The Latest (Secret) Rescue Plan For Europe
FORECASTS & TRENDS E-LETTER
IN THIS ISSUE:
2. Europe Split on Rescue Plan
3. Options for Expanding the Rescue Fund
4. Greece to Default on 50% of Its Debt?
5. Timeline for What Happens Next
IMF/G-20 Summit in Washington
Over this past weekend, the International Monetary Fund (IMF) and G-20 leaders met in Washington, and the main focus was the deepening financial crisis in Europe. Leaders from around the world called on the stronger nations of Europe to “leverage” their emergency bailout fund, the European Financial Stability Facility (EFSF), by up to trillions of euros if necessary.
President Obama has reportedly called German Chancellor Angela Merkel repeatedly in recent months, urging her government to do more to address the escalating financial crisis. Treasury Secretary Tim Geithner has met with European leaders three times in the last month, calling on them to significantly increase the size of their bailout fund and prop up their banks.
Despite these efforts, the European Central Bank (ECB), Germany and other EU members have resisted such calls to greatly enlarge the EFSF. But it now appears that this reluctance changed dramatically over the weekend at the IMF/G-20 summit.
While none of the G-20 leaders will confirm what follows, it is widely believed that a new three-part plan was introduced at the weekend meeting to address the growing debt crisis in the eurozone: 1) increase the EFSF to at least €2 trillion; 2) recapitalize eurozone banks by at least €150 billion; and 3) allow Greece to default on 50% of its debt.
Since July 19, I have maintained that the European debt crisis would dominate financial markets around the world. Since then, we’ve seen the Dow and the S&P 500 plunge by nearly 20% at the low point. However, the global equity markets rallied strongly on Monday and again today on hopes that the new bailout plan hatched over the weekend will stem the crisis in Europe.
Highlights from the weekend IMF/G-20 meetings in Washington were front-page news yesterday morning. What follows are excerpts from The Wall Street Journal’s front-page on Monday.
European officials are debating ways to boost the firepower of their financial-bailout fund after the world's finance ministers, worried about the potential for a market meltdown, ratcheted up pressure on euro-zone officials to act…
During meetings of the International Monetary Fund in Washington over the weekend, the U.S. and other major nations pressed European leaders to increase the effective size of their €440 billion ($594 billion) rescue fund to perhaps trillions of euros by borrowing against it.
The talks are at a early stage, and it is far from clear they can forge a political consensus to act. German officials say the idea is moot as long as the European Central Bank continues to reject it. Some European officials hope the central bank might soften its stance under incoming president Mario Draghi, but his views on the issue aren't known…
At one closed-door meeting, euro-zone officials revealed their reluctance to move forward too quickly because of politics at home. "This is as fast as we can move. It's going to take six weeks" to weigh the options, one euro-zone official said, and others echoed his comments, according to one person in the room. In response, some leaders from outside the euro-zone asked, "Do you have six weeks?"
Meanwhile, German Deputy Finance Minister Joerg Asmussen said on Sunday that Greece may have to wait longer than expected for a decision on the next disbursement of bailout funds, while the ECB, IMF and the European Commission evaluate Greece's progress on policy changes, according to Reuters. Mr. Asmussen also said that a bond-exchange program, part of an earlier tranche of assistance, didn't yet have a fixed launch date…
The IMF and euro-zone officials are working on a variety of options for using leverage to make the resources of the rescue fund, called the European Financial Stability Facility, or EFSF, go much further…
Some of the options could be used to help prevent a Greek default, or to try to insulate the rest of the euro-zone from such a default by pushing capital into European banks and building a fire wall around larger, vulnerable euro-zone nations. [As you can see from the chart below, borrowing costs for Greece have skyrocketed and to a lesser extent in Portugal and Ireland. Could Italy and Spain be next?]
Investors are questioning whether the bailout fund is large enough to respond effectively to the debt crisis as larger countries such as Italy and Spain face upward pressure on their borrowing costs. The ECB is reluctantly buying both countries' bonds to put a lid on yields, but has warned that it won't keep up its bond purchases for long.
In private conversations, the U.S. continued to push the Europeans, particularly the Germans, on the importance of coming up with large amounts of money, a position that European Commission officials accept. President Barack Obama has called German Chancellor Angela Merkel repeatedly in recent months to encourage her to take strong action to prevent the currency crisis from escalating further.
Treasury Secretary Tim Geithner has met with European leaders over the past three weekends, in France, Poland and now Washington. He is pressing euro-zone governments on several key points: expand the firepower of the rescue fund; forge closer ties between the European Central Bank and euro-zone governments; ensure that euro-zone nations can borrow at affordable rates; and ensure that European governments stand behind their banking systems.
"The threat of cascading default, bank runs, and catastrophic risk must be taken off the table, as otherwise it will undermine all other efforts, both within Europe and globally,"Mr. Geithner said Saturday. [Emphasis added, GDH.]
During one closed-door session, Mr. Geithner stressed the need for swift action and relayed some of his experiences addressing the 2008 financial crisis, when he was president of the Federal Reserve Bank of New York. Mr. Geithner also talked with finance ministers or central bankers from a number of countries.
Germany isn't opposed in theory to leveraging the EFSF, but sees a number of practical problems with the idea and is refusing to be forced to make quick decisions, according to people familiar with the government's position…
The German finance minister, Wolfgang Schäuble, told reporters that the bailout fund can only work within the legal framework of the European Union's treaty, and more specifically, within the agreement governing the bailout fund. Neither of those allows the facility to be leveraged, he said.
