Eurozone Leaders Ready €80 Billion Band-Aid for Banking Industry Gunshot Wound

I must confess I don’t stay on top of the blow by blow of the ever-devolving Eurozone mess. The broad lines of the trajectory look all too predictable. The officialdom could patch up things for quite a while if the powers that be let the ECB monetize the debt (eventually, you could have an inflation problem, but with the EU and global economy so slack, “eventually” will take quite a while to show up).

However,everyone in positions of authority seems to believe in certain-to-fail-much-faster austerity instead. So the permissible short-to-medium term fixes involves lots of complicated programs, multi-party negotiations, and in some cases, political approvals. The timeline for the governmental maneuvering seems badly out of line with what Mr. Market requires. And to make matters worse, an earlier deal on a Greek funding, which involved bondholders taking a 21% haircut, is now deemed not to be punitive enough to banks. While that is narrowly true, having this deal come unglued could be the detonator that sets off a crisis chain reaction.

And from a wider vantage, none of these remedies address the real issue: Germany wants to keep running big trade surpluses to the rest of Europe, but does not want to keep funding its partners’ current account deficits. It can’t have both wishes but is unwilling to give either one up.

Things have gotten so ludicrous that you can now read contradictory stories in the Financial Times mere days apart (I’m not criticizing the FT but the apparatus that does the messaging). The day before yesterday, Eurozone banks “threatened” that they’d have to be nationalized if the haircuts on the aforementioned Greek funding deal were increased from 21% to 50%. Note credible estimates as early last year put the level of writedowns needed on Greek debt at a minimum of 50% (75% was not an uncommon number) and Greece has undershot forecasts repeatedly since then.

The idea that nationalization is a horrible outcome to anyone other than bankers shows how far down the rabbit hole we’ve gone. But aside form that, recognize the implication: increasing the haircuts from 21% to 50% on Greek debt would tank banks. Even if we use the total amount of Greek debt outstanding, €350 x .29, we get €102 billion. But that figure is high, since what is relevant is the debt held by banks, not the total. A FT Alphaville story reported the private debt target for participation in the earlier restructuring plan (the goal was 90% participation) was €135 billion. Gross that up and you get €150 billion, and take 29% of that, and you get €44 billion.

If a mere incremental €44 billion loss across Eurobanks is such a devastating event, the banks are pretty wobbly as it is. Mind you, we all know that, but the banks have just said that, loudly and publicly. And pretty much no one expects the resturcturings to stop with Greece.

Yet today, the FT tells us that European officials thinks the level of recapitalization needed is a mere €80 billion. Earth to base, if they are so fragile that €44 billion in losses will allegedly put a lot over the edge, they need a lot more dough than that. The prevailing estimates of the magnitude of the combined banking/sovereign is in the €2 to €3 trillion range. This measure is not a solution, and it falls so far short that it’s an embarrassing and dangerous admission that the European financial leadership isn’t merely politically constrained, it’s utterly clueless. At best, the authorities must view this action as tantamount to administering a shot of adrenaline to the heart of a failing patient.
Except in their case, as opposed to the intