A decade of austerity

UK Chancellor George Osborne thinks that government will have to continue austerity until 2018, a full decade after the financial crisis started. That's the optimistic view of finding the bottom of a downward spiral of deflation and budget cuts.

Public Talk on the Euro Zone Crisis

Tonight I will be talking about the euro zone crisis at the University of Twente, with a focus on what has and has not been done, and why the consequences are so dire:

http://www.utwente.nl/gw/sg/programma/Europa.doc/

Germany limits the European Stability Mechanism

Germany's consitutional court ruled today that Germany may participate in the European Stability Mechanism, but with strict limits and conditions. The ESM is the permanent fund meant to prop up finances in some of the euro zone's countries.

Condition one is a cap on Germany's contribution at 190 billion euros. No salami tactics in which the commitment becomes larger.

Condition two is full consultation with the German parliament on an ongoing basis. This means the terms of the loans and the compliance with the terms.

Condition three is a new treaty to write those conditions down. Even a modification of the existing treaty is a new one, so that is clear.

These conditions mean that those opposed to the ESM's establishment will not get their way entirely. But they will have it in their power to make the recipients of ESM funds wish they had. Those in Germany that want to cut off Southern Europe entirely will have to settle for cutting them down to size. They will now have the tools do so with all their might. And Europe will suffer again.

Conservative Change in the Euro Zone

There are hurdles to be taken before the decisions are definitive, but EU government leaders made decisions this week that set the course for the future of the euro zone. Austerity has won a host of demands that lock in  debt repayments from Europe's periphery to its richest member states, and that prop up banks in the periphery just enough to prevent them from defaulting on loans, once again to the EU's richest member states.

The European Financial Stability Facility and the European Stability Mechanism (from July 2013) will be changed to make it possible to bail out banks directly. In the current climate, that means bailing out Spanish banks, Bankia in particular. In return, Germany has won creditor countries seniority rights on the loans they've made, which means that if things go badly, they will be paid out first of whatever money is left, before private bond holders. This reduces the risk of throwing good money after bad, at least in principle. It also increases the demand for such subsidies. Ireland has already demanded more. Italy has demanded, and received a commitment to aid for growth in exchange for austerity. These demands will not be the last.

It is a solution of sorts. It is the opposite of what most of the G20 and a transnational coalition have called for, which is a European banking union. Restructuring and recapitalization would take place across national borders, and allow the toxic assets to be dealt with in a way that markets will greet, not continue to punish. At a time when Europe is threatening to drag down the rest of the world economy, calls have become louder for the EU to take the plunge. The main problem, however, is economic nationalism--the fusion of national purpose with bank ownership. That has become much stronger as a result of the crisis, and the EU's member states show no sign of backing off.

Imagine that the political, social and economic revolutions that occurred in the 1930s and ushered in modern economics had never happened. That is why the initial stability that Europe achieved this week is unlikely to last.

Grexit: G20 to the rescue again

Open Europe reports on Twitter today that the President of the European Council has apparently called for a video conference of the G20 countries, to be held in approximately 3 hours time. The topic will undoubtedly be support for a new infusion of cash into the global economy ahead of Greek elections on Sunday, as suggested by Daily Forex. Support for austerity is low, but support for leaving the euro is also low, meaning that the Grexit, if it comes, will be messy.

The G20 talks point to an expectation that the Greek election will leave the rest of Europe with an enormous problem. The key players in those talks will have to be the main central banks, which have rescued the situation before. And they will have to again if the politicians in Greece and the rest of Europe can't agree.

And now we wait.

Greek elections and capital flight

Greece is bleeding out in advance of Sunday's elections, and is in danger of dying on the operating table. And it is the Greeks who are making this happen, not the EU or the international community. News reports are that Greeks have been withdrawing an average of 800 million euros per day from the country's banks. Greek companies are doing the same. An attempt to make Greeks pay tax or have their power shut off has failed, money to pay for electricity production is running out, and Greek companies can no longer get lines of credit that are vital to the import-export business, or insurance to cover imports. The result is that imported items are disappearing from the shelves.

There is now nothing the EU or the international community can do but wait for Sunday's election results. The current behaviour of the Greeks does not yet support the idea that another infusion will be productive. Greek voters may want to stay in the euro for reasons of national pride, but membership in this euro zone, with its globally peculiar emphasis on orthodoxy and restraint, comes with responsibilities that they will either articulate a willingness to accept on Sunday.

Or not.

Bankia, Spain and the Euro Zone

Bankia in Spain has become the next institution to require a bailout in the euro zone, and as is now a familiar pattern, Bankia has been declared too big to fail. 40 billion are needed immediately, and 80 billion eventually. The IMF has already suggested that the money simply has to be spent, and reassured markets that a bailout will be coming. European finance ministers meet next. This is the last in a series of moves to use the money reserved for public bailouts for private institutions.

What Bankia does, beyond costing the EU a great deal of money, is call into question the quality of stress testing at the European Banking Authority. as the EBA says itself, the information is provided by the banks themselves:

"We have to remind you that this is a bottom up exercise, conducted by the banks in most cases using their own internal models. The estimates of risk parameters by banks are sometimes very diverse, also for exposures in the same portfolio and against counterparties in the same country. Although the EBA took action to achieve greater consistency and more rigorous estimates. More work on this issue is needed in the future."

Although the last round of stress testing revealed a high concentration of undercapitalisation at Spanish banks, Bankia was not considered one of the banks worthy of regular review (which you would expect of  banks that are too big to fail). The banks reviewed can be seen at the end of the EBA's last stress test review for 2011.