A number of ECB officials have rejected the leverage idea. But on Sunday, executive board member Lorenzo Bini Smaghi of Italy became the first ECB official to publicly throw his weight behind the idea of leveraging the bailout fund to stem the crisis. END QUOTE
Options for Expanding the EFSF
As I have written often since mid-July, the European Financial Stability Facility is currently capped at €440 billion, €110 billion of which was earmarked for Greece. Everyone agrees that the EFSF is far too small to provide bailouts to Italy and Spain, the region’s third and fourth largest economies, respectfully.
Many eurozone leaders now say they are willing to boost the firepower of their bailout fund, but they aren’t sure their governments back home would agree to it. This dilemma spawned the idea of “leveraging” the EFSF by four or five-fold vis-à-vis the ECB, which they apparently believe can be done without legislative approval back home.
Another option being discussed to leverage the bailout fund would be to give it a banking license, so that it can buy government bonds and post them at the ECB as collateral in exchange for liquidity to buy more bonds. With ECB help, the EFSF could raise its firepower to an almost unlimited level (ie – trillions of euros if needed).
Treasury Secretary Geithner is reportedly pushing for increasing the EFSF, one way or another, by five-fold (or more) if needed. While some European leaders still say that they are opposed, most observers now believe that the wheels are already in motion to leverage the EFSF following last weekend’s G-20 summit.
Also over the weekend, JPMorgan and Goldman Sachs called on European leaders meeting in Washington to recapitalize eurozone banks along the line of our own Troubled Asset Relief Program (TARP) in 2008. JPMorgan said that eurozone banks need at least €150 billion ($202 billion) to stabilize the credit markets. This now appears to be on the table as well.
They will need even more if the following takes place.
Greece to Default on 50% of Its Debt?
While no European leaders who emerged from the IMF/G-20 meeting this past weekend will admit it, there is widespread talk that Greece may be allowed to write off (default on) 50% of its outstanding debt and still remain in the euro. If this plan actually materializes, it will mean that holders of Greek debt would take a 50% haircut. This includes the ECB, the IMF, eurozone banks, private investors and some US banks if they have unhedged Greek debt.
Germany is said to be among the EU members in favor of a 50% “controlled default” by Greece. Others say Germany is demanding such a default in return for its large financial support for expanding the EFSF. Interestingly, this would suggest that the German banks have already off-loaded most of their Greek bonds.
As noted earlier, the global equity markets soared higher on the news of a new “grand plan” to save Europe. As this is written US stocks have rallied almost 5% in two days. I would argue, however, that a Greek default of 50% will have some serious negative ramifications that I don’t believe have been fully considered. I’ll have more to say on these developing issues, either in my Blog (www.GaryDHalbert.com) later this week or in next week’s E-Letter, or both.
Timeline for What Happens Next
While European financial officials and the ECB apparently have warmed up to expanding the bailout fund and recapitalizing their banks, this process will take time and could still meet roadblocks. In the interim, there is the question of the next tranche of bailout money to Greece. The EU, ECB and the IMF are expected to approve another €8 billion to Greece soon. Greece warns that it will run out of money to pay October wages and pensions if this next tranche of the original €110 billion is not forthcoming.
I don’t think the EU, ECB and IMF will allow Greece to default in October. If the rumors emanating from the IMF/G-20 meetings are remotely true, Greece will be kept afloat at least long enough for the EFSF to be leveraged to at least €2 trillion and the banks to be recapitalized to the tune of at least €150 billion.
Supposedly, all of these controversial measures are to be resolved in time for the next IMF/G-20 summit on November 3-4. That is very optimistic! Rumors are that the G-20 leaders will decide at that time whether Greece will be allowed to have a “managed default” on apprx. 50% of its debt. I’ve seen no speculation on when such a default might occur.
It is clear that the Obama administration has finally become scared about the impending financial crisis in Europe. This past weekend’s G-20 summit was Geithner’s third round of arm-twisting in less than a month. Despite all the denials, the rescue plan discussed above has likely been agreed upon.
Whether it actually happens or not remains to be seen. Certainly, there will be resistance among some members, especially the Netherlands, Finland and others. Germany is definitely not an automatic yes, although Chancellor Merkel is said to be onboard.
It is interesting that Europe is preparing to go down a similar path as the US took in 2008 – huge bailouts and a possible Euro-TARP to restructure its ailing banks. The hand of Tim Geithner is all over this one. I hope it turns out better for Europe, but I am not optimistic.
As noted above, the possibility of a “controlled default” by Greece on 50% of its debt has numerous potentially disturbing ramifications. For example, what does that mean for Ireland and Portugal? Or Spain and Italy for that matter? Think unintended consequences.
All of this suggests that October could be another very rough environment for the global equities markets. Keep your seatbelts fastened!
I’ll have more to say on my Blog (www.GaryDHalbert.com) later this week as new developments arise.
Very best regards,
Gary D. Halbert
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Forecasts & Trends E-Letter is published by ProFutures, Inc. Gary D. Halbert is the president and CEO of ProFutures, Inc. and is the editor of this publication. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of Gary D. Halbert (or another named author) and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific investment advice. Readers are urged to check with their investment counselors before making any investment decisions. This electronic newsletter does not constitute an offer of sale of any securities. Gary D. Halbert, ProFutures, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have investments in markets or programs mentioned herein. Past results are not necessarily indicative of future results. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent.