Europe in crisis

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Europe in crisis
The leaders of the euro zone are in crisis mode this weekend, scrambling to reach agreement and cobble together a plan to ease the debt troubles that have plagued the monetary union for two years.

While this has been a prolonged crisis that at times has buoyed or damaged global financial markets - fiddling as Athens burns - there's a sense that this time it's a case of make it or break it.

There were several meetings planned as the tension reached unbearable levels for those involved, and the euro zone leaders found themselves under mounting pressure from other governments to find a resolution. French President Nicolas Sarkozy and German Chancellor Angela Merkel were scheduled to meet Saturday in advance of an EU summit in Brussels Sunday.

That summit was supposed to be the Big One, but differences between Ms. Merkel and Mr. Sarkozy forced the scheduling of a second gathering, to be held by Wednesday. The idea is that grand plans will be debated over the weekend, and then adopted at the second summit.

Markets appeared buoyed on Friday that there is actually some action, though it's worth noting that investors have been let down many times during this saga. Euro zone finance ministers did approve paying Greece its next tranche of bailout money at a meeting Friday, but that was expected.

"Unless the governments demonstrate that they have found a clear path toward resolving the sovereign debt, banking sector and economic crises that confront the euro zone, markets will not wait until after Wednesday's Summit II to start trashing the euro and the stocks and bonds of the zone," Carl Weinberg, chief economist at High Frequency Economics, said in a report.

"We think markets need to see a clear path toward creating and funding a large pool of money - that is, hard cash and not just promises to raise cash if needed - and a clear vision of how the agony of Greece will be brought to an end."

Among the issues dividing France and Germany - though Ms. Merkel said the two countries were largely in agreement - were a push by the French over the powers of the bailout fund and whether it could get financing from the European Central Bank. Germany opposes that. The French finance minister backed away from that Friday, saying it was not "a definitive point of discussion for us," which lends some hope to the process although is somewhat vague.

Investors are looking for signs that the main package - shoring up the region's banks, determining the powers of the region's bailout fund, and the size of haircuts for Greek bondholders are under discussion - is taking shape. This has been a week of rumour and speculation, with various signals from various players. That's why, as Greece teeters on the brink and is shattered by widespread anti-austerity protests and strikes, the next several days are crucial to markets that need some certainty.

"The big Sunday summit is set to become a Sunday/Wednesday (add-days-as-appropriate-until-euro-zone-policy-makers-agree) summit," said Elsa Lignos, senior currency strategist at RBC in London.

"It is not a huge surprise that we won’t get big decisions this weekend given the enormity of the task and the divisions amongst Germany and France but the longer this drags on, the more damaging it becomes. The now commonplace stream of comments, leaks and denials hitting wires from various EU quarters has most players sitting on the sidelines waiting for some clarity."

According to reports Friday, debt inspectors examining Greece's finances believe private Greek bondholders, who have agreed to take a hit of 21 per cent, would actually have to take a haircut of up to 60 per cent to bring debt to a sustainable level by 2020.

A 50-per-cent haircut for bondholders would result in only bringing down Greece's debt-to-GDP ratio to 120 per cent by 2020, said Stewart Hall, senior fixed income and currency strategist at RBC Dominion Securities. Sixty per cent would take it to 110 per cent.

"A lot of ifs and buts in terms of assumption around inflation and growth but regardless, the numbers are as astonishing as they are disheartening," Mr. Hall said.

Also under discussion, according to reports, is the possibility of combining two bailout funds, the original EFSF and a second permanent rescue mechanism scheduled for 2013. Together, they would, at this point, total in the range of €940-billion. But it's far from clear what that might achieve.

"That’s without even chipping away at the total by acknowledging that around €200-billion is already committed, and the rest is likely to be set aside for combined purposes like bank recapitalization, direct country assistance and bond buying," said Derek Holt and Karen Cordes Woods of Scotia Capital.

"The remaining just over €700-billion is a drop in the bucket compared to the vast scale and scope of the challenge and a far cry from the generally acknowledged €2-trillion size that may be required."

As for shoring up the banks, reports on Sunday said EU finance chiefs were looking at demanding that the banks raise €108-billion.

Mr. Holt is particularly harsh in his take on the developments, saying in a report Friday that "it seems the inability to strive toward a meaningful agreement was replaced in the short-term by a cheap headline to extend the European game of trying to buy time with equities that have had at best a limited understanding of the crisis from day one."

Chief economist Sherry Cooper also took an in-depth look at the crisis in a report Friday, and found that what's under discussion simply won't be enough. That includes a 50-per-cent writedown of Greek debt, the amount of bank recapitalization under discussion, and the size of the EFSF.

"There is no way this Sunday’s summit or the one after that will provide all that is needed to really deal with the European debt crisis," Ms. Cooper said.

"The true litmus test for credibility is a writedown of Greek debt of €200-billion, a recapitalization plan of €200-billion, and an increase in the effective capacity of the EFSF to €1-trillion. Anything short of this extends the crisis and suggests the Europeans still don’t get it or at least not enough to accept the real price tag of the mess they are in."

To understand how high the stakes are, look at Greece, where police and protesters clashed this week as the world watched and the debt inspectors poring over the books warned earlier in the week that even a second bailout may not save Athens.

The leaders of the euro zone are, of course, trying hard to ease the burden, but are fast losing credibility.

"In almost two decades as a professional economist I cannot recall witnessing as much confusion and policy incompetence as this last week has shown," said global economist Paul Donovan of UBS. "Regardless, we must hope that the euro can be made to work. The alternative is too hideous to contemplate."

Mr. Donovan believes that today's crisis is "a visible manifestation of the complete failure of the euro to work as a monetary union." Put another way, Europe's leaders are flogging a dead horse, repeatedly.

(The EU's statistics arm, Eurostat, has released debt and deficit figures for 2010. While something of a rear-view mirror look, they're still worth a peek.)