FT: Moody’s warns of second rescue for Portugal

If the objective is restored market access, the limits of exisitng crisis resolution arrangements were further exposed by Moody’s four-notch downgrade of Portugal.   The FT has the story here.   This bit is particularly important:

Moody’s cited the tortuous negotiations over Greece in its note, warning that although the likelihood of a restructuring in Portugal was lower than in Greece, the European Union’s “evolving” approach to providing further support “implies a rising risk that private sector participation could become a precondition for additional rounds of official lending to Portugal in the future as well.”

The full Moody’s statement is available via ft.com/alphaville.

London, 05 July 2011 — Moody’s Investors Service has today downgraded Portugal’s long-term government bond ratings to Ba2 from Baa1 and assigned a negative outlook. Concurrently, Moody’s has also downgraded the government’s short-term debt rating to (P) Not-Prime from (P) Prime-2. Today’s rating action concludes the review of Portugal’s ratings initiated on 5 April 2011.

The following drivers prompted Moody’s decision to downgrade and assign a negative outlook:

1. The growing risk that Portugal will require a second round of official financing before it can return to the private market, and the increasing possibility that private sector creditor participation will be required as a pre-condition.

2. Heightened concerns that Portugal will not be able to fully achieve the deficit reduction and debt stabilisation targets set out in its loan agreement with the European Union (EU) and International Monetary Fund (IMF) due to the formidable challenges the country is facing in reducing spending, increasing tax compliance, achieving economic growth and supporting the banking system.


The first driver informing today’s downgrade of Portugal’s sovereign rating is the increasing probability that Portugal will not be able to borrow at sustainable rates in the capital markets in the second half of 2013 and for some time thereafter. Such a scenario would necessitate further rounds of official financing, and this may require the participation of existing investors in proportion to the size of their holdings of debt that will become due.

Moody’s notes that European policymakers have grown increasingly concerned about the shifting of Greek debt held by private investors onto the balance sheets of the official sector. Should a Greek restructuring become necessary at some future date, a shift from private to public financing would imply that an increasingly large share of the cost would need to be borne by public sector creditors. To offset this risk, some policymakers have proposed that private sector participation should be a precondition for additional rounds of official lending to Greece.

Although Portugal’s Ba2 rating indicates a much lower risk of restructuring than Greece’s Caa1 rating, the EU’s evolving approach to providing official support is an important factor for Portugal because it implies a rising risk that private sector participation could become a precondition for additional rounds of official lending to Portugal in the future as well. This development is significant not only because it increases the economic risks facing current investors, but also because it may discourage new private sector lending going forward and reduce the likelihood that Portugal will soon be able to regain market access on sustainable terms.

The second driver of today’s rating action is Moody’s concern that Portugal will not achieve the deficit reduction target — to 3% by 2013 from 9.1% last year as projected in the EU-IMF programme — due to the formidable challenges the country is facing in reducing spending, increasing tax compliance, achieving economic growth and supporting the banking system. As a result, the country may be unable to stabilise its debt/GDP ratio by 2013. Specifically, Moody’s is concerned about the following sources of risk to the budget deficit projections:

1) The government’s plans to restrain its spending may prove difficult to implement in full in sectors such as healthcare, state-owned enterprises and regional and local governments.

2) The government’s plans to improve tax compliance (and, hence, generate the projected additional revenues) within the timeframe of the loan programme and, in combination with the factor above, may hinder the authorities’ ability to reduce the budget deficit as targeted.

3) Economic growth may turn out to be weaker than expected, which would compromise the government’s deficit reduction targets. Moreover, the anticipated fiscal consolidation and bank deleveraging would further exacerbate this. Consensus growth forecasts for the country have been revised downwards following the EU/IMF loan agreement. Even after these downward revisions, Moody’s believes the risks to economic growth remain
skewed to the downside.

4) There is a non-negligible possibility that Portugal’s banking sector will require support beyond what is currently envisaged in the EU/IMF loan agreement. Any capital infusion into the banking system from the government would add additional debt to its balance sheet.

Moody’s acknowledges that its earlier concerns about political uncertainty within Portugal itself have been largely resolved. Portugal’s national elections on 5 June led to the formation of a viable government, both components of which had campaigned on the basis of supporting the EU-IMF loan agreement negotiated by the previous government. Moody’s also acknowledges the policy initiatives announced at the end of June demonstrate the new Portuguese government’s commitment to the programme. However, the downside risks (as detailed above) are such that Moody’s now considers the government long-term bond rating to be more appropriately positioned at Ba2. The negative outlook reflects the implementation risks associated with the government’s ambitious plans.


Developments that could stabilise the outlook or lead to an upgrade would be a reduction in the likelihood that private sector participation might be required as precondition for future rounds of official support or evidence that Portugal is likely to achieve or exceed its deficit reduction targets.

A further downgrade could be triggered by a significant slippage in the execution of the government’s fiscal consolidation programme, a further downward revision of the country’s economic growth prospects or an increased risk that further support requires private sector participation.

53 replies on “FT: Moody’s warns of second rescue for Portugal”

Is anyone else getting tired of rating agencies? It sometimes seems like the future of the global financial system lies in the hands of three private organisations. And they talk about the systemic risk of banks….

The situation becomes more bizarre by the day. On the one hand we have a leading trade unionist referring to the possibility of the inevitability of default and on the other a headline about the remarks of the MOF suggesting that the countries involved in the Irish bailout are making an undeserved profit from their loans i.e. that they are charging a rate more than the going one when the opposite is demonstrably the case.

While the MOF appears to have referred only to the interest rate being charged as “excessive”, equating moral hazard with one party losing power and another gaining it is unlikely to impress Ireland’s creditors.

There is a way in which the case for a lower interest can be put but only in the context such as that outlined by Colm McCarthy in last weekend’s Sindo.

It seems that the penny will not drop until the budget and then it threatens to do so with a vengeance. But it may provide the one thing that is missing viz.confidence as to how those now in charge of Ireland’s destinies intend to proceed. Talking the talk is not enough, it is now time to walk the walk (with all the uncomfortable consequnces for those hitherto largely protected from the impact of the crisis).

Martin Wolf has a superb analysis here :


“Assume that these countries (PIG) could borrow affordably in private markets at a gross debt ratio of 80 per cent of GDP. Assume, too, that European governments ensure that the IMF takes no losses. Then, the reduction in value of the rest of the debt would need to be as much as 65 per cent of GDP for Greece, 50 per cent for Ireland and 45 per cent for Portugal. The total “haircut” would be €423bn: €224bn for Greece, €107bn for Ireland and €92bn for Portugal. ”

So €107 bn for Ireland How much of that is Anglo, BoI and AIB development loans ? The builders bring down the sovereign.

He also has this :

“the more successful a country turns out to be in cutting its costs, the worse the debt burden becomes. Thus, debt restructuring is merely a necessary condition for an exit. It is unlikely, in all cases, to be enough. Some economies may just wither away.
Alternatively, politicians may pull their countries out of the eurozone regardless of short-run costs. It is far too early to assume this will be the outcome, though some already do. But if there is to be any chance of avoiding this outcome, realism is required. At some point, the present value of the cost of debt must be drastically lowered. This does not have to happen today. But it has to happen soon enough to give people hope. In its absence, failure is not just likely. It is close to a certainty.”

Given the ratings agencies’ past history of ‘success’ with worthless assets, surely a degree of selective deafness needs to be practiced by European elites?

@ Seafoid

Wolf’s figures for Ireland seem erratic at best but it may be a typo.

He suggests that a €107 billion debt reduction would be 50 percent of GDP. Our nominal GDP in 2011 will be around €160 billion, give or take
rather than €215 billion which Wolf’s figures imply.

A debt of 80% of our GDP would be around €128 billion. The “haircut” listed above is €107 billion. That requires a total debt of €235 billion – for 2011!

The forecast General Government Debt for the end of the year is around €170 billion. A “kitchen sink” approach might be able to find the additional €65 billion (NAMA, ELA) but getting plausibly to €235 billion does not seem likely.

We do not need €107 billion of savings to bring the ratio down to 80%, but if we decide to go this road we must explore how we will make these savings by determining what we can default on.

@ Seamus Coffey

It is gratifying to see the figures advanced by Wolf subjected to expert criticism. If the view he took of those advanced by Sinn are any guide, anything he writes should be viewed with a deal of scepticism (a criticism to which, as far as I know, he has not deigned to offer a reply).


By the way, as a layman, I simply cannot undertsand how default can be considered as a “policy option” in any logical discussion of recovering creditworthiness within a monetary union.

At some point people who believe that simply saying “we won’t default” over and over again will solve the problem will have to remember Albert Einstein’s definition; “Insanity: doing the same thing over and over again and expecting different results.”

There seems to be a logical flaw in Mr. Wolf’s argument (FT link see above). He says the countries could “borrow affordably in private markets at a gross debt ratio of 80 per cent of GDP”. He suggests the IMF should lose no money. As he suggests the countries should be able to borrow in the market, then there surely cannot be any “involuntary” involvement of private bond holders either. Its a safe bet that at the end of the day “voluntary” involvement in restructuring will be minimal at best. Bank boards will risk to be sued by their shareholders otherwise. Which leaves the European tax payer to take up the tap and, with the size of the amounts in discussion, this is hardly imaginable politically. It will be very messy once the can hits the wall down the road…

@Seamus Coffey / others

Can anyone clarify how this year’s deficit – likely to be €18.2 billion – is described as being equivalent to 10% of GDP (eg in Irish Times report from Monday of latest Exchequer figures, below) when our nominal GDP for 2011 is around €160 billion?

“Minister for Finance Michael Noonan predicted Ireland would meet its year-end exchequer deficit target of €18.2 billion or 10 per cent deficit to GDP ratio – set out in the EU-IMF rescue plan.”


I would guess that there is switching between the Exchequer Deficit and the General Government Deficit as the measure used.

This year’s Exchequer Deficit is forecast to be €18.2 billion. The General Government Deficit is forecast to be €15.7 billion.

There are a number of reasons for the difference. The main one is the treatment of €3.1 billion payment on the Promissory Notes. This is as confusing as the next paragraph sounds.

This payment is included in the Exchequer Deficit as the Exchequer has to find the €3.1 billion to give to Anglo, INBS and EBS. The payment is not included in the General Goverment Deficit as the Promissory Notes were included in the General Government Debt when they were created and to count them when they are also paid would be double counting.

You can see the full breakdown of the differences between the Exchequer and General Government Deficits on the last page of the Stability Programme Update from April. It’s all a bit technical.

The 10% target set out in the EU/IMF plan is for the General Government Deficit. That is forecast to be around €15.7 billion this year which will be around 10% of our nominal GDP.

@ Paul Ryan

John Gapper wrote about cutting the ratings agencies down to size last year :


@Séamus Coffey

Does Wolf perhaps count the CB exposure to the banks? If you chuck that in the debt ratio is close to 200% of GDP. – There is an excellent graph here that shows the combined Sov debt, bailout and CB magic beans.


The point I was interested in is how much of the debt is unsustainable and how much of that is development loans shunted onto the sovereign. Will it be the Anglo loans that set off the default ? It seems very obvious from the bond yields that the market does not believe Ireland’s debt is sustainable.

From the FT report on Portugal in the post:

“3) Economic growth may turn out to be weaker than expected, which would compromise the government’s deficit reduction targets. Moreover, the anticipated fiscal consolidation and bank deleveraging would further exacerbate this.”

I also note in today’s Independent that the consolidation package for Ireland might be upped to e4bn due to weaker than the IMF’s prediction for growth.

Similar in the excellent reuters summary posted by Ordinary man at the top of the thread.

At what point, and how, does the troika have to take consequences when/if Ireland fulfulls its obligations and yet the growth is not as predicted by them: though the effects of austerity are being busily pointed out by others.


By the way, as a layman, I simply cannot undertsand how default can be considered as a “policy option” in any logical discussion of recovering creditworthiness within a monetary union.

Your tireless lobbying for bank bondholders and the misbegotten mess that is the European financial sector is a thing of almost miraculous wonder.

@ John McHale

As it has been mentioned, Jack O’Connor’s speech is here:


With a relevant passage here:

“We have to extricate ourselves from the straightjacket of the “Troika”
agreement which is suffocating any prospect of growth in domestic demand
and without which there will be no appreciable recovery. The question is
how to trigger re-negotiation? Opinion is divided as to the potential
consequences of threatening default and we have not, thus far, supported
the call. We may well come to do so and we are conscious that resources
are being run down as time passes. However, we cannot anticipate the
response of the ECB which could withdraw support from our covered
banks. Neither can we assume the way it would play with the global
companies, including those in the financial services sector, upon which so
many of our people depend for their livelihoods. We can be pretty certain
it would mean balanced budgets overnight – which would be devastating for working people and all who depend on public services.”

I was wondering if you have any substantial disagreement with this analysis?

@Seamus Coffey

Thanks for that very helpful explanation (and your latest post analysing the mid-year figures).

“Moody’s warn of second bailout for portugal”

Moodys note Pope may be catholic.

There is some good stuff here on rating agencies.


“Tracking the Greek/European crisis over past year and a half, I can’t think of a single time when rating agencies have played a constructive role and might actually have made crisis worse by their creeping rating downgrades”

“Rating agencies are just stating the obvious. Rating agencies are of value if their ratings anticipate possible outcomes.”

@ seafóid,

Depending on what you add in you can get virtually any number you want for the public debt. The difficulty I have with the central bank liability (currently €53bn ELA + €71bn ECB = €124bn) is how to accurately link that to the public debt.

To do so I think you have to look at the asset side of the banks’ balance sheet rather than this huge item on the liability side. The problem with the banks is that their assets are a mess. It is because of rubbish assets that the banks can’t meet their liabilities.

So far the banks have received (or will receive) over €100 billion to cover such losses (€25bn equity and reserves + €14bn haircuts to junior debt + €66bn from the State = €105bn). If the banks are going to fall short in meeting their liabilities, the losses will have to be greater than those covered by this money. There are very few forecasts of substantially more than €100bn for the covered banks.

NAMA also casts a shadow over our public debt. It has paid €31 billion for €72 billion of loans. We do not know what these loans will be worth but it will be some positive number. The NWL index from the excellent Namawinelake indicates that NAMA needs a blended 13% rise in property prices to break even. We don’t know where prices will go in future, but that gives a projected loss of around €3.5 billion based on current prices.

As to our current ‘official’ debt which is projected to be €174 billion at the end of the year. The State is committing €66 billion to the banks and about €50 billion of that will be with borrowed money. The rest will come from the NPRF. €50 billion will be just over one-quarter of the year-end General Government Debt. Three-quarters will not be directly related to the bank bailout.

I am Greek. First very briefly some observations and opinions about the memorandum and austerity in Greece: it does not work, it does not solve any problem, it just makes Greek debt, European debt. However, the neoliberal fundamentalists in charge of the EU system cannot accept changes that will actually allow Greece to repay. The left-wing government has no other option though (for many reasons) but to accept the new memorandum and the new ‘bail-out’ and hope for the best. It is a lie though, it won’t solve the problem. The opposition (right-wing) is absolutely spot on to disagree and propose alternatives. I believe that should insist on a different road and not back down to pressure. How can they agree on something that is so manifestly wrong: too much austerity and taxes that kill the economy and make default more not less probable and contagion even more probable.
On Ireland and Portugal now. It is true that the problems have different origins (in my country the excessive public borrowing compounding but inability to raise taxes from the corrupt private sector for too many years. The common Greek citizens have not really realised the first but everybody knew about the second). However, unfortunately for the markets we are all just PIGS, the fate of the one is linked to the fate of the other. I find that it is not really good policy to state our (real) differences so that the markets behave to us more gently. Of course every country is different but if we do not come together to press for a renegotiation with troika we are all dead in the water. We have to see our common needs and press for a better deal that will be beneficial for all EU citizens (as things stand they will lose their money big time sooner than later).

Irish 10 year at 12.41%…

Good article on Bloomberg about Iceland and how they are back in the market 3 years after defaulting. Cannot do link on this machine.

@Seamus Coffey
Re your figures… ECB at 71b. Where did the other 29b go to or have the banks managed to deleverage by 29b in a very short space of time.

Yet again, with Portugal this time, we see Austerity negatively trumping the ‘exports’ tooth fairy when it comes to furnishing the economic growth & tax receipts upon which the various PIGS ‘bail-out’ plans depend. Half way thru’ the year & we’re already getting the message in Ireland that further budget cuts (more austerity), over & above the ‘plan’, are going to be needed.

Even by 2013, the DoF expects unemployment here to remain above 10%. What’s the likelyhood it will be nearer 15%? More probable than not anyway. But what of the prospects then, going forward? Let’s be honest, there’s going to be slippage in the ‘austerity’ plan. We’re going to have a very large debt burden still, with high interest rates even if the bond markets will touch us. There’s surely little prospect that in the ensuing decade or more we will reduce this burden much, if at all. This is a recipe for permanently high unemployment, devastated public services & all the social costs resulting.

And this before another planet-sized elephant-in-the-room has been considered – world energy supply constraints & rising prices. (Not to mention other resources, some metals & ‘rare earth’ materials, crucial to the world economy.)

What we have is a plan for a two tier Ireland of even higher inequality than now. A permanent poor underclass of significant numbers, maybe 35% of citizens, no-waged or low waged with few welfare services, poor health & low life expectancy. Nor is it likely that Ireland will regain any meaningful economic sovereignty that could address this even if the will exists.

Why are we subjecting ordinary Irish citizens to all this, who had no real responsibility in creating the mess in the first place?

We are doing this to bail out & perpetuate a deeply immoral, flawed & corrupt financial system (little sign of serious aknowledgement, never mind ‘reform’). One that has demonstrated it’s interests lie firmly with the minority financial & wealth sectors over ordinary working citizens.

I have to wonder, do any of the economists here consider the longer term future & what really the social purpose of a monetary & financial system should be?

