Tag Archives: 2010 European sovereign debt crisis

Europe: A Lehman Collapse in Slow Motion, Former Lehman Banker Says

Former derivative trader at Lehman Brothers and founder of Re-Define, Sony Kapoor, has been trying for years to explain to European governments how they can handle the financial crisis and create a new sustainable economy – on both national and international level. But  sadly they don’t seem to have been listening to the experienced financial expert. In a recent published article it seems like Mr. Kapoor is about to give up on the whole euro zone and its politicians.

“Instead of reacting decisively to reduce uncertainty, our political leaders have done the exact opposite.”

Sony Kapoor


“When Lehman Brothers collapsed, no one knew which bank would be next. Counter-parties lost faith in all measures of the soundness of banks. Under such a scenario, the only course of action that made sense was to hold one’s money close to the chest. This individually rational response was collectively disastrous. The uncertainty around the size and distribution of potential losses led to systemic collapse. Something similar has been unfolding in the euro zone banking and sovereign debt crisis albeit in slow motion,” Mr. Kapoor writes.

I first met Sony Kapoor about three years ago, a few months after the historical bankruptcy at Lehman Brothers, as he was working on setting up the headquarter for his international think-tank, Re-Define, in Oslo, Norway.

Kapoor had left Lehman Brothers in 2005, because, he said, felt uncomfortable with the things he was doing at Lehman.

Sony Kapoor has been the Director of Policy & Advocacy with Stamp out Poverty (UK), Strategy Advisor to Oxfam Novib (Netherlands), Senior Advisor to Christian Aid (UK) & the Jubilee Network (USA).

He is also a former Member of the Boards of Directors of Eurodad (European Network on Debt and Development) and the International Tax Justice Network which he also helped set up.

He played a leading policy and advocacy role in the multilateral debt cancellation deal reached in 2005, recently he has been an influential voice in shaping the discussion on innovative sources of financing, and helped driving the international agenda on tackling capital flight and tax havens.

As I introduced him to leading Norwegian market participants, we both agreed that a new global financial and monetary system is urgently needed. Mr. Kapoor had already been acting as a consultant for several European governments, and seemed optimistic about future.

(You may want to read his comprehensive – 112 pages – analysis of the financial crisis; “The Financial Crisis – Causes & Cures”)

It is therefore with some sadness I publish his recent commentary, in which he points out that the politicians of Europe have done exactly the opposite of what they should have done, and completely dismissed his advise.

He says it’s like watching the collapse of his former employer all over again – only this time in slow motion.

Anyway – here’s the full post, called:

The Shadow Fiscal Union

The failure to draw a line under the crisis has meant that the continuing uncertainty around the size and distribution of losses in the euro zone is hemorrhaging our economy.

The size of this deadweight economic loss, with all its human cost, is increasing with every additional day of inaction.

Political dithering and mixed messages have ensured that no one knows how, when or where these losses will materialize.

Under these circumstances, it is rational for investors to keep their distance.

They are penalizing both sovereigns exposed to weak financial institutions and financial institutions exposed to troubled sovereigns.

They assume the worst for both, but this collective fear is far in excess of the worst possible realistic economic outcome.

Increased Human Costs

States and banks with healthier balance sheets have got caught in the crossfire.

Instead of reacting decisively to reduce uncertainty, our political leaders have done the exact opposite.

Their continuing dithering has increased the absolute economic and human cost of the crisis.

“Mixed messages, a seeming lack of competence and a decision to focus on issues such as competitiveness that at best tangential to crisis resolution today have increased uncertainty with grave economic consequences.”

This is bad economics.

Euro-federalists have suggested everything from minimalist E-bonds to a complete fiscal union. At the other end, some skeptics have even called for kicking troubled countries out of the euro zone.

Political expediency and economic logic rules out any break-up of the euro zone, and political stalemate and public opinion stand in the way of a fully fledged fiscal union.

Our political leaders have instead chosen to gamble taxpayer funds with abandon.

They are taking on ever-increasing amounts of liabilities on public balance sheets in the EU.

This happened not just when countries rescued their banks the first time round and again when a deteriorating situation in Greece led to a ‘rescue package’ for Greece. This was less a bailout of the Greek sovereign but more an indirect bailout of banks in Germany and France exposed to Greek bonds.

Ireland, having foolishly issued guarantees for its financial sector, was forced by the ECB and the EU to honor these with the consequence that an otherwise sound Irish sovereign was dragged down by its hemorrhaging banking system. Bondholders have been made whole.

Taxpayers are being made to pay.

A Shadow Fiscal Union

The loans provided to Greece, the ECB’s purchase of Euro zone sovereign bonds, and the creation of the European Financial Stability Mechanism (EFSM), have all shifted the risk of losses from creditors to the taxpayers of troubled member states underwritten by the taxpayers of member states with more sound finances.

An opaque “shadow fiscal union” has been created but no one bothered asking the voters.

