Europe Unravels In Panic, As Fed Considers A European Bailout

Posted by John J. Xenakis Jul 19th 2011 at 2:04 pm in Economy, Europe

Over the weekend, Der Spiegel quoted former German Chancellor as saying of the current Chancellor, Angela Merkel: “Die macht mir mein Europa kaputt!” — “She is destroying my Europe.”

A highly emotional photo of Mitterand and Kohl at Verdun in 1984 (Spiegel)

When the English language version of the Spiegel article appeared on Monday, Kohl is quoted as saying the comment is “totally fabricated,” because the fault lies not with Merkel, but with Merkel’s predecessor, Gerhard Schröder. In other words, Kohl’s Europe was still being destroyed, but it’s just not Merkel who’s doing the destroying.

Kohl’s back-peddling is unlikely to convince many people. The same article accuses Merkel of having a “dangerous lack of passion for Europe”: “To her, Europe isn’t a question of war and peace but of euros and cents. Her policy so far has consisted of cheerless repair work, of plugging holes and putting out fires.”


Such is the difference between Boomers like Merkel (born 1954) and Silents like Kohl (born 1930). Kohl lived through the Great Depression, and then saw his country go to war led by what many believe is the most evil man in history, Adolf Hitler.

I last used the highly emotional picture at the beginning of this article was in “13-May-11 News — Europe’s immigration crisis strikes at heart of European Union.” The moment in 1984 was the pinnacle of Kohl’s lifetime, putting behind the bitter, genocidal wars between Germany and France, and creating a European project that would guarantee that nothing so horrible would ever happen again.

Kohl unfortunately has had the bad luck (one might say) of living too long — long enough to see his life’s achievement, HIS Europe, disintegrating right before his eyes over immigration and financial crises.

 What’s now clear to anyone is that Europe is in the throes of a full-scale financial panic — not a stock market panic (though that’s coming), but a bond panic. In the PIIGS countries (Portugal, Ireland, Italy, Greece, Spain), bond prices are falling like a stone, pushing yields (interest rates) up to 36% for Greece, and above 20% for Portugal.

And readers with a good memory may recall that the last time I talked about a full-scale panic was over a year ago, in “27-Apr-10 News — Greece’s bonds are hammered, with yields at 13%.” But that involved only Greece. This involve large sections of Europe. And it’s 20%, not 13%.

The crisis worsens measurably every day. As I recently told a friend who asked me about the Greece crisis: “Worse than yesterday, better than tomorrow.”

Bitter disagreements

There’s no solution to the problem, and everyone is looking for someone else to blame. A lot of people are claiming that the entire European project (“Kohl’s Europe”) was flawed, and those criticisms were undoubtedly in Kohl’s mind when he first blamed Merkel, and then Schröder.

The European ministers are scheduled to meet on Thursday, and the disagreements are bitter. There are numerous proposals, according to the Guardian, but they can all be boiled down into two choices:

• Have Europe’s taxpayers (especially Germany’s taxpayers) bail out Greece again, but hide the fact that you’re doing it by creating a complex tangle of bond purchases that no one can understand. This is what the European Central Bank (ECB) is demanding, and ECB president Jean-Claude Trichet is bitterly opposed to the next option.
• Have Greece default on its debt, so that investors will take the hit, rather than taxpayers, but hide the fact that you’re doing it by creating a complex tangle of bond purchases that no one can understand. This is what Germany is demanding, and Angela Merkel is bitterly opposed to the previous option. There is almost no one, not even the political élites, who are doubting that Greece will default, either now or later.

How much of a haircut?

I’ve always assumed that the “haircut” in a Greek default would be about 50-70%, meaning that investors would lose 50-70% of the amount the invested in the first place. But one rating firm, Egan-Jones Ratings, claims that the haircut will be much higher.

The manager, Sean Egan, was profiled in Barrons (Access) over the weekend, and he appeared on both CNBC and Bloomberg TV on Monday.

 According to Egan, the haircuts will approach 90%, in his CNBC interview (my transcription):

“In fact, that’s what’s not accepted in the market yet. As of six months ago, people said there’s no way an EU country could default. Now a lot of people fall into that, and so the next question is, what is the loss, given that default going to occur. We think it’s going to be about 90% in the case of Greece, and about 70% in Ireland and Portugal.”

Egan claims that he’s more accurate than Moody’s and the other ratings agencies, because they’re compensated by the banks who issue securities and have a conflict of interest, while his firm is compensated by investors who have disparate interests. His claims are backed up in the

Barron’s article by saying that he’s been much more accurate in the past than the others.

I’ve heard several analysts obliquely hint that the Fed would be the institution that bails out Europe:

Question: “The ECB is going to be the final lender for Europe, but they don’t have enough money. That’s makes us the lender of last resort. And I don’t know who bails us out. You think the fed is the lender of last resort to Europe. How does that even work?

EGAN: “It’s working right now. in a couple of different ways. one is the swap lines, and I broaden it from just the Fed to the US government because you have the IMF support, you have the swap lines, and then you have some back stopping of the CDSs. And you don’t really know about that, because that market is not completely transparent. Really, the US government is the only one that can move quickly, and then enforce to solve this problem.”

A little additional explanation: The “swap lines” refer to having the Fed purchase European bonds, as it did to bail out Wall Street banks in the past. In fact, these swap lines have been in use for a while. The IMF support refers to the 25% contribution that the U.S. makes to any IMF bailout. And backstopping CDSs (credit default swaps) is very murky, but it was a big deal in the bailout of AIG.

Egan-Jones lowered the U.S. government debt rating one notch below AAA over the weekend, and explained the decision as follows:

Question: “Will the government have a default or delay a bond payment on August 3?”
EGAN: “It’s possible, but that’s a red herring. The bigger issue in our opinion is adjusting the debt to gdp [ratio]. There are basically three problem in the US: One is that the debt to gdp is 100% or so, compared to Canada, which is a true AAA, they’re at about 35%. Second you have a dysfunctional government – you could view it that way, and I’ll explain it in a second. Third, you have the Baby Boomers who are retiring, and that increases all the retirement payments.

On the dysfunctional part, we have three undeclared wars that have cost $3 trillion. The US government’s debt has gone from $8 trillion to $14 trillion over the past 5 or 6 years. 3 of that is undeclared wars, 2 of these is from the debt crisis that hasn’t been addressed. We haven’t solved, or even addressed, what got us into this difficulty to start with.

We cut the US government debt rating over the weekend. We were the first to put a negative watch on March 1, and now we cut US government debt.”

Egan didn’t make the connection between the U.S. bailing out Europe and the need to decrease the U.S. debt to GDP ratio.

What will happen in Europe this week?

There’s actually some genuine suspense this week. There’s this meeting in Brussels on Thursday. It’s possible that the meeting will be canceled because of the bitter disagreements, but it’s also possible that one of the two solutions previously described will be agreed on.

Will Greece be allowed to default this week? It’s a genuine cliffhanger, worthy of a major suspense movie.

It would actually be enjoyable to watch this spectacle, if it weren’t for the fact we’re all part of the movie, and we’re all going to get screwed. As I’ve said before, we’re really watching a horror movie that we’re part of, but the doors of the theatre are locked, and we can’t get out.

Big Peace