The European Financial Stability Facility (EFSF) : The creation of an emergency special purpose vehicle (SPV)- On May 9th 2010 the 16 countries( Estonia joined on Jan 1 2011) that share the euro entered an agreement to form a new entity. It was incorporated in Luxembourg under Luxembourgish law on June 7th 2010. Read the rest of this article
The Greek financial minister just came out and announced the continuing receipt of aid from the IMF and ECB. And the European Financial Stability Facility (EFSF) seems to be well set up to deal with further problems. So what exactly is the EFSF? How will it help solve the current European crisis? Read the rest of this article
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Will the Canadian economy lift itself from the slump and how can it do so? Read the rest of this article
As the eurozone fiscal debt problems are yet to be solved, more negative news have appeared during the past two weeks. Greece is still struggle to receive bailouts. The May PMI for eurozone dropped sharply from previous 58 to 54.6, indicating a rather slow growth in that area.
Italy
The Italian new ECB president-to-be Mario Draghi warned his home country in the end of last month saying that Italy should return to growth. The speech was given 10 days after S&P put Italian credit on a negative watch.
Spain
Cajas or saving banks in Spain are continuing facing pressures. Protesting crowds conflicted with the police force in Barcelona last month that resulted in more than 100 injured. Then it was reported last week that the Spanish government may offer asset protection schemes that are similar to Maiden Lane to cajas, in order to keep them survive.
Portugal
The socialist has just lost the election to the opposition centre-right Social Democrats, which expresses the willingness to form a coalition government with the conservative CDS-PP party. And the country is still on the radar to watch out for any changes to the already deteriorated fiscal deficit.
Ireland
Ireland leaders came on the news last week saying that the country has enough cash to keep running until at least 2013. Many question the credibility since they had similar comments last year right before they sought for bailout.
Putting all together, it looks like the economic situation in eurozone is stable, although not showing much growth. And in the case that Greece defaults on its debt, things might change unexpectedly. As discussed in this article, “Greece default could make others junk”
“A Greek default would be highly destabilizing and would have implications for the creditworthiness of issuers across Europe,”
“This would result in more highly polarized credit worthiness and ratings among euro zone sovereigns, with the stronger countries retaining very high ratings and the weaker countries struggling to remain in investment grade,”
Our previous scenario analysis on Greece fiscal problems still stands.
Worries about Greece has recently escalated, in both Greece itself and other eurozone countries such as Germany. First on last Friday, the opposition New Democracy Party rejected the proposed tax increase by the Prime Minister George Papandreou as part of the austerity measures.
Fearing of government default that may cause bank freezing, Greece citizens started to withdraw cash from their domestic bank accounts. It was estimated some €1.5B was taken from banks in cash on last Thursday and Friday alone. Most of the withdrawals are small amounts from €2,000 to €15,000.
As discussed in the eurozone fiscal problem situations, Greece is receiving the bailout from ECB and IMF in tranches and the next trench is conditioned on meeting the fiscal targets in June. A report by German news magazine Der Spiegel, which was soon denied by Greek officials, stated that “Greece miss all agreed fiscal targets, the so-called Troika in its report , the next week to be presented, solid. The deficit in the state budget falls from higher than expected.”(google translated from German). And the PM George Papaconstantinou said:
“Negotiations continue and will be completed in the next few days. We have every reason to believe the report will be positive for the country,”
If tax increase is not approved, and Greece were to meet Fiscal Targets, selling state-owned properties seemed to be the only quick fix. However, employees in the state companies to be privatized are showing their anger by going on strike and protest on the streets.
While it is too early to conclude that Greece will default on their debt immediately after bailout is halted, it will bring about another round of unrest both on the street and the market if Greece is deemed to be missing the fiscal targets for bailouts.
The fiscal deficit problems in Eurozone was discussed not long ago, yet Greece comes back to the headlines again. It was indeed not surprising that the Finance Minister George Papaconstantinou talked about extensions on repayment of EU/IMF loans. It was neither very surprising that the S&P rating is cut again. Greece has not really shown fiscal discipline and Greek sovereign bonds were below investment grade long time prior to that. What happened just updated the development of this government debt problem.
It was reported on May 10th that Greece is asking ECB/IMF for another €60B of bailout, which is an expectation of what their June audit will show. Also there was talk of Greece leaving the EURO currency. These reports was soon denied by an anonymous Greek official.
On the next day, massive riot hit the streets again in Athens, to protest against the government’s harsh austerity measures. However, as dictated by the terms in the €110B bailout package, Greece has to retain its austerity measures in order to continue receive money from the bailout package. The IMF terms will also likely disable Greece from new bond issuance starting next year.
Discussions of the need of Greek debt restructure continues, given the current situation, the €1.63B bonds sold on May 10 is far from sufficient to ensure the cash flow. Given that Greece is having problems raising debt in the private markets to cover its fiscal deficit and unless the E will continue to finance Greece’s fiscal deficits there will be a default of some type. The financial institutions holding Greek bonds are worrying about asset write-downs which there weak balance sheets cannot afford.
North America also funding Greece
North America is also involved because the IMF bailout fund is partially from North America. It is doubtful that the IMF will support Greece without a resolution from the Eurozone.
The future outcome will definitely be important for repercussions of the other fiscally weak Eurozone countries.
WHEN DID THIS BECOME AN ISSUE?
In December 2009, the financial press started to focus on the VERY HIGH fiscal deficits of some Eurozone countries, and nicknamed them PIIGS (Portugal, Ireland, Italy, Greece and Spain). It wasn’t until six months later (May 2010) that the world investment markets reacted. This was the largest challenge since the EURO creation and the original agreement outlining the member countries’ obligations. It was not the first time the terms of the agreement were tested – the fiscal guidelines have been relaxed several times – but this was the first time when a member country was in danger of defaulting on their bonds.
GREECE THE FIRST CASUALTY
Greece appeared in the headlines first. They had to restate their 2009 reported deficit several times. They originally reported a 2009 deficit estimate of 3.7% in Apr 2009, increased to 12.9% in Dec 2009, and 13.6% in Apr 2010. The adjustment was very large and raised credibility questions (this was not the first time). In April 2010, ECB and IMF had emergency meetings and agreed on a €110bn bailout package. The commitment would be transferred in several trenches, contingent on the effectiveness of Greece’s austerity plan. Seeing that this might not be an isolated occurrence, the European Financial Stability Facility (EFSF) was formed.
When analyzing Greece’s debt requirement, it is interesting to note that even if Greece did not pay any interest payments on its debt in 2010, it was still be in a net deficit position and borrowed 4% of GDP more through bond issuing. Also current yields have skyrocketed with bond yield exceeding 20% (on 2-year as of Apr 18). The austerity plan has met resistances from the public and the economic environment has deteriorated.
The next trench of bailout will be conditioned on the progress report due in June, and sources expect restructure of the sovereign debt before the end of summer.
IRELAND HAD TO SAVE THE BANKS
Ireland was the next who required official help. Within half a year after passing the ECB bank stress test, Allied Irish Bank and Bank of Ireland suddenly needed a bailout, thus made Ireland the first to use the EFSF. At the time Ireland was suffering from a major recession. Unemployment rose sharply and hit the highest since after the recession in the early 90s, and tax revenue were falling. The fiscal situation was already strained. The government of Ireland decided to nationalize the banks and take on additional debt of the banks. The bailout cost of 43% of GDP was too much for the government to handle. After receiving assistance their situation has stabilized.
PORTUGAL VOTES NO TO AUSTERITY
Portugal’s Prime Minister Jose Socrates had insisted that Portugal would not require help to solve its fiscal problems. In February 2011, the ECB acted swiftly to stabilize the Portuguese government bond yield by buying the bonds in the open market. In late March, people expected Portugal to survive through a viable austerity plan. However, the plan presented by Mr. Socrates to the parliament for a vote was rejected by all opposition parties. The PM resigned 2 hours after.
In early April 2011, Portuguese officials started to negotiate with the EU for assistance on the short term cash flow problems. Officials were loathed to call it a bailout until Mr. Socrates confirmed the decision. The IMF has estimated the bailout package to be €73.9bn.
THE EUROZONE STRONGER TOGETHER THAN APART – CREATION OF THE STABILITY MECHANISM
All the countries in the Eurozone benefit from currency stability. Since its introduction, the euro has been well received around the world and it is a legitimate contender as a major reserve currency. Currently, all of the governments that use the euro within their borders are committed to it. And even more countries in the European Union want to adopt it.
WHY DOES THIS PROBLEM EXIST- IS THERE A SOLUTION?
Because the countries are using a shared currency and monetary policy, which they do not control, they are required to run a more rigid fiscal policy. When fiscal policy is abused, it is very difficult to rectify without major consequences to the economy. At this time, there could be a major desire to abandon the euro and switch to in house monetary policies, which will rectify the fiscal situation without the same pain. If the Eurozone wants to stay together, there has to be a system of wealth transfer from the stronger countries to the weaker. And first, the strong countries will not be willing to support the weak countries without assurances of payback. But eventually, there will have to be concessions. Looking at history, we can use similar circumstances in the United States and Canada when they were amalgamating states and provinces. They had to develop a system where the federal government supports the members of the country. This is going to be a major challenge to the euro because the member countries have such diverse histories and cherish their individuality.
SHORT TERM OUTLOOK FOR THE NEXT QUARTER (2011Q2)
Currently, all of the countries in the Eurozone want the euro to succeed. This will result in compromises by the member countries to resolve any questions or any doubts which might arise for some time. The ultimate goal is to show unified support. Since the problems started to arise in 2009, the Eurozone has established this confidence with the investment community. But the future is not assured. Finland just had an election which gave more support to an anti-euro party. There could also be a major change after ECB President Jean-Claude Trichet’s term expires in late 2011.
To date, these problems have not been hurting the investment market, and seem not to be a major factor in the near future. Greece, Portugal and Ireland are all small countries whom together account for less than 8% of Eurozone GDP. Currently there is a lot of talks of Greek bond default, and different plans for restructuring their debt. As long as the restructuring does not cause a write down on the books of insurance companies and banks, the effect will probably be mute. Greek debt is a small portion of the outstanding debts on the balance sheets of banks and insurance companies outside of Greece, but it sends a signal of how other countries’ debt default will be handled. Werner Hoyer, German Foreign Minister for European affairs said “A haircut or a restructuring of the debt would not be a disaster,” “if Greece’s creditors agreed that talks with the Greek government would be helpful toward a restructuring of the debt, then of course this would be supported by us.”
It will be the larger countries that will create more concerns, such as Spain, Italy, or even France. Spanish banks are under pressure from mortgage backed assets. Can the stability mechanism support larger bailouts?
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