“The official discourse is that both creditors and taxpayers from countries such as Germany will be fully repaid in time. Since this is not possible, this public stance is irresponsible and probably dishonest.#

With debt burdens bigger than their economies, and growth rates below or close to zero and skyrocketing borrowing costs, the only choice for Greece and Ireland will be to restructure outstanding debts by rescheduling or imposing significant haircuts on creditors.

“Creditor losses are likely to run into tens of billions (hundreds if Spain and Portugal also seek aid) of Euros.”

When they hit taxpayers in Germany and France, it will be a serious body blow to the eroding trust that EU citizens have in their leaders.

Bad Economics – Bad Politics

Even more important, it would also poison member states’ relations with each other, perhaps irreparably.

“Losses at the ECB will damage its credibility inflicting additional damage to the Euro project.”

This is bad politics.

Delaying this inevitable restructuring of Greek and Irish will simply increase the losses to EU taxpayers.

Too much has already been given away to creditors and too much has already been taken away from taxpayers.

Let the March summit signal the end of the era of bad economics and bad politics.

By Sony Kapoor

Managing Director

Re-Define

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Europe In Debt (Part 3): Exit On Main Street

After reading through all three parts of Satyajit Das’ comprehensive analysis of the European debt crisis, it is evident that the final end game is approaching. But what it might be, what might happen or how long it might take to turn the economy around, is anybody’s guess.  Das writes that there is increasing concerns about the fact that the European problems now threaten the global recovery. The most scary part, however, is that our politicians seems to have lost all control over the economy, and that the forces of the financial markets are about to dictate some kind of New World Order.

“In 11 May 1931, the failure of a European bank – Austria’s Credit-Anstalt – was a pivotal event in the ensuing global financial crisis and the Great Depression. The failure set off a chain reaction and crisis in the European banking system. Some 80 years later, European sovereigns may be about to set off a similar sequence of events with unknown consequences. As Mark Twain observed; history does not repeat, but it may rhyme.”

Satyajit Das

Politics now increasingly dominates the economics. Commenting about the EU bailout of Ireland, the Irish Times referred to the Easter Rising against British rule asking: “was what the men of 1916 died for a bailout from the German chancellor with a few shillings of sympathy from the British chancellor on the side”.

An Irish radio show played the new Irish national anthem to the tune of the German anthem.

In Greece, the severe cutbacks in government spending have resulted in strikes and violent protests on the streets of Athens.

“Faced with cutbacks in living standards, Europeans are fighting back. The Rolling Stones’ late sixties anthem has been resurrected in Europe: “Everywhere I hear the sound of marching, charging feet, boy- Summer’s here and the time is right for fighting in the street, boy.”


In many countries, governments, often unstable coalitions, are struggling to pass legislation, implementing necessary spending cuts or tax increases.

“In Ireland, the opposition parties have promised to re-negotiate the bailout package if elected at an election due early in 2011. In Germany, the paymaster and strength behind the EU, Europe’s biggest tabloid Bild asked “First the Greeks, then the Irish, then…will we end up having to pay for everyone in Europe?”

In December 2010, a special EU meeting, convened to discuss the situation, provided a clear pointer to how events might evolve. At the meeting, the German view, set out by Chancellor Angela Merkel, prevailed.

The meeting rejected any attempt to increase the scope and amount of the existing bailout facilities. The E-Bond proposal was quietly shelved. The EU agreed to formalize the ESM through a short amendment to the Lisbon Treaty.

The new facility would be inter-governmental with any Euro Zone member having a national right of veto. The facility was highly conditional, capable of being triggered only as a last resort.

A key element was the requirement for “collective action clauses”, effectively forcing lenders to bear losses. The provision, which must be included in all European government bonds after June 2013, would require the payment period to be extended in case of a crisis.

If the solvency problems persisted, then further extension of maturity, reductions in interest rates and a write-off in the principal would occur. In addition, new bailout funds would automatically subordinate existing debt and have to be paid back first.

Chancellor Merkel’s position reflects the views of the German constitutional court, which endorsed European economic and monetary union prescribed in the 1992 Maastricht treaty only on the basis of the treaty’s no-bail-out provisions.


This influences the need to impose losses on investors.

“It is clear that the stronger members of the EU, led by Germany, have decided to limit future liability in bailouts.

As membership of the Euro prevents large devaluation of the currency, economic adjustment will require reduction of the budget deficit and deflation.

As Greece and Ireland demonstrate, more rigorous deficit cutting may not return the countries to solvency.

The EU proposals implicitly recognize that over-indebted countries cannot sustain currency debt levels. The reduction of the debt burden will have to come through restructuring or default, with creditors taking losses.

“Unless confidence returns rapidly or the EU changes its position, it seems restructuring or defaults by several peripheral European sovereigns may be unavoidable.”

Investor concerns that the Greek and Irish did not solve the fundamental problems may be confirmed.

The safety nets are now seen as unlikely to be large enough to rescue larger countries, like Spain and Italy, if they require support.

