Colm on the summit

The ECB getting involved doesn’t distinguish as to whether crisis was one of solvency or liquidity, and doesn’t reduce toxicity of existing bonds held by banks.

ECB involvement is a necessary condition to deal with a liquidity crisis, but not sufficient to deal with the overall crisis. Ultimately existing toxic debt needs to be split into 2,or perhaps 3 categories:

A) Default: paid for either via private sector, fiscal transfers or monetization. Amount would vary per country (e.g. say Greece 70%, Irl 20%)
B) Official buffer: if a swingeing default is not liked, an official source (e.g. EFSF etc) can take on some ‘super junior’ debt, that will act as a buffer proving the rest is solvent
C) Solvent debt: stuff that can be trusted

Unless losses are recognized, there is no solution. Also, furthermore, the crisis is wider than one of mere sovereign debt.

“Raoul Ruparel, of think tank Open Europe, told the Telegraph:

Rather than focusing their energies on the key issue at hand – avoiding immediate crisis – France and Germany have tried to secure another couple of changes which they are keen on, namely the harmonisation of corporate tax bases and the use of majority voting for ESM decisions.

Unfortunately, this looks to have backfired by stoking the anger of Ireland and Finland respectively, another obstacle to forming a lasting agreement.”

Apparently the law committee that advise the Finnish Government has said that the proposal to adapt majority voting is unconstitutional.
So we have another dead proposal.
Enda is angry..watch out Angela.

I liked this article by Martin Wolf a couple of days back:
http://www.ft.com/intl/cms/s/0/396ff020-1ffd-11e1-8662-00144feabdc0.html#axzz1fxcAUSrL

I have little confidence that a solution will be found at this summit. Judging by the wishlist that appeared after the recent German/French talks it seems no progress is being made on the important issues. For example a move on corporation tax is on their wishlist but this has bugger all to do with the current crisis. It really gave me the impression that the French and Germans sat down and disagreed on LOLR and agreed to produce a wishlist that would appeal to voters in both countries.

@Ceterisparibus
They possibly could have made a mistake by exposing their plans before they had complete control.
Surely thats a good thing ?
Maybe we will not be assimilated , maybe

Ernst Stavro always made that mistake – his arrogance was his weakness.
He never just killed Bond in a conventional fashion with a quick bullet to the head but always talked about his plans to take over the world before a overly elaborate death sequence.
Must have been a deep psycological guilt thingy that needed to be expressed.

Its a curious piece I attribute to the fact the Irish are good at beginnings; we are good at middles; but we are not good at endings 🙂

Colm presents lots of evidence for leaving the euro, but he can’t seem to draw upon the deductive conclusion implied by his own logic 🙂

For example,

Whether Europe should proceed to fiscal union is rather a large question and it is not clear that such a project enjoys political legitimacy.

Actually, its quite clear that it doesn’t. Fiscal union in the meaning implied above is not in Lisbon, or anywhere else. That’s why we are debating necessary treaty changes.

Having argued well that the EMU is a zeppelin balloon poorly conceived and now catching fire, colm writes:

The agenda for Friday’s summit should consist of just two items. First, deal swiftly with the immediate crisis. The ECB (not the IMF, China, or the Red Cross) should be instructed to do what central banks do in a financial panic, that is, mobilise the balance sheet decisively to restore confidence.

Ahem, no, Colm, its time we got ready for exit, muddles can’t last forever, we can’t go back to 1999 and reconstruct it. You need to focus on a good ending rather than middle muddle mess.

We are in the Zeppelin, its on fire and we need to get out of it.

Hopefully, the whole matter will be sorted soon and I can dwell on more interesting topics, but while the game is on, I’ve been giving it a little thought, social responsibility, you know, followed later by, told you so, my opinion given earlier, eg

http://www.irisheconomy.ie/index.php/2011/12/08/the-euro-summit/#comments

11:31

12:25

12:53

1:08

nb

1:50

1:54

nb

http://wp.me/pBbF3-gp
3:36

@Colm
Re…”The agenda for Friday’s summit should consist of just two items. First, deal swiftly with the immediate crisis. The ECB (not the IMF, China, or the Red Cross) should be instructed to do what central banks do in a financial panic, that is, mobilise the balance sheet decisively to restore confidence.”