@ All

I think that the logical impossibility of arguing for a default within a monetary union is amply demonstrated by the excerpt from the speech by Jack O’Connor quoted above. It only becomes a logical possibility when the logical consequence of it is drawn i.e. abandoning the euro and re-introducing the punt.

The other point missing from these exchanges is the distinction to be drawn between different categories of government expenditure, that on maintaining salaries, pensions and retirement lump sums at an unaffordable level in a bloated public sector, on the basis of borrowed money, being a sure recipe for disaster, a disaster from which the taxpayers of other countries have no intention of rescuing us.

@ Séamus Coffey

Wolfs figures might seem erratic but his logic is impeccable. Others figures might be “more correct” to use a Bertism. However, I prefer Wolf’s analysis based on ‘wrong’ figures rather than the erratic, flawed and self-serving analysis based on ‘correct’ figures such as we have been treated to throughout this crisis. Three times we were told that our banking system was well capitalised based on ‘correct’ or ‘best available figures’ which is the get out of jail clause used by DoF, CB and regulators office.

The biggest dose of self-serving nonsense by our own troika, is, we can get out of this by taking the Croke Park scenic route. A default route, which terminates bottom of a very large cliff. Either we are forgiven 50bn or 75bn of our debt by our EU “friends” or as Wolf implies, we drive ourselves to default by the relentless grinding consequences of austerity, low growth/debt deflation and unsustainable debt servicing. Our SW bill alone is approaching 22bn in a state that could only raise 31bn in taxes last year, Surely this should have put us on red alert. Small wonder Mr. Varadkar was caught mumbling out loud about bailout 2.

At the end of the day, this small population even with the revelation of another 100,000 people “rediscovered”, is becoming increasingly skewed in terms of dependency. When Argentina went broke, there was plenty of money, but that money was put abroad where it could not be “got at” and when the wealthy could not be persuaded to share in the insolvency of the state the country defaulted. Ireland is “not different” and when America addresses the issues of leaking investment (FDI to us) it will hit us like a ton of bricks. This was mooted at the beginning of the current presidency but nothing has been done about it since but now with the Municipal debt crisis and state debt crises looming large how much longer do you think Ireland will be able to hide behind a booming export business that is like the property market at its peak? Much of this export business could disappear overnight. It could disappear as fast as the Celtic tiger and before you tell me it has everything to to do with our 12% corporate rate let me tell you, that rate can be excised at the stroke of a pen, if it means a second term in office.

Ireland, simply cannot carry the weight of 450,000 unemployed along with the further dead weight of so many self-important members of society who produce nothing more than reams of analysis, many of whom, are in effect on another unemployment register. Charitably, much of what they produce can be described as spinning yarns to keep ordinary people wrong footed and confused, while they hastily arrange their own financial departure, knowing they will have to take a 50% diminution of what is left of their wealth if they stay along with revised salaries, pensions and other “entitlements”. This will all be driven along by the wider public’s desire to survive and even to punish those who bankrupted the state.

@Robert B

“The biggest dose of self-serving nonsense by our own troika, is, we can get out of this by taking the Croke Park scenic route. A default route, which terminates bottom of a very large cliff.”

I see the imagery is getting through 😉

@Séamus Coffey

Thanks for that clarification.

Unfortunately I don’t get the impression the markets are interested in the details. Ireland is lumped in with Portugal and Greece, for worse or for dreadfully worse.

“In his speech, Gilmore said the current crisis was of such magnitude and complexity that it had effectively put the new Government on a war footing, with nothing less than Ireland’s sovereignty at stake.
He said sectoral interests, including party-political interests, would have to be set to one side.”
Croke Park????

We are lumped with them or they are lumped with us? The inability to balance a budget despite being bust is a wonder to behold.

I am afraid you are right. It all looks fairly predictable with 10 year yield on Portugal rising 18.5% today and Irish 7.4%. The yield increase for one day is massive. This seems to indicate that the markets do not accept that the programmes for Ireland and Portugal will succeed. Throughout this crisis the markets have been ahead of the curve.


We are lumped with them or they are lumped with us? The inability to balance a budget despite being bust is a wonder to behold.

Though we are clearly in dire straits Greece has a number of problems we do not have to cope with:

* Widespread tax evasion
* NATO membership and a very large military spend (talk about a sector of the economy that destroys value).
* A relatively recent history of military dictatorship.
* Higher levels of inequality than Ireland and therefore lower levels of national cohesion

Obviously Ireland is in trouble, involuntary debt restructuring seems a certainty and exit from our beloved Euro is an outside possibility but Greece has problems that even unfounded optimism about the world economy can not deal with.