Investors will need to take losses

Large volumes of maturing debt mean that the test is likely to come sooner than later. The heavily indebted European sovereign states face $2.85 trillion of maturing debt in the period to 2013. Portugal, Italy, Ireland, Greece and Spain have bond maturities of $502 billion in 2011.

“The financing needs of Greece, Ireland, Portugal and Spain over the last quarter of 2010 and 2011 are Euro 320 billion, rising to Euro 712 billion if Italy is included.”

In addition, private sector borrower in these countries face maturities of $988 billion of corporate bonds and $200 billion of syndicated bank loans over the same period. Likelihood of low economic growth, failure to meet IMF plan targets, further banking sector problems and credit downgrades exacerbate the risk.

If Europe muddles it way through the refinancing crisis, then the expiry of existing support facilities in 2013 and the changed regime of the ESM poses new risks and may continue the instability.


A Faraway Continent

In the prelude to World War 2, British Prime Minister Neville Chamberlain dismissed the German occupation of Sudeten arguing that it was “a quarrel in a far away country between people of whom we know nothing.” North American and Asia have been bystanders as the European crisis developed.

“Increasing concerns are evident, as European problems now threaten global recovery.”

China, which contributed around 80% of total global growth in 2010, has expressed growing concern about the problems in Europe.

Trade between China and the EU, its largest export market, totals around $470 billion annually, contributing a trade surplus of Euro 122 billion for China in the first nine months of 2010.

Any slowdown in Europe would affect Chinese growth. China is also a major holder of Euro sovereign bonds, standing to lose significantly if problems continue. China has indicated preparedness to use some of its $2.7 trillion of foreign exchange reserves to buy bonds of countries such as Greece and Portugal.

“A slowdown in China would affect commodity markets, both volumes and prices, and commodity exporters such as Australia, China and South Africa.”

Minutes of a 7 December 2010 from the central bank of Australia, one of the world’s best performing economies, indicated increasing concerns about developments in Europe.

A continuation of the European debt problems, especially restructuring or default of sovereign debt, would severely disrupt financial markets.

Losses would create concerns about the solvency of banks, in particular European banks. In a repeat of the events of September 2008 (when Lehman Brothers filed for bankruptcy protection and AIG almost collapsed) and April/ May 2010 (prior to the bailout of Greece), money markets could seize up, as trust about the ability of parties to perform contracts evaporated.

In turn, this volatility would feed through into the real economy, undermining the weak recovery.

“Unless resolved, the European debt problems will affect currency markets and through that channel the global economy.”

Any breakdown in the Euro, such as the withdrawal of defaulting countries or change in the mechanism, would result in a sharp fall in the new currencies. In turn, this would, in the first instance, result in large losses to holders of debt of those countries from the devaluation.

Depending on the new arrangements, the US dollar would appreciate abbreviating the nascent American recovery.

This may compound existing global imbalances and trigger further American action to weaken the dollar.

Further rounds of quantitative easing are possible, setting off inflation and de-stabilizing, large scale capital flows into emerging markets. In turn, the risk of protectionism, full-scale currency and trade wars would increase.

A breakup of the Euro would adversely affect Germany, which has been growing strongly.

A return to the Deutschemark or, more realistically, an Euro without the peripheral countries may result in a sharp appreciation of the currency, reducing German export competitiveness.

As the Australian central bank noted in its December 2010 minutes: “… the deterioration in the situation in Europe over the past month had increased the downside risks to the global economy. How this would ultimately play out, and the implications … were difficult to predict. It was possible that conditions could settle down, as they had after the episode of financial instability in May. Alternatively, an escalation of the current problems was not out of the question. If this prompted a fresh retreat from risk-taking in global financial markets, it would probably have more impact … than any trade effect.”

The End Game

Events since the announcement of the bailout package in early 2010 have been reminiscent of 2008.

Then, the optimism following bailouts of Bear Stearns and other troubled American banks produced premature.

The promise of China to purchase Portuguese bonds is similar to the ill-fated investments of Asian and Middle-Eastern sovereign wealth funds in US and European banks.

Eventually with each successive rescue and the reemergence of problems, the capacity and will for further support diminished.

The EU rescue of Greece and Ireland are also reminiscent of US attempts to rescue its banking system, with more and more money being thrown at the problem. The strategy was defective, preventing the creative destruction required to restore the system to health. The actions may have doomed the economy into a protracted period of low growth, laying the foundations for future problems.

At the time of the Greek bailout, the real question was: “If Euro 750 billion isn’t enough, what is?” Increasingly, markets fear that there may not be enough money, to solve the problem painlessly.

In 11 May 1931, the failure of a European bank – Austria’s Credit-Anstalt – was a pivotal event in the ensuing global financial crisis and the Great Depression.

The failure set off a chain reaction and crisis in the European banking system.

Some 80 years later, European sovereigns may be about to set off a similar sequence of events with unknown consequences.

As Mark Twain observed; “history does not repeat, but it may rhyme.”

By Satyajit Das

eurointelligence.com

(Satyajit Das is a former derivative trader and the author of the book “Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives”.)


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