:

The ECB is the last line of defence. It can halt the immediate Irish crisis whenever it wishes by buying Irish bonds.

Think it’s done that already…to the tune of Eur130Bn..and for my part, I think that it actually has halted the Irish crisis; pending the next bout of Irish internal politics, and assisted by the flip on bond haircuts broadcast by Seoul.

Yet instead of pulling out all the stops to save monetary union, the bank is winding down its emergency operations and draining liquidity. It is repeating the policy error it made by raising rates into the teeth of the crisis in July 2008.

…no doubt all sorts of European politicians are keen to engage the ECB in discussions about its liquidity policy…

Yes, the ECB is already propping up Ireland and Club Med by unlimited lending to local banks that then rotate into their own government debt in an internal “carry trade”. And yes, the ECB is understandably wary of crossing the fateful line from monetary to fiscal policy by funding treasury debt.

The ECB is already at least halfway through a pretty major “repurposing”, as Rebel Economist observed. The continued debt stress might just keep enough pressure on to continue that process.

More from me on bailouts, Euroinstituions, etc if the FT comes out of its sulk (will be checking in a moment), and if I get time.

Originally published at naked capitalism and reproduced here with the author’s permission.