We are starting to see a little bit of information coming out of the EU summit but there is still a long way to go. There are stories circulating that this could go on for days, but in the meantime here is what has happenned so far:
Overnight the Bundestag voted in favour of using the EFSF as insurance for loans taken out by nations while opposing the use of the ECB to increase the size of the EFSF. During her address, Merkel stated that the goal for Greece is to reduce the country’s debt to GDP ratio to 120pc by 2020. Given the latest estimates by the IMF, that means Greece will need another €110 billion over the next ten years and a write-off in the region of 60%. This was in line with expectations but the debate was extremely heated with Merkel being accused of “blatant untruths” after she rolled over on her pledge to the parliament just 3 weeks ago that there would be no leverage of the EFSF. In the end it didn’t matter and the vote went through, but Merkel has lost a lot of credibility and it is likely the German taxpayers are going to punish Ms Merkel’s when they next get an opportunity.
Meanwhile, European banks will be told to seek capital from the markets first and the bail-out fund only as a last resort. The banks will have strict constraints on dividend and bonus payments until they meet capital targets of 9 percent Tier 1 capital by June next year. This is significantly sooner than under Basel and given the state of the markets you have to wonder how this is going to be achieved with so many banks requiring additional capital at the same time. Bloomberg has an article with some interesting claims from bankers about what re-capitalisation will mean:
European banks say they have to cut assets to help satisfy a government push to boost capital faster than planned to insulate them against the sovereign debt crisis. That may trigger a credit crunch for companies and consumers throughout the 17-nation euro zone, helping to push its economy into recession, say Citigroup Inc. and Deutsche Bank AG analysts.
…James Ferguson, head of strategy at Arbuthnot Securities Ltd. in London, draws parallels between Europe’s current situation and the credit crunches suffered in recent decades by Japan, the U.S. and the U.K.
“History shows that bank recapitalizations provide the catalyst for the credit crunch,” he said in an Oct. 20 note. “Japan learned this in 1998, and the U.S. and the U.K. in 2008. Continental Europe’s lesson starts now.”
Banks across Europe have announced they will trim more than 775 billion euros from their balance sheets in the next two years to reduce short-term funding needs and achieve the 9 percent in regulatory capital required.
…So-called bank deleveraging could reach 5 trillion euros in the next three to five years, according to Alberto Gallo, head of European credit strategy at Royal Bank of Scotland Group Plc in London. “It is incredibly worrying that this wall of deleveraging will, in fact, continue to add additional pressure onto the European economies,” John Moran, head of bank restructuring at Ireland’s Finance Ministry, said in a speech in Dublin Oct. 12. There is “an absolute necessity to avoid excessively speedy deleveraging across the system.”
Obviously this is brinkmanship from the banks, but you get the idea. It looks like these changes are now set in stone.
On the southern front, Italy has announced some more austerity measures which as reported seem woefully inadequate. These include increasing the pension age from 65 to 67 from 2026 (yes that is 15 years away), raising €5bn through privatisation over the next 3 years and implementing changes to job protection legislation by next year. The actual letter sent from the Italy government to the EU is actually a little more substantial, you can find it here via google translate. I also note Speigel have an interesting article on the recent squabble between Merkel, Sarkozy and Berlusconi.
There is still no word on exactly what plan for the EFSF is going to be but the usual rumour about China and other BRICs coming to save Europe via an EFSF SPIV is once again circulating even though it has been denied many times before and was once again just 12 hours ago according to reuters. I assume there will be many similar such rumours before we see anything definitive out of this summit. I did note yesterday that the Swedish PM was offering Norway’s SWF as an alternative, I just wonder how the Finns feel about that ?
As I stated yesterday, the big decision is really what the private sector write-off on Greek debt is going to be because that flows into how much re-capitalisation the banks will require and also how much of the EFSF is going to be taken up with Greece. So far there has been no announcement on this crucial component although there have been some reports of negotiations:
Banks moved closer on Wednesday to agreeing to cut the value of their Greek bond holdings in half under a bailout plan that Finance Minister Evangelos Venizelos was quoted as saying would deliver 15 euros back in cash for every 100 invested.
Citing sources in Brussels, Greek newspaper Kathimerini said the minister told banks and insurers they would receive 15 euros in cash and 35 euros in 30-year, 6-percent coupon bonds for every 100 euros of debt they own.
In Berlin, a source close to the finance ministry told Reuters that, while Germany, Finland and Netherlands were still pressing for a haircut of 60 pct, “there will be an agreement (with bondholders) at 50 pct of the notional value (and) there is no chance for an agreement below 50 pct.”
Until there is a fully ratified agreement on this, including agreement from the European banks and then the rating agencies , this summit really hasn’t moved past first base.
Update 1: I may have been a bit quick with my first base analogy. If the negotiations with holders of Greek debt are anything to go by then we may not even have anyone on the field yet.
Negotiations over the extent of the private sector’s involvement in a second financial aid package for Greece are stalled, with no agreement over any elements, the managing director of the Institute for International Finance said on Wednesday.
“There has been no agreement on any Greek deal or a specific “haircut,” Charles Dallara, who is leading negotiations on behalf of the IIF, which represents private sector creditors, said in a statement.
“We remain open to a dialogue in search of a voluntary agreement. There is no agreement on any element of a deal.”
Euro zone states are pushing the private sector to accept a 50 percent writedown on their holdings of Greek bonds in an effort to reduce Greece’s debt burden by around 100 billion euros.
Failure to agree on a voluntary writedown or “haircut” could lead to a fullscale default in Greece’s debt, with a heavy knock-on impact on markets.