@ Ceterisparibus

“In his speech, Gilmore said the current crisis was of such magnitude and complexity that it had effectively put the new Government on a war footing, with nothing less than Ireland’s sovereignty at stake.” Talk about the emperor’s clothes?

Is the man completely and utterly delusional? “Ireland’s sovereignty at stake”? Has no one had the nerve to tell him? This is truly frightening stuff. What is the MOU and why exactly did Damien Kiberd describe it as a “surrender document”? Not noted for his intemperance, is the same Damien though he does not suffer fools gladly.

Is this the same Mr. Gilmore who told us it was Labour’s way or Frankfurt’s way or the same man caught out by wikileaks telling some US official, not to worry, as there would definitely be a second referendum on Lisbon, in jig time and to ignore his “Ireland’s vote must be respected” stuff, as he had to say things like that for strategic reasons.

I suppose, you cannot teach an old dog new tricks. “Sectoral interests cannot be tolerated”? is that right Eamon? What I’d love to know, is what he is telling David Begg and Jack O’Connor right now. I’d say, it is something like, don’t worry I had to say that for strategic reasons to which Jack O’Connor repeats “I was given personal guarantees”! and he was, I was there the night he strolled into the Dail alone to meet Brian Lenihan to be given personal guarantees on Croke Park.

The markets are dumping the peripherals like they want the whole Eurozone to collapse. It must have been like this in the summer of 1914 when nobody wanted war.

Check out the “Börsenstimmung” graph on the right of the link. Julius Baer composite sentiment index


It’s a measure of the mood in the market from 2006 on and is trina cheile or, as they say in German, auseinander . Risk on risk off risk on risk off This is what happens when nobody knows what they are doing.

Portugal and Ireland are going to go down during a risk off phase.

@Shay Begorrah
“* Widespread tax evasion
* NATO membership and a very large military spend (talk about a sector of the economy that destroys value).”
Both of these are opportunities rather than problems.
1 – opportunity to raise a bunch more tax without increasing tax rates.
2 – opportunity to cut spending without damaging the economy.

Ireland has few of these opportunities…

The ratings agencies have blown it. If they are telling us that austerity gets you a junk rating and a voluntary rollover gets you a default rating, then the signal to countries is that they have little to lose with the fully monty. The World War I analogy for these fools is apt.


Arguing that default is a logical impossibility in a currency union is nonsense. For Greece default is inevitable, given the debt/GDP ratio, the shambles that is Greek public administration, and any realistic assessment of future growth in the face of the austerity measures.

The question is who will be defaulted on. The answer is that it will be predominantly official creditors – i.e. restructuring will be delayed long enough for the bulk of private creditors to be swapped out and replaced by official ones. I expect that tipping point to be reached in 2013-2014. Then the writedowns and maturity extensions will begin for real (unlike the sham version last week), with the EU taxpayer picking up the tab.

Until then of course, cheerleaders for the private bondholder brigade can live in the make-believe world that is EU leadership at the highest levels:

Junker on Greece’s debt: “It is very clear that the debt is sustainable”

Bank of France Governor in answer as to whether Greek debt is sustainable: “Absolutely”

But wait – what’s this? Finally a sense of realism from Josef Ackermann?

Whether Greece over this time period is really in a position, to bring up the strength to make this effort, I have my doubts,” Ackermann said in the transcript, adding that this requires “unbelievable efforts”

Well no – that was last year before the first Greek bailout. Seems Greece’s ability to sustain its debt has improved a lot since then, at least in this make-believe world.

The current crisis has nothing to do with logic or common sense, and everything to do with power. The combined forces of the ECB, the core NCBs, the large core private banks and the EU integrationists (who can further their political goals) acting in concert are too great to be opposed for now. A couple of fig-leaves will be thrown to Schauble and the Bundestag, but Merkel’s capitulation was the defining moment of this phase of the crisis. No wonder that since then the core banks have been falling over themselves all proposing different schemes “to help Greece” (as Der Spiegel reported last week) – the groundrules in place mean that they can’t really lose.

Personally I’m far from thinking the ratings agencies are a paragon of competency…but the backlash astonishes me:

UN: oddly has an opinion today and wants them dissolved and banned from rating countries in the intervening
EC: Wants to control them ‘clamp down’, and accuses them of ‘anglo-saxon’ bias
Germany: wants to ‘break their oligopoly’
see: http://www.telegraph.co.uk/finance/economics/8621520/Europe-declares-war-on-rating-agencies.html

Folks it should be clear by now that those at the centre of Europe, have taken leave of their senses. They are looking for censorship, and high level command and control of the economy(s). There’s a ridiculous omount of feet dragging, kicking to touch and plain reality avoidance going on.

For better or for worse we’ve thrown in our lot with an European solution…but surely the time has come where we point out that the present ‘solutions’ and mindset, are really in no one’s interest. Pleading our own self interest won’t work (as we are a minnow)…at this stage we need to formulate and (voiciferously) propose an overall solution. Standing still and ‘waiting for orders’ is unconscionable and worse…unworkable.

# hoganmahew Says:
July 6th, 2011 at 7:48 pm

hoganmayhew bursts my balloon.

“* Widespread tax evasion
* NATO membership and a very large military spend (talk about a sector of the economy that destroys value).”
Both of these are opportunities rather than problems.
1 – opportunity to raise a bunch more tax without increasing tax rates.
2 – opportunity to cut spending without damaging the economy.

Ouch. Two good points, and almost identical arguments are made about the US and how it could deal with its budget deficit.

My counter argument would be that both the military and the tax evading classes do not seem to have lost influence and wealth relative to the rest of the state so there is little reason to believe that they will suffer proportionately more from cuts than any other parties.

@ Bryan G

I am obviously not explaining myself very well. My point is that one can argue for default or maintenance of membership of a monetary union but one cannot do both. The German finance minister is a classic example of someone wrestling with this dilemma, oscillating between bailing out Greece and allowing a default and inevitable exit from the euro.

For an outstanding presentation of the current crisis and the possible avenues for resolving it cf. article by Polish finance minister in today’s FT.


I would personally rule out the lower interest route because it is based on the cost-free idea that countries with a better rating can borrow in already over-crowded markets and lend on. The markets are not so stupid as not to recognise a CDO when they see one.

Either the creditor countries take losses – through their banks or their taxpayers (almost inevitably the latter) – or the euro collapses. Germany – and France – has to make up her mind.


I am obviously not explaining myself very well. My point is that one can argue for default or maintenance of membership of a monetary union but one cannot do both.

Your point was clear in your previous post when you claimed it was a logical impossibility to default and remain in a monetary union, but your position is a false dichotomy. There is no necessity, logical or otherwise, to leave a monetary union if debts are restructured. For example, states in Brazil defaulted in the 1990s, but they are still using the same currency today – the Federal government paid up instead. Many states in the USA defaulted in the 19th century – these were not bailed out by the Federal government, and were not forced “to exit from the dollar”. The argument that a default by Greece (e.g. as part of a Brady-bond type restructuring) would lead to Greece having to exit the Euro (and subsequent short-term collapse of the Greek economy) is similar to the “default will lead to the collapse of the Euro” argument. Dramatic rhetoric perhaps, but not supported by the evidence.

Either the creditor countries take losses – through their banks or their taxpayers (almost inevitably the latter) – or the euro collapses. Germany – and France – has to make up her mind.

This seems to imply that you think Greece will default, with the consequence that some combination of private and public creditors will take losses, so now I am confused. Do you think that Greece will not default, or will default and remain in the Euro, or will default and exit from the Euro?

@Bryan G
“The question is who will be defaulted on. The answer is that it will be predominantly official creditors – i.e. restructuring will be delayed long enough for the bulk of private creditors to be swapped out and replaced by official ones. ”


The French bank plan is music to the ears of the private investors.
Full protection/payment of 50% of loans plus a sporting chance on the balance at subprime rates.
This is all about getting the vast bulk of bank loans repaid or transferred to the State.
The biggest bank heist in the history of the world. And in favour of the bank themselves.

@Joseph Ryan

The situation is becoming even more of a shambles every day – Schauble is back talking about his seven year plan, and the Dutch finance minister is talking tough again, but the same pattern will repeat itself. There’ll be no agreement at Finance Minister level; it will be bounced up to EU Council level; Sarkozy and Merkel will go for a walk on the beach; Merkel will agree to Sarkozy’s plan; the plan will be presented as a “take it or collapse the Euro” proposal to the rest of the EU Council, who will acquiesce. Sarkozy’s plan will be in broad alignment with the Trichet/Junker/Ackermann/Noyer axis so the banks have nothing to worry about except how to maximize any profit opportunities that may arise.

The only new twist is that the list of official creditors may be expanded to include sovereign wealth funds/Arab nations/China or anyone else with a bit of spare cash to lend to Greece so it can engage in debt buybacks. This might help although I believe that the experience has been that buybacks don’t work well since the price immediately rises once it is clear that there is a serious buyer in the market. The debt price is really a price at the margins, and does not represent a price at which large chunks of the debt can be acquired.

@ Bryan G

You may well be right! However, as your subsequent post underlines, no country in Europe seems ready to put the matter to the test. I would also remark that I have been using the terms default in its current context viz. a unilateral sovereign default triggered by the sovereign.

In fact, it seems to me that the issue of which side triggers the event is crucial and, until we see the actual wording in the proposed ESM treaty, we will not know how this matter is to be handled. In the meantime, the participants are learning by doing and will eventually have to accept to take losses. If forcing banks to do so causes them to collapse, the distinction between public and private debt becomes rather less relevant.

As a layman, but now instructed in matters which I never thought I would be, like many other citizens, the relationship between banks and sovereigns reminds me of that between a lion-tamer and a pack of lions. Without both participants there is no spectacle (credit) but if the lion-tamer drops his vigilance and whip (regulation), the result is not a pleasant sight.

@ Joseph Ryan

“The biggest bank heist in the history of the world. And in favour of the bank themselves.”


I agree, furthermore the interest rate hike by the ECB has little to do with inflation, that story is for the little people. It has everything to do with repairing the balance sheets of reckless European banks. It will be counter productive and soon they will be pumping more credit into Ireland and Spain. Spain is the one they should have been accommodating this not Germany.

@ Robert Browne

‘Nine Reasons Why Spain’s Economy Is More Different Than You Think!’
Edward Hugh

(Sorry. Can’t post link from this location).

@ paul quigley

Thanks, I will read Edward Hughs arguments when I get the chance. In the meantime here is something form Constantin’s blog http://trueeconomics.blogspot.com/ ” Spain feverish & fading out of consciousness on negative watch and with banks starting to implode (HT to Namawinelake, Spain is facing €660 billion of redemptions in 24 months ahead and with banks providing just 10% provisions cover on €450 billion worth of development loans)”.

The ECB is pulling the rug from under Spain with these interest rate hikes. just as it scuppered us when it started talking about burden sharing and prioritization of creditors in 2013, since amended. They knew full well that Ireland will have redeemed the vast bulk of senior debt by them. Drove our spreads through the roof that bit of loose talk by Merkel and you cannot help wondering if there is another agenda going on here such as setting the stage for Germany own exit from the Euro.

@ Brian G

A bit late but herewith the relevant extracts from the ESM Treaty to be formally signed by finance minsters on Monday (courtesy of Dutch government website which one assumes is reliable).



1. If indispensable to safeguard the financial stability of the euro area as a whole, the ESM may provide financial assistance to an ESM Member, subject to strict economic policy conditionality under a macro-economic adjustment programme, commensurate with the severity of the economic and financial imbalances experienced by that ESM Member.

2. An adequate and proportionate form of private-sector involvement shall be sought on a case-by-case basis where financial assistance is received by an ESM Member, in line with IMF practice. The nature and the extent of this involvement shall depend on the outcome of a debt sustainability analysis and shall take due account of the risk of contagion and potential spill-over effects on other Member States of the European Union and third countries. If, on the basis of this analysis, it is concluded that a macro-economic adjustment programme can realistically restore public debt to a sustainable path, the beneficiary ESM Member shall take initiatives aimed at encouraging the main private investors to maintain their exposure. Where it is concluded that a macro-economic adjustment programme cannot realistically restore the public debt to a sustainable path, the beneficiary ESM Member shall be required to engage in active negotiations in good faith with its non-official creditors to secure their direct involvement in restoring debt sustainability. In the latter case, the granting of financial assistance will be contingent on the ESM Member having a credible plan for restoring debt sustainability and demonstrating sufficient commitment to ensure adequate and proportionate private-sector involvement. Progress in the implementation of the plan will be monitored under the programme and will be taken into account in the decisions on disbursements.

3. Collective action clauses shall be included in all new euro area government securities, with maturity above one year, from July 2013, in a standardised manner which ensures that their legal impact is identical.

Annex III (N.B. An integral part of treaty)

Pricing policy
The ESM stability support pricing structure is the following:
ESM funding cost, plus a margin consisting of:
1) A charge of 200 bps applied on the entire loan;
2) A surcharge of 100 bps for loan amounts outstanding after 3 years.
For fixed rate loans with maturities above 3 years, the margin will be a weighted average of the charge of 200 bps for the first 3 years and 200 bps plus 100 bps for the following years.

The whole structure of the funding for the ESM is wrong. Floating rate debt is not what is required by the PIG. Fixed rate debt with a low interest level and long duration is what is required if the can is to be kicked down the road. The ESM itself should be issuing longer dated debt than the money it is lending out. At least 10 year money is required.

Instead it is issuing short dates and exposing the PIG to market turbulence. It was market turbulence (as a proximate cause) that got the PIG into the poke it is in…

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