Simply wrong, as confirmed by Draghi today and constantly by Weidmann, Merkel and the Bundesbank.

Excellent summary from Colm McCarthy. I woud add one element however: the ECB has to intervene on the sovereign bond markets not only to stem the crisis, but simply to fulfil its primary mandate of price stability. This is probably the only way to counter the extremely severe monetary contraction that is taking place and that is leading the whole Euro Area into pure and simple deflation.

@ All

The link may be behind the FT paywall. The title of the article is “Why banking works one big confidence trick” by Zoltan Pozsar.

@DOCM
I remember seeing a graph of total euro M3 on the FT maybe 2+ years ago now and Euro shadow bank(bank bonds etc etc) debt dwarfed “sovergin” debt back then which unlike bank bonds remained stable until 2008.

It was clear to even Dorks that Europe could not afford to service this debt at the current value of the Euro and its remaining bits of productivity – but it chose to implode the system to secure a return for the real owners.
It destroyed its economy by not doing a massive debt for equity swap on ALL BANK DEBT – depreciating real assets both human & physical to secure a return on this credit.
We are dealing with highly connected criminal organisations – don’t people get it ?
Peels bank act and its central flaw still has eternal relevance – The “authorties” new this in 2007 but gave the connected time to escape while they still could.
It was all so predictable.
At least the money destruction part was – up until recently I thought they would go for inflation but now it will come down to who owns the right kind of paper me thinks unless this is the greatest bluff of all time.
These guys are good , real good – you always have to remind yourself of that fact.

Der Spiegel
Taking on the Doubters
Chancellor Merkel’s Difficult Battle in Brussels

Britain wants concessions. The Czech Republic is concerned about referendums triggered by treaty changes. And top EU officials have reintroduced alternatives that German Chancellor Merkel has already rejected. On the eve of a crucial EU summit in Brussels, Berlin is not amused — and has made it clear that compromise is not an option.

http://www.spiegel.de/international/europe/0,1518,802444,00.html#ref=nlint

On an earlier thread, I noted the Arabic innovation of Zero; time to borrow Zero from Ibn Khaldoon/Avicenna’s digitized guthenberg press, and present both the ‘zero’ and the ‘press’ to the ECB with instructions that its independence will be maintained on condition that the debts of all EZ members have been reduced to Zero. And we can build again from there … have referenda even …

@DOCM

DOCM tks re Pozcar link, Pozsar also here on Shadow Banking, since 1980’s grown to a $20 trillion rival to commercial banking system.

Shadow Banking was what largely caused the 2008 meltdown. Reason is Shadow Banking occurs outside the control of the FED and is not subject to its regulatory functions.

Its huge unstable cargo sloshing around the hold.

Authors: Zoltan Pozsar, Tobias Adrian, Adam Ashcraft, and Hayley Boesky
http://www.newyorkfed.org/research/staff_reports/sr458.pdf

9 conclusions in it:

@Gregory Connor

Having watched Draghi speaking on Channel 4 news my view is that he has bottled it.
He will try to support the banking system and is clearly preparing for collapse but he either will not or is not being allowed to go beyond his ‘brief’.

I doubt that anybody at this summit will buy the fiscal austerity agenda. Deep down most people have a gut feel that the result is as per posted by Kevin O’Rourke: “Europe = austerity + unemployment” and there is zero confidence in Merkozy.
Not only zero confidence but a deep suspicion that the ‘austerity’ focus is being used to take the spotlight off their own banks and of course as re-election rhetoric painting peripherals as wasters etc. The effects on Greece articulated very well by the communist lady MP are now devastating.
If that is the best the EZ can come up with, we are better off without the EZ. Far better off.

The solutions to the immediate crisis are simple.
The ECB backstops the banks including forced resolution of bust banks and either imposes losses or makes the creditors whole, printing the losses for them.
With the banks off the backs of the sovereigns that would allow breathing space for the sovereigns.
But now that we have been driven to recession again by the very people who say they have a solution, the effects of that recession will make it difficult if not impossible for some sovereigns to pay their debts. In Ireland’s case of course the debts are an imposition. My view is that the bank potion of those debts are not legitimately the debts of the Irish State.

It is impossible to see a proper resolution of this crisis this weekend. This can only mean the geezer is about to blow.

Banking is one large, clever, and finely tuned, confidence trick.

On the one hand are bank notes which are “legal tender for all debts, public and private”, trade at par and are referred to as money. They are liabilities of the sovereign. On the other are demand deposits – from savings to cheque accounts – which also trade at par and thus function as money. But, unlike bank notes, they are the liabilities of banks.

As long as the public knows it can get bank notes for its deposits, it will not ask for them and banking works just fine. In other words, the genius of banking is the arbitrage of the public’s ex-ante and ex-post demand for instruments that trade on demand at par. This allows banks to conduct credit, maturity and liquidity transformation: holding assets that are riskier, longer dated and less liquid (and hence higher yielding) than its liabilities.

But if confidence goes, bank runs ensue with the public demanding liquidity at par through the withdrawal of all deposits into bank notes at par. In such instances, the banking system is insolvent. This is because at its core the system promises something it cannot deliver.

In the early 1900s, bank runs were frequent. Runs were ultimately solved by the creation of the Federal Reserve in 1913 and the Federal Deposit Insurance Corporation in 1933. These subsidiaries of the sovereign ensure public confidence in on demand liquidity at par and make banking a public-private partnership.

Pre-crisis, only retail depositors had access to publicly guaranteed liquidity on demand and at par, however. Institutional cash investors – modern-day species of the financial ecosystem that include asset managers and global corporations – did not. This was because their size was above the FDIC’s pre-crisis insurance limit. Their alternative would have been to keep their cash in uninsured deposits. However, these were unsecured, undiversified and perceived as risky.

Institutional-class money funds were the answer. Like banks, money funds promise on demand liquidity at par. However, unlike banks, which are backed by the sovereign, money funds are not. Still, they were perceived to be safer than uninsured deposits due to their diversified holdings of safe, short-term and liquid instruments.

No matter their degree of diversification, however, the crisis proved that money funds can only provide on demand liquidity at par if they are backed by the sovereign. And backed they were during the crisis through a series of liquidity facilities from the Federal Reserve for both their secured assets (repos and asset-backed commercial paper) and even some unsecured assets (commercial paper), and guarantees from the US Treasury on their promises of on demand liquidity at par. It was a 360-degree backstop of the shadow banking system by the sovereign.

An under-appreciated aspect of shadow banking is that it arose due to institutional cash investors’ demand for guaranteed liquidity on demand at par, and other safe, short-term, liquid instruments.

Today uninsured institutional cash investors manage over $3,500bn in cash, up from $100bn in 1990. On an ecosystem level, the larger they grow, the more credit, liquidity and par value puts they demand from too big to fail institutions, which are expected to be backed by the sovereign.

The balance sheet of the sovereign played into the emergence of the shadow banking system and the integrity of its money claims. Therefore, solutions for shadow banking – besides regulation – must also involve the balance sheet of the sovereign. Here are two.

First, solutions for institutional demand for publicly guaranteed on demand liquidity at par could involve them undertaking repos, with central banks setting dynamic haircuts. Who has access to the central bank would need to be clarified in advance. Repos would serve as alternatives to money funds, which, as purely private money claims, defy the laws of banking. In their current circumstances, money funds should float their net asset values.

Second, solutions for institutional demand for safe, short-term, liquid instruments could include the US Treasury increasing its supply of bills, an idea similar to the Treasury Borrowing Advisory Committee’s proposal of floating-rate notes. More bills would also complement regulatory efforts to design a smaller and simpler global banking system with less dependence on wholesale dollar funding. Treasury bills are as fit for the intermediation of institutional dollar cash balances as global wholesale banks.

Paraphrasing Forrest Gump: money is as money does, and in a crisis, money is only money if the public knows the sovereign stands ready to make it trade at par.

Zoltan Pozsar is a visiting scholar at the Global Interdependence Center and a former New York Fed economist. This piece was co-authored by Paul McCulley, Chair of the Society of Fellows of the Global Interdependence Center and a retired senior partner of Pimco

@Ceterisparibus: “Simply wrong, as confirmed by Draghi today….”

I hope you’re not making these guys the arbiters of right and wrong.

It seems crazy to me that we are compensating for our one size fits all monetary policy by restricting the scope for future fiscal manouevres. This solution solves the symptoms of a few countries (public profligacy in Greece and Italy) without addressing the root problems which caused problems in those countries as well as causing private asset bubbles in Ireland and Spain.

This solution is designed to solve the wrong problem and will make our situation even worse. It will avert future Greeces, but will give rise to multiple Irelands in the coming decades. Surely they can see this??

@Gregory, can you describe (or give a sense) which bits of the CB balance sheets are largely fictional and in what sense?

@KOR: Summiteers?

@Stephen

re : Summiteers

+1 and two smileys.

@Kevin Donoghue

It depends on how seriously one takes the rule of law and the question of democratic mandates, I suppose.

@cet. par.

Speaking of which, though, have you noticed how, amidst all the renewed zeal for Art. 123, we no longer hear anything about the ECB’s lack of any financial stability mandate*?

* Apart from that thing about reserve requirements of course …

its getting serious guys…..
“Mr Kenny, like many other leaders, has been resisting the German-led clamour for treaty change.

However, a consensus is emerging that there will be no way of spurning chancellor Angela Merkel.

While the question is made more complex by Britain’s demand for an unspecified concession in return for its support, Dr Merkel said treaty change was essential to bolster the euro’s credibility.

“The euro can only regain its credibility by changing treaties to such an extent that we are moving towards a stability union,” she said.

Although core elements of the new rescue package are still subject to sharp dispute, EU leaders hope to achieve a definitive solution to the two-year crisis before they leave Brussels tonight.

In advance of last night’s talks, French president Nicolas Sarkozy warned that the viability of the EU itself was at risk.

“If we don’t have an agreement on Friday, there won’t be a second chance… Europe has never been closer to exploding,” he said.”

From Arthur Beesley IT

Here’s the deal….really no deal…
“The EU leaders, meeting in Brussels, agreed on automatic sanctions for euro area deficit offenders unless three-quarters of states vote against the move, and approved a new fiscal rule on balanced budgets to be written into national constitutions.

“There is a deal between leaders on the new fiscal compact,” an EU official told reporters.

After nearly 10 hours of talks running into the early hours of Friday morning, they also decided that the currency bloc’s future permanent bailout fund, the ESM, would be capped at 500 billion euros, as Germany had insisted.

It will also not get a banking license, which would have allowed it to draw on European Central Bank funds to increase its firepower, another move Germany objected to.”

So we have to have a referendum.

Much ado about nothing.

I wonder if that wholesale ratings downgrade of Europe will now go ahead?

@ All

FYI

http://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ec/126658.pdf

http://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ec/126657.pdf

@Ceterisparibus: “the emphasis at this summit should be to change the mandate for the ECB and give it legal authority to act like a normal central bank.”

Since Colm McCarthy undoubtedly agrees, you leave me wondering why he is “simply wrong” — my best guess is that his error consists in taking Draghi’s protestations a little less seriously than you do.

@ All

Apart from market reaction, which is self-evidently going to be the real measure of success or failure, the implications for the relationship between the UK and the rest of the EU, and the possible follow-on consequences for Ireland, are of the utmost significance.

The agreement states (page 7) “Considering the absence of unanimity among the EU Member States, they decide to adopt them through an international agreement to be signed in March or at an earlier date”.

The footnote at page 6 with regrad to Finland needing to get the approval of its parliament for the 85% voting rule for the ESM will also be noted.

@Kevin Donoghue

The issue is what Lisbon says, not whether Draghi feels like adhering to it at any point in time.

Press release from Ms. Christine Lagarde.

http://www.imf.org/external/np/sec/pr/2011/pr11455.htm

So what are the IMF “priciples and practices” cited in the new accord?

I found a general summary from the IMF here:

http://www.imf.org/external/about/lending.htm

Which contains the following:

“Today, IMF lending serves three main purposes.

“First, it can smooth adjustment to various shocks, helping a member country avoid disruptive economic adjustment or sovereign default, something that would be extremely costly, both for the country itself and possibly for other countries through economic and financial ripple effects (known as contagion).”

But I’d be very interested if people could specify further what these “principles and practices” are.

@Gavin Kostick
Well in fairness, Ms Legarde could hardly be expected to say this is a crock of shit.

The ECB cannot guarantee any kind of price stability for member states with a 2% inflation target, as it will likely lead to Euro break-up.

This will not only cause price instability but will also do permanent damage to the ECB’s ability to control prices into the future.

The ECB needs to set a target which will give greater price stability for ALL the citizens of the EZ. I suggest a target of 5% for 5 years reverting to 2% thereafter..

@ Gavin

the ever kowledgeable Bryan G…

IMF Level 1:

In most cases, the involvement of the private sector therefore takes the form of maintaining exposure and/or providing additional financing on terms consistent with medium-term sustainability (either voluntarily or as a result of official moral suasion).

IMF Level 2:

In exceptional cases, the IMF may come to the conclusion that debt sustainability cannot be achieved through policy adjustment. If so, the IMF is precluded from providing further financing without assurances that the country is negotiating a comprehensive debt restructuring plan with its private creditors.

http://www.irisheconomy.ie/index.php/2011/12/05/fiscal-union-in-the-1990s/#comment-204967

Ignoring the UK veto noise, the big question for me is still: “Has this summit fixed the crisis?”

Answers to Tim Geithner please.

No doubt there will be some hammering out of detail today as the summit continues to put the best spin it can on what’s been agreed so far (press conference at 3pm I think) but that will also be dressed up with a large dose of damage limitation.

Any views out there on whether the downgrade of French banks will speed up the downgrade of AAA for France? Did I hear that one of the ratings agencies (moody Moody?) suggests that Soc Gen desperately needs government assistance? Quelle surprise.

Show me the bazooka!

Overall, I find the 126658 and 126657 docs above to be a bit of a pantomine and a sell out to the banking sector.

You know how children at a pantomine enjoy the part when Goldilocks is speaking to them from the front of the stage but sneaking up behind Goldilocks is the wicked witch or some other danger Goldilocks is unaware of…

Well, Goldilocks was the content of those docs above.

But the wicked witch was the hidden agenda we are not fully briefed about:

EG

5. Steps and sanctions proposed or recommended by the Commission will be adopted unless a qualified majority of the euro area Member States is opposed.

Ominous that. We should fear the eject button. We should fear tax harmonisation, steps re CT, we may not have a vote upon. We should fear
the absence of a veto and loss of sovereignty.

Bilateral loans….need a lot more detail on this to evaluate where this money is coming from and even more curiously how and where this will be targeted?

14…………”• euro area and other Member States will consider, and confirm within 10 days, the provision of additional resources for the IMF of up to EUR 200 billion (USD 270 billion), in the form of bilateral loans, to ensure that the IMF has adequate resources to deal with the crisis. We
are looking forward to parallel contributions from the international community.”

We should have walked out on this one as it endorses the position there will be no debt forgiveness for Ireland.

15…..We clearly reaffirm that the decisions taken on 21 July and 26/27
October concerning Greek debt are unique and exceptional;

Qualified majority voting for the ESM is to replace mutual agreement further erodes our position and influence.

The summit should have dealt with three pillar solutions to three problems:

1) what to do with debt:

but whether the firepower above can be raised instead of aspirated for is an entirely different question.

2) enhancement of ECB with Treaty changes

but proposed new powers for ECB are minimal, other changes are empty aspirations to do better in the future with vague threats of undetermined future action against transgressors.

But here’s where the above watered down proposals are really a pantomine. They do not address the real problems faced by the euro. There are no rules to cover reforms to rein in shadow banking, that brought about the 2008 crash. No rules to force bank recapitalisation, no rules for stress testing banks across the eurozone. No rules for debt forgiveness, in fact a joint proposal against debt forgiveness. No eurobonds in any shape or form.

We are left with the prospect of a much weaker EMU borrowing hundreds of billions that wont go to taxpayers, but will be poured into the shadow banking sector, to pay off the debts of blackHole Anglos across the EMU. This will result in the further impoverishment of taxpayers across the EMU.

All good pantomimes should have a good laugh. The joke is the Brits were unable to get assurances to guarantee their financial sector and have refused to agree to above changes because of this. We have signed on because our financial sector and the matter of tax harmonisation are left out of the agreement.

My fiver is on the Brits; I don’t bet on donkey coyotes 🙂 None of the above faint hearted mess will assure the markets! Morgan Stanley et al in the US will be assured the hidden black holes in France and Germany will be borrowing more money from them. They expect to be paid back their previous OTC’s and other unwise investments that lie festering in their vaults along with sovereign debt borrowings of course 🙂

How does one interpret point 15

Concerning the involvement of the private sector, we will strictly adhere to the well established IMF principles and practices. This will be unambiguously reflected in the preamble of the treaty. We clearly reaffirm that the decisions taken on 21 July and 26/27 October concerning Greek debt are unique and exceptional; standardised and identical Collective Action Clauses will be included, in such a way as to preserve market liquidity, in the terms and conditions of all new euro government bonds.

I understood IMF principle was to invoke PSI. How then can Greece be a once off?

What are standardised and identical collective actions clauses in Govt bonds?

Overall the agreement is full of aspiration.
It is also much more Dickensian than Keynesian:Point 4.

General government budgets shall be balanced or in surplus; this principle shall be deemed respected if, as a rule, the annual structural deficit does not exceed 0.5% of nominal GDP.

So each country will have to keep within the Micawber thresholds:

“Annual income twenty pounds, annual expenditure nineteen pounds nineteen and six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.”

I wonder how many countries (incl Germany) have managed that kind of discipline over the course of a fifty year period.

@Joseph,
Greek PSI seemed to be planned to operate on the basis of giving what would be known, in normal commercial terms, as fraudulent preference to ECB holdings of Greek debt over private sector holdings of identical debt. The text may amount to a commitment not to do that again.

@ Joseph Ryan,

🙂 right on, it should be renamed the Micawber Summit

@anonym
No, I don’t. To see why, let M = refrain from shutting down bank H (known to be insolvent) until markets close. (Assume that the law requires that insolvent banks be shut down promptly.) This is not an example I just invented, but I won’t go into the history here.

But even if your view is that central banks should always follow the letter of the law, which is certainly not the unanimous view of ECB officials, it’s nonsense to say that Colm McCarthy is “simply wrong” because he rejects that strait-laced approach.

@Gavin K

I’d go along with that paraphrase. The can has been kicked down the road for maybe 3 years or so. Given that there now appears to be a synchronized bloc of 26 countries, all pursuing contractionary pro-cyclical policies, and all with deleveraging banks, the chances of growth exceeding Italy’s funding costs, for example, seem miniscule. So the debt/GDP ratio will get worse each year – 130%, 140% 150%, 160% and at some point the IMF will say – OK now it’s getting ridiculous.

In the short term though there’s no problem. In fact it now appears that a bank can borrow for three years at next to nothing from the ECB, and with the money buy 3-year Italian bonds at 6% to 7%, and pocket the difference. Looks like free money for the banks, and a way to keep up demand for Italian bonds.