Ex. Goldman Chief Economist Comment on European Debt Crisis

Former Chief European Economist Erik Nielsen at Goldman Sachs takes an in-depth look at what’s going on in Europe at the moment, before he’s joining the Italy based bank UniCredit as Chief Global Economist in September. Nielsen is obviously worried.    

“..there is a risk that while the urgency of the economic and financial crisis may be over, a political crisis could be looming..”

Erik F. Nielsen

Finally, the big boys at Wall Street is getting the message: The financial crisis in Europe is about to turn into a political crisis. If that happens, the consequences will be severe and unpredictable. Here’s what former Chief European Economist at Goldman Sachs, Erik Nielsen’s latest thoughts on the subject – entertaining, as always.

The following article is syndicated by www.eurointelligence.com:

The frontlines in the battle over what to do with Greek sovereign debt has shifted, highlighting a new and uncomfortable intra-European split.

The original frontline was drawn between, on the one side, a majority of market participants, academics and commentators, and on the other side, the entire class of European policymakers.

Most market participants and other private sector analysts have long argued that the debt levels are unsustainable under any reasonable set of assumptions for growth and interest rates and that debt relief therefore would be needed. Referring to past debt crises and the first principle of fairness, they concluded that relief should and would be shared broadly among all the creditors, including bondholders, who might suffer a loss of maybe 50% of their claims.

On the other side of this argument stood the united front of policymakers. Originally, they all claimed that there would be no need for debt relief because Greek policy reforms alone would do the trick. They were not persuasive. Through their more recent actions, however, they have since acknowledged the need for debt relief by lowering the interest rate they charge on their own loans to Greece. But they have kept arguing that the bonds would not be restructured.

The casual observer would be forgiven for thinking that the world has turned on its head:  Here is the community of market participants arguing for haircuts on the bonds.  And here are the governments – representatives of taxpayers – insisting that private bondholders be protected at the implicit expense of Europe’s taxpayers.

There is good reason for the official sector’s insistence on avoiding a bond restructuring.

However, there is good reason for the official sector’s insistence on avoiding a bond restructuring. Greek bonds do not include collective action clauses, and they are distributed widely to domestic and foreign holders.  Worse, there is no reliable information on who exactly owns what, including who has bought and who has sold protection on these bonds.  The ECB’s Lorenzo Bini Smaghi has rightly suggested that the aftermath of the Lehman default might look like a walk in the park compared with a forced restructuring of Greek bonds. Some have argued that since about 90% of the bonds have been issued under Greek law, the Greek parliament could simply change the law and impose haircuts on the existing bondholders; a highly questionable preposition since retroactive legislation would run counter to any normal modus operandi in democratically ruled market economies.

The political winds throughout Europe have begun to swing towards fringe parties with a more sceptical – if not outright hostile – attitude to European cooperation.

Left with no practical way of including in an orderly way the private creditors in the burden sharing, the official sector is now contemplating further relief, including via longer maturities and maybe still lower interest rates, while insisting on further measures to speed up the inevitable policy adjustments in Greece.  However, as the political winds throughout Europe have begun to swing towards fringe parties with a more sceptical – if not outright hostile – attitude to European cooperation, the appropriateness of involving the private creditors for a fairer sharing of the burden has now been accepted by several governments, led by Germany.

With a disorderly attempt at restructuring still ruled out, the idea of voluntary participation of bondholders through a maturity extension, possibly under the vaguely defined Vienna Initiative, has been introduced. The Vienna Initiative aims as keeping banks involved in crisis countries. Importantly, while a voluntary maturity re-profiling would be unlikely to provide much,if any, net present value reduction, it might provide sufficient political cover to keep taxpayers involved for the heavier lifting.

I suspect that the ECB has concluded that the generally improved economic and financial outlook justifies a return to normal monetary policymaking. 

Strangely, this reasonable and gentle call for private sector involvement has met strong opposition from the ECB.  Having no explicit vote in the system, the ECB has threatened a practical veto by suggesting that voluntarily re-profiled bonds might not be eligible as collateral under its repo system.  Surely, if that were to be the ECB’s final word, then no bank would voluntarily participate, and the attempt to include even modest private sector participation would end right there.

Why would the ECB now throw a spanner in the wheel for what appears to be a perfectly reasonable compromise to involve most of the bondholders – and recalling that they have before made important exceptions to the treatment of debt in their collateral set-up?  I suspect that the ECB has concluded that the generally improved economic and financial outlook justifies a return to normal monetary policymaking.  Therefore, they now want to send their extraordinary and at times quasi-fiscal measures back to their rightful owners; the governments.  This means that governments need to adjust their policies, and when help is needed for one of the member states, it is to be provided via implicit or explicit tax transfers by other members, not the ECB.

There is a risk that while the urgency of the economic and financial crisis may be over, a political crisis could be looming if additional taxes have to be transferred.

Erik F. Nielsen

I have a lot of sympathy for that argument. But there is a risk that while the urgency of the economic and financial crisis may be over, a political crisis could be looming if additional taxes have to be transferred. And if, God forbid, the financial crisis indeed were to be followed by further political tensions with the potential to drag euro zone member states away from the common good, and towards nationalism, then the ECB could soon find itself back with policies much more uncomfortable than the acceptance of collateral of bonds which the holders have voluntarily accepted in place of their holdings of shorter bonds. Wanting to do the right thing, there is a real risk that the ECB is moving too fast towards the exit door right now.

 

Erik F. Nielsen is the former Chief European Economist at Goldman Sachs. 

He’ll join Unicredit as Global Chief Economist in September.

www.eurointelligence.com

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New Econo-Parody Song: “Dominique”

The folks at Versusplus.com is back with another perfectly timed econo-parody song. It’s a musical parody of the Deckers/Sparks song “Dominique,” dedicated to Mr. Dominique Strauss-Kahn. Enjoy!

Lead vocal: JANIS LIEBHART Background vocals: JOANNA BUSHNELL, SCOTTIE HASKELL, JANIS LIEBHART Music Director: GREG HILFMAN. 

For the complete collection of VERSUS political musical parodies, and the text of the parody lyrics, visit us at http://versusplus.com.

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Greek Commissioner Lets Cat Out of the Bag

The Greek EU Commissioner of Fisheries, Maria Damanaki, becomes the first senior EU official who speak openly about the possibility of Greece leaving the euro zone. She warns that Greece must make sacrifices to overcome its debt crisis or face the risk of leaving the euro zone and returning to the Drachma.

“Either we agree with our lenders on a programme of tough sacrifices … or we return to the Drachma.”

Maria Damanaki

 
It was probably well intended, but this type of comment is actually quite dangerous, the eurointelligence.com points out in their daily briefing. I suppose it’s more dangerous for the EU than for Greece. Anyway – let’s see how the financial markets react during today’s session.

The Greek fisheries Commissioner Maria Damanaki warned Wednesday that Greece must make sacrifices to overcome its debt crisis or face the risk of leaving the euro zone and returning to the drachma.

“I am forced to speak openly. Either we agree with our lenders on a programme of tough sacrifices … or we return to the drachma,” she said, according to the semi-official Athens News Agency.

Ms. Damanaki is the first senior European official to publicly declare that the debt crisis could result in Greece leaving the euro zone and reverting to its old currency.

Olli Rehn’s spokesman immediately dismissed the idea of a return to the drachma, naturally.

(Wasn’t that the guy who publicly denied that the EU ministers was attending a meeting in Luxembourg a couple of weeks ago?)

 Well, if you want rumors, you got it!

At the moment there are rumours that Greece might consider to hold a referendum to gain a mandate for proceeding with further austerity measures, spending cuts and privatizations, Greek newspaper Kathimerini reports.

The idea was raised at a Hellenic Federation of Enterprises (SEV) conference on Tuesday by the group’s chairman, Dimitris Daskalopoulos.

Prime minister Papandreou’s aides says that the minister was not averse to the idea and had actually discussed it with ministers at Monday’s Cabinet meeting.

However, Reuters reports that the Greek government denies that a referendum is a real option.

That seems to have become like a strategy for the Greek government – deny everything.

Meanwhile back in Brussels, the politicians are running around making all kinds of proposals, inventing new words for default and then taking it all back…

Now, German finance minister, Wolfgang Schäuble, seems to have changed his mind about a so-called “soft restructuring” for Greece. (Probably something along the lines of a “reprofiling”).

Speaking with Handelslbatt, the German minister explain that a credit event might be the consequence.

(Translation; credit event = financial havoc).

On top nobody knows how to deal with such a situation in country that is part of a monetary union.

“That would be an entirely different constellation that in 1990’s in Argentina and other countries”, Schäuble adds.

But no matter how you twist it; there’s nothing soft about the austerity measures that are in store for the people of Greece. 

Talking to Frankfurter Allgemeine Zeitung, the Bundesbank president, Jens Weidmann, warns that monetary policy will not clean up the mess after a soft restructuring in Greece.

The German central bank is not opposed the restructuring in principle, he points out in his first interview since taking office this month, adding:“As a question of principle the consequences of mistakes in financial policy must not be rolled over to the central banks. That would be a monetization of state debt. There must be a clear separation of monetary and financial policy.”

Weidmann warned a soft restructuring as currently discussed for Greece – a voluntary extension of the maturities of government bonds for private investors – would inevitably have the consequence that the ECB would no longer accept these bonds as collateral.

(Not even as soft assets?)

Talking about the ECB’s securities market program (SMP) Weidman says it is currently on hold.

Explaining the rationale of the SMP he says:

“The eurosystem has acted in a phase when the fiscal policy was unable to act. By doing so it built a bridge. With the EFSF and the EFSM there are now the instruments and the end of the bridge has been reached. The ECB council agrees that the program is limited in time, the only discussion is about the right timing of the exit.”

Well, Mr. Weideman, I can assure you the EU leaders can stay irrational longer than you can stay in office!

However – as eurointelligence.com also underline – these comments are important because Weidmann chooses to bring the Bundesbank back in line with all the other central banks.

Remember that his predecessor Axel Weber marginalized himself and the Bundesbank by publicly opposing the SMP.

(…I did not mention Merkel or PMS…)

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