Europe's Problem, America's Solution

By: John Rubino | Tue, Dec 13, 2011
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Greece has been out of the spotlight for a couple of weeks, which means it's past due for another market-rattling announcement. And sure enough, today we find out that its economy is shrinking even faster than expected:

Greece Apparently Even Worse Off Than Realized, Hitting Euro, Stocks

This flew under the radar a little bit because we were all waiting with bated breath for the pulse-pounding thrills of the latest FOMC statement, but apparently Greece's economy is in even worse shape than realized.

"Who could possibly have foreseen that?" asked no one.

Nevertheless, it might be knocking the euro for another loop, although it's tough to separate out the various actors hammering on the euro today, including the overarching sense of disappointment with last week's EU summit, the results of which are crumbling as we speak. Recently the euro was down to $1.3026 against the dollar, near its low for the day and pushing critical technical levels.

This "news" has been discovered and reported by the bean-counting minions of the Troika, who have taken on the thankless task of hanging out in sunny Greece in winter to make sure it's holding up its end of the bailout bargain by getting its fiscal house in shape.

Apparently not so much, reports Stelios Bouras of Dow Jones Newswires:

"The International Monetary Fund sees the Greek economy deeper in recession in 2011 than the government expects and a wider-than-forecast budget shortfall, adding that the country has still a lot of work to do on reforms.

In a country review, the IMF said Tuesday the Greek economy is forecast to contract by up to 6% in 2011, versus Greece's official estimate for negative economic output of 5.5%, ahead of a downturn in 2012 in the region of 2.75% to 3%. In its fourth year of recession, Greece has already revised lower its growth figure to 5.5% of output for 2011 from a forecast of negative 3.8% earlier in the year."

What's more, Greece is not exactly rushing down the road to fiscal reform:

"Among the changes the IMF said Greece needs to adopt in order to return to a growth path are shutting down inefficient state entities, reducing the large public-sector work force, cutting public wage and pension levels and stronger budget control.

'Greece is still well away from the critical mass of reforms needed to transform the investment climate.'"

Here's a prediction: The Greek economy is going to continue to disappoint, thanks to these austerity measures and the broader euro-zone recession

Meanwhile, the big European banks have been up to their usual oddly self-destrucitive hijinks...

Banks Sit in a Tangled Web

Many European Lenders Have Sold Sovereign-Default Protection to One Another

European banks do have insurance against sovereign-debt default, but they've sold it all to each other, Laura Stevens reports on Markets Hub.

Dozens of banks across Europe have sold large quantities of insurance to other banks and investors that protects against the risk of ailing countries defaulting on their debts, the latest illustration of the extensive financial entanglements among the continent's banks and governments.

New data released last week by European banking regulators suggest the risks of banks suffering losses tied to European government bonds could be higher and more widespread than previously realized.

The numbers show European banks have sold a total of €178 billion ($238 billion) worth of insurance policies, in the form of financial derivatives known as credit-default swaps, on bonds issued by the financially struggling Greek, Irish, Italian, Portuguese and Spanish governments. If those bonds default, as some investors fear they might, banks could be on the hook for making large payments to the holders of the swaps.

The banks have at least partly insulated themselves from such potential losses by buying large quantities--roughly €169 billion worth--of credit-default swaps tied to the same bonds, apparently in large part from other European banks, according to European Banking Authority data.

The disclosures highlight another layer of risk interwoven through the continent's banking system. Already, investor fears about the hundreds of billions of euros of potentially risky government bonds European banks are holding have eroded confidence in the industry, making it harder for many banks to finance their daily operations.

Some analysts and investors say they had assumed that sovereign credit-default swaps, known as CDS, were primarily sold by giant global investment banks in the U.K., France and Germany, as well as in the U.S. Those banks sell the swaps to big corporate clients and other banks and institutions.

But the new EBA data show a surprising breadth of large and small European banks--at least 38 of them--have sold instruments that protect against potential losses on Greek, Irish, Italian, Portuguese and Spanish government bonds.

Deutsche Bank executives say their positions are well-hedged and that they buy CDS protection only from institutions based outside the countries in which the bank is trying to buy protection. In other words, Deutsche Bank wouldn't buy Italian swaps from an Italian bank.

...for which the US has an ingenious solution:

U.S. Presses Europe for More

WASHINGTON--A full-court press by Obama administration officials fell short of its goals at the latest European summit, and the U.S. is once again pushing euro-zone officials for a much stronger bailout fund to fight the debt crisis.

U.S. officials praised the deal reached Friday at a European Union gathering in Brussels, which would tighten ties between the 17 nations in the currency bloc. It would penalize members that fail to control their budget deficits and would also put balanced-budget rules in place.

The U.S. hopes the pact will make further action by the European Central Bank and other authorities more palatable down the road.

But the Obama administration was disappointed by the lack of progress in bolstering the European bailout fund as the crisis roils financial markets around the world.

U.S. officials want Europe to build a far more powerful firewall to keep the crisis from spreading in the short run. More financial resources would ensure that Italy, Spain and other major economies facing bond-market threats could finance their governments at sustainable interest rates.

The efforts to forge the fiscal pact were "all for the good," President Barack Obama told reporters here last week. "But there's a short-term crisis that has to be resolved, to make sure that markets have confidence that Europe stands behind the euro. And we're going to do everything we can to push them...in a good direction on this, because it has a huge impact on what happens here" in the U.S.

Officials across the U.S. government are in frequent contact with their European counterparts. Treasury Secretary Tim Geithner conducted a rapid run through five European cities in three days last week, meeting with officials from four euro-zone nations and the ECB, all ahead of the EU summit. Vice President Joe Biden met with Greek officials in Athens, while Mr. Obama continued his phone calls to European leaders.

Obama administration and Federal Reserve officials see the euro-zone debt crisis as one of the largest threats to the sluggish U.S. economic recovery.

With an election focused on economic concerns next year, the administration fears that another downturn triggered by European turmoil could depress the U.S. economy and quickly reverse the recent improvement.

In Brussels, European leaders last week agreed to introduce their permanent €500 billion ($669 billion) bailout fund in 2012, a year earlier than planned, replacing a €440 billion temporary bailout facility. But they planned no major expansion in the fund's total financial resources available.

U.S. officials want the continent to have much more firepower--perhaps $2 trillion or more--available to lend to struggling euro-zone governments. They believe such vast resources would dissuade investors from betting against the countries' debt and driving up their borrowing costs.

"The sums that you need for Italy and Spain are huge," said American Enterprise Institute economist Desmond Lachman, a former IMF official. "You can pass the hat around, but the real money is going to come from the ECB."


Some thoughts

Greece's finances are deteriorating...what a shock. Who in their right mind would be building factories or hotels or hiring new workers there now? As government layoffs rise and private sector hiring stagnates, tax revenues will obviously contract and national finances will deteriorate. The only solution -- leave the Eurozone, devalue massively and watch the tourists pour in -- threatens the "insurance" that the big European banks have sold to each other and is therefore unacceptable to the rest of the EU.

Speaking of credit default swaps, what do you think this means?: "Deutsche Bank executives say their positions are well-hedged and that they buy CDS protection only from institutions based outside the countries in which the bank is trying to buy protection. In other words, Deutsche Bank wouldn't buy Italian swaps from an Italian bank." Hmm...it's not clear that Deutsch Bank buying insurance from Spanish banks to cover Italian debt, and then from Greek banks to cover Spanish debt, is all that reassuring. The people running these banks would be Darwin Awards candidates if that organization had a finance category.

Meanwhile, "Obama administration and Federal Reserve officials see the euro-zone debt crisis as one of the largest threats to the sluggish U.S. economic recovery." It's only a threat because we're broke. If the US had a healthy balance sheet, a European crisis would be a once-in-a-lifetime buying opportunity. We could be like Warren Buffett, who builds up a mountain of cash in good times and uses it to buy cheap assets when lesser mortals go bankrupt. Instead we're so fragile that a few troubled banks 3,000 miles away can send us into another Depression.

And about the US pressing Europe for bigger bail-out: Sometimes (okay, often) it's embarrassing to be an American. Easy money is the heroin of the financial world and we're the main pusher. Generally, the pusher wins arguments with his addict clients, so expect a coordinated US/Europe quantitative easing that dwarfs even the Fed's secret loan program of the past few years, and expect it soon. Get ready, American and European taxpayers. You're about to become proud owners of several trillion dollars of slightly used Greek and Italian credit default swaps. Merry Christmas!

 


 

John Rubino

Author: John Rubino

John Rubino
DollarCollapse.com

John Rubino is author of Clean Money: Picking Winners in the Green Tech Boom (Wiley, December 2008), co-author, with GoldMoney's James Turk, of The Collapse of the Dollar and How to Profit From It (Doubleday, January 2008), and author of How to Profit from the Coming Real Estate Bust (Rodale, 2003). After earning a Finance MBA from New York University, he spent the 1980s on Wall Street, as a currency trader, equity analyst and junk bond analyst. During the 1990s he was a featured columnist with TheStreet.com and a frequent contributor to Individual Investor, Online Investor, and Consumers Digest, among many other publications. He now writes for CFA Magazine and edits DollarCollapse.com and GreenStockInvesting.com.

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