Sunday, July 8, 2012


Con todas las crisis nacionales y europeas ganando en virulencia cada día, resulta necesario recordar algunas cuestiones esenciales y decisivas de la continuidad europea en riesgo:


Paul de Grauwe:

"The ESM has financial resources amounting to €500 billion. Compare this with the total government bonds outstanding of close to €2,000 billion in Italy and of about €800 billion in Spain and it is immediately evident that the ESM will be unable to stem a crisis involving one of these two countries, let alone the two countries together.
In fact it is worse. As soon as the ESM starts intervening, it will quickly destabilise the government bond markets in these two countries. The reason is the following.
Suppose a new movement of fear and panic, triggered for example by the deepening recession in Spain, pushes up the Spanish government bond rate again.
  • To stem the tide the ESM starts buying Spanish bonds. Suppose it buys €200 billion worth of Spanish bonds.
At the end of the operation it will be clear for everybody that the ESM has seen its resources decline from €500 billion to €300 billion. Less will be left over to face new crises.
  • Investors will start forecasting the moment when the ESM will run out of cash.
They will then do what one expects from clever people.
  • They will sell bonds now rather than later.
The reason is not difficult to see. Anticipating the moment the ESM runs out of cash forcing it to stop its intervention, they expect bond prices to crash. To prevent making large losses, they will have an incentive to bring their bond sales forward to the present rather than wait until the losses are incurred. Thus the interventions by the ESM will trigger crises rather than avoid them.
This feature is well-known from the literature on foreign exchange crises. The classic Krugman model, for example, has the same features (Krugman 1969, see also Obstfeld 1994). A central bank that pegs the exchange rate and has a finite stock of international reserves to defend its currency against speculative attacks faces the same problem. At some point, the stock of reserves is depleted and the central bank has to stop defending the currency. Speculators do not wait for that moment to happen. They set in motion their speculative sales of the currency much before the moment of depletion, triggering a self-fulfilling crisis.

Only the ECB can stabilise bond markets

The only way to stabilise the government bond markets is to involve the ECB, either indirectly by giving a banking license to the ESM so that it can draw on the resources of the ECB (see Gros and Mayer 2010), or by direct interventions by the ECB. But the European leaders were unable (unwilling) to take that necessary step to stabilise the Eurozone.
The ECB is the only institution that can prevent panic in the sovereign bond markets from pushing countries into a bad equilibrium, because as a money-creating institution it has an infinite capacity to buy government bonds. The fact that resources are infinite is key to be able to stabilise bond rates. It is the only way to gain credibility in the market.


The SMP is the wrong precedent

The ECB did buy government bond markets last year in the framework of its Securities Markets Programme (SMP). However it structured this programme in the worst possible way. By announcing it would be limited in size and time, it mimicked the fatal problem of an institution that has limited resources. No wonder that strategy did not work.
The only strategy that can work is the one that puts the fact that the ECB has unlimited resources at the core of that strategy. Thus, the ECB should announce a cap on the spreads of the Spanish and Italian government bonds, say of 300 basis points. Such an announcement is fully credible if the ECB is committed to use all its firepower, which is infinite, to achieve this target.
If the ECB achieves this credibility it creates an interesting investment opportunity for investors. The latter obtain a premium on their Spanish and Italian government bond holdings, while the ECB guarantees that there is a floor below which the bond prices will not fall. (The floor price is the counterpart of the interest rate cap). In addition, the 300 basis points acts as a penalty rate for the Spanish and Italian governments giving them incentives to reduce their debt levels.
The ECB is unwilling to stabilise financial markets this way. Many arguments have been given why the ECB should not be a lender of last resort in the government bond markets. Many of them are phony (see De Grauwe 2011, Wyplosz 2011). Some are serious like the moral hazard risk. The latter, however, should be taken care of by separate institutions aimed at controlling excessive government debts and deficits. These are in the process of being set up (European Semester, Fiscal Pact, automatic sanctions, etc.). This disciplining and sanctioning mechanism should then relieve the ECB of its fears of moral hazard (a fear it did not have when it provided €1,000 billion to banks at a low interest rate).


What should be done?

The correct business model for the ECB is one that has it pursuing financial stability as its primary objective (together with price stability), even if that leads to losses. There is no limit to the size of the losses a central bank can bear, except the one that is imposed by its commitment to maintain price stability. In the present situation the ECB is far from this limit (Buiter 2008).


"Putting the ECB in charge of banking supervision thus solves one problem. But it creates another one. Can one still hold national authorities responsible for saving banks which they no longer supervise?
This is not a new problem. The De Larosiere Report (2009), which became the basis for the creation of the European Banking Authority (EBA) and the Systemic Risk Board (ESRB), argued that the ECB should not be involved in ‘micro’ supervision mainly because banking rescue and resolution involves tax payer money, which they assumed had to be national.

First comes EZ bank regulation then comes EZ bank rescues
Banking regulation and restitution are difficult to separate – no wants to pay for things they cannot control. Economic (and political) logic thus requires that the Eurozone will soon need also a common bank rescue fund. 
Officially this is not fully acknowledged yet, except for a hint in the EZ summit statement of June 28/9 which says that once a system of supervision involving the ECB has been created it would become possible for the permanent rescue fund, the ESM, to inject capital into banks. 
This is how European integration often advances. An incomplete step in one area later requires further integration in related areas. In the past this method has worked well. The EU of today is a result of such a process.  But a financial crisis does not give policymakers the time they used to have to explain things to their electorate. The steps will have to follow each other much more quickly if the euro is to survive in its current form. 
Problems ahead
The worrying thing is that the terrain EZ leaders must cross is heavily mined. Europe does not have the luxury to construct its banking union from a stable situation. This new institution is being set up in the midst of a banking crisis.
There are clearly large losses that have to be realized and allocated.  
  • This means serious distributional conflicts both within and between member countries. 
The most difficult case is going to be Spain. The local savings banks are the weakest part of the Spanish banking system because they specialized in mortgages and lending to developers, i.e. the areas where very large losses are to be expected. A number of these were recently 'privatized', often in the context of mergers. These new institutions then had to raise capital in various forms (shares, preferred shares, subordinated debt).
Given that institutional and especially international investors were not willing to invest in these instruments (not surprising given that the state of the Spanish real estate market) the new capital was raised mainly from domestic investors, often the depositors themselves.
Who pays for past mistakes?
This leads to the first conflict: Who should bear the losses the (Spanish) investors or the Spanish government? 
As retail investors are also voters, the government (and the management of the cajas) have now incentives to pay back as quickly as possible all instruments that would otherwise be loss absorbing. This seems to be happening on a broad scale. It is thus possible that by the end of this year the weakest banks will have repaid all of their hybrid instruments at par or close to par.  At that point the loss absorption capacity of the Spanish banking sector will be much reduced. 
But this leads to the second distributional conflict: Will the European tax payers want to pay for past losses?  As the answer is presumably no, there is thus a danger that by the end of this year it will become impossible to inject European capital into Spanish banks unless either a number of banks have gone into informal insolvency (to bail in other creditors) or the Spanish government has put enough into the system to cover past losses (which it might not be able to do).  The road towards banking union is going to be difficult."


Han sido también diagnosticado y calculado con arreglo a lo anterior  por Edwin M. Truman:

" The European leaders this time have offered a more hopeful approach than in the past in both form and substance, but Europe could still be headed in the wrong direction unless the ECB builds an appropriate bridge on the structure of the decisions taken at the June summit and the political process implements those decisions comprehensively and expeditiously."


Ha sido concedido a Capital Economics (Roger Bootle) y considera los aspectos vinculados al fracaso de todos los intentos dirigidos a poner a la eurozona en una senda menos destructiva para los miembros más débiles que, en otro caso, se vean obligados a abandonarla.

BusisnessEurope, asociación empresarial europea, por el contrario, también ha formulado sus propuestas para evitar dicha ruptura.

No comments: