SYDNEY (MarketWatch) — Rallying European stocks and bonds reflect a growing belief that both the euro zone and the European Central Bank are at last taking the correct policy actions to combat the region’s debt crisis.
But it is premature to claim victory.The financial resources remaining to deal with the crisis may be insufficient. The amounts available have not changed for almost two years, with little appetite among “permanent creditors” such as Germany for increasing commitments.
The major bailout facility — the European Stability Mechanism (ESM) — has total lending capacity of around 500 billion euros EURUSD -0.36% .
Financial assistance agreed for Greece, Ireland and Portugal in the form of loans and guarantees is around 294 billion euros. Of that, 192 billion euros come from the European Financial Stability Facility, which will be subsumed into the ESM.
The remaining 102 billion euros come from the EU budget or bilateral aid to Greece. Meanwhile, 100 billion euros are committed to Spain for the recapitalization of its banking sector. This leaves the ESM with available lending capacity of around 208 billion euros.
There are increasing constraints on further IMF participation, to augment the ESM’s resources. Money worries As their economies remain weak and market funding is unavailable or expensive, Greece, Ireland or Portugal may need additional funding to meet maturing debt and also finance budget deficits.
Spain and Italy may need assistance as well. Spain has debt of 800 billion euros (74% of GDP). Italy has debt of 1.9 trillion euros (121% of GDP).
Both countries have significant debt maturities in the near future. Spain has principal and interest repayment obligations of 160 billion euros in 2013 and 120 billion euros in 2014.
The Spanish government has announced a financing program of around 260 billion euros for 2013.
Italy has principal and interest repayment obligations of 350 billion euros in 2013 and 220 billion euros in 2014.Capital flight from peripheral European countries is a problem.
Banks in peripheral countries have lost between 10% and 20% of their deposits, reflecting concern about solvency of individual banks and the risk of currency redenomination.
Additional resources may be needed to finance a deposit insurance scheme to halt capital flight. Europe has total bank deposits of around 8 trillion euros, including around 6 trillion euros in retail deposits, with around 1.5 trillion to 2 trillion euros in banks in peripheral countries.
An effective deposit scheme would need to cover around 1 trillion to 1.5 trillion euros’ worth of deposits, placing a large claim on available funds.
Europe may need bailout facilities of at least 3 trillion euros to be credible. Potential requirements exceed available resources.Needing major support The only other possible source of financial support is the ECB.
It has already provided more than 1 trillion euros in term financing to banks through the LTRO program alone.
These programs mature in late 2014 and early 2015. They may need to be increased or extended to finance the weak banking system. The ECB has purchased around 210 billion euros in sovereign bonds under its Securities Markets Program.
Last July, the ECB announced the Outright Monetary Transactions (OMT) program allowing purchase of unlimited quantities of sovereign bonds.
ECB President Mario Draghi announced that: “within our mandate, the ECB is ready to do whatever it takes to preserve the euro.”
Markets and investors have assumed that this is the “big bazooka” — a European version of the quantitative easing and debt monetization precedents similar to steps taken by the U.S., Japan and the U.K.
The ECB’s announcement underpinned relative stability in Europe in the second half of 2012. But the OMT program is conditional. ECB action is contingent on the relevant government formally requesting assistance and agreeing to comply with the conditions applicable to assistance from the ESM/ EFSF.
Instead of avoiding market pressures, the triggering mechanism requires that financing problems of “at-risk” countries get worse before the ECB will act. ECB purchases will be confined to short or intermediate maturities.
This condition is designed to make intervention similar to traditional monetary policy. It is also designed to reduce the cost of bank loans, which is driven by shorter-term interest rates. The ECB can also nominate a cap on yield or the size of its purchases in advance of any intervention.
There is uncertainty as to whether the ECB will relinquish its status as a preferred creditor on such purchases in the event of default or restructuring.
The OMT program revealed significant divisions within the ECB. Jens Weidmann, the head of the German Bundesbank and a former adviser to the chancellor, opposed the measure. Other euro-zone members are also known to be uncomfortable with this plan.
The legal basis of the OMT program remains uncertain. Article 123 of the Lisbon Treaty prohibits the ECB from directly buying national governments’ debt.
Future legal challenges cannot be ruled out. Overcoming legal issues would require time consuming treaty changes, support for which is not assured. The OMT has not been activated to date.
Contrary to expectations, Spain has not asked for assistance under the OMT. Asking for activation would be politically damaging for a deeply unpopular government. Spain is also reluctant to accept the conditions and supervision of such aid.
Germany has actively discouraged Spain from asking for assistance, at least before domestic elections scheduled for September/ October 2013. In 2008, then-U.S. Treasury Secretary Hank Paulson argued that if everyone knows that you have a bazooka in your pocket it may not be necessary to use it.
The ECB has gambled that merely announcing it is prepared to intervene will restore market access of peripheral borrowers and reduce the interest rate demanded by the market. After an initial sharp fall, the borrowing cost of weaker countries increased and remains above sustainable levels.
“Believe me, it will be enough,” Draghi, anointed as the Financial Times’ 2012 Person of the Year, operatically stated about the OMT program.
But the ECB president’s statements have been dominated by two words: “may” and “adequate.” Market analyst Carl Weinberg neatly summarized this as: “A promise to do something unspecified at some yet-to-be-determined time involving yet-to-be-invented programs and institutions, in a yet-to-be-decided way”.
Markets will undoubtedly test the ECB’s resolve. As Yogi Berra observed: “In theory there is no difference between theory and practice. In practice there is.”
marketwatch.com
But it is premature to claim victory.The financial resources remaining to deal with the crisis may be insufficient. The amounts available have not changed for almost two years, with little appetite among “permanent creditors” such as Germany for increasing commitments.
The major bailout facility — the European Stability Mechanism (ESM) — has total lending capacity of around 500 billion euros EURUSD -0.36% .
Financial assistance agreed for Greece, Ireland and Portugal in the form of loans and guarantees is around 294 billion euros. Of that, 192 billion euros come from the European Financial Stability Facility, which will be subsumed into the ESM.
The remaining 102 billion euros come from the EU budget or bilateral aid to Greece. Meanwhile, 100 billion euros are committed to Spain for the recapitalization of its banking sector. This leaves the ESM with available lending capacity of around 208 billion euros.
There are increasing constraints on further IMF participation, to augment the ESM’s resources. Money worries As their economies remain weak and market funding is unavailable or expensive, Greece, Ireland or Portugal may need additional funding to meet maturing debt and also finance budget deficits.
Spain and Italy may need assistance as well. Spain has debt of 800 billion euros (74% of GDP). Italy has debt of 1.9 trillion euros (121% of GDP).
Both countries have significant debt maturities in the near future. Spain has principal and interest repayment obligations of 160 billion euros in 2013 and 120 billion euros in 2014.
The Spanish government has announced a financing program of around 260 billion euros for 2013.
Italy has principal and interest repayment obligations of 350 billion euros in 2013 and 220 billion euros in 2014.Capital flight from peripheral European countries is a problem.
Banks in peripheral countries have lost between 10% and 20% of their deposits, reflecting concern about solvency of individual banks and the risk of currency redenomination.
Additional resources may be needed to finance a deposit insurance scheme to halt capital flight. Europe has total bank deposits of around 8 trillion euros, including around 6 trillion euros in retail deposits, with around 1.5 trillion to 2 trillion euros in banks in peripheral countries.
An effective deposit scheme would need to cover around 1 trillion to 1.5 trillion euros’ worth of deposits, placing a large claim on available funds.
Europe may need bailout facilities of at least 3 trillion euros to be credible. Potential requirements exceed available resources.Needing major support The only other possible source of financial support is the ECB.
It has already provided more than 1 trillion euros in term financing to banks through the LTRO program alone.
These programs mature in late 2014 and early 2015. They may need to be increased or extended to finance the weak banking system. The ECB has purchased around 210 billion euros in sovereign bonds under its Securities Markets Program.
Last July, the ECB announced the Outright Monetary Transactions (OMT) program allowing purchase of unlimited quantities of sovereign bonds.
ECB President Mario Draghi announced that: “within our mandate, the ECB is ready to do whatever it takes to preserve the euro.”
Markets and investors have assumed that this is the “big bazooka” — a European version of the quantitative easing and debt monetization precedents similar to steps taken by the U.S., Japan and the U.K.
The ECB’s announcement underpinned relative stability in Europe in the second half of 2012. But the OMT program is conditional. ECB action is contingent on the relevant government formally requesting assistance and agreeing to comply with the conditions applicable to assistance from the ESM/ EFSF.
Instead of avoiding market pressures, the triggering mechanism requires that financing problems of “at-risk” countries get worse before the ECB will act. ECB purchases will be confined to short or intermediate maturities.
This condition is designed to make intervention similar to traditional monetary policy. It is also designed to reduce the cost of bank loans, which is driven by shorter-term interest rates. The ECB can also nominate a cap on yield or the size of its purchases in advance of any intervention.
There is uncertainty as to whether the ECB will relinquish its status as a preferred creditor on such purchases in the event of default or restructuring.
The OMT program revealed significant divisions within the ECB. Jens Weidmann, the head of the German Bundesbank and a former adviser to the chancellor, opposed the measure. Other euro-zone members are also known to be uncomfortable with this plan.
The legal basis of the OMT program remains uncertain. Article 123 of the Lisbon Treaty prohibits the ECB from directly buying national governments’ debt.
Future legal challenges cannot be ruled out. Overcoming legal issues would require time consuming treaty changes, support for which is not assured. The OMT has not been activated to date.
Contrary to expectations, Spain has not asked for assistance under the OMT. Asking for activation would be politically damaging for a deeply unpopular government. Spain is also reluctant to accept the conditions and supervision of such aid.
Germany has actively discouraged Spain from asking for assistance, at least before domestic elections scheduled for September/ October 2013. In 2008, then-U.S. Treasury Secretary Hank Paulson argued that if everyone knows that you have a bazooka in your pocket it may not be necessary to use it.
The ECB has gambled that merely announcing it is prepared to intervene will restore market access of peripheral borrowers and reduce the interest rate demanded by the market. After an initial sharp fall, the borrowing cost of weaker countries increased and remains above sustainable levels.
“Believe me, it will be enough,” Draghi, anointed as the Financial Times’ 2012 Person of the Year, operatically stated about the OMT program.
But the ECB president’s statements have been dominated by two words: “may” and “adequate.” Market analyst Carl Weinberg neatly summarized this as: “A promise to do something unspecified at some yet-to-be-determined time involving yet-to-be-invented programs and institutions, in a yet-to-be-decided way”.
Markets will undoubtedly test the ECB’s resolve. As Yogi Berra observed: “In theory there is no difference between theory and practice. In practice there is.”
marketwatch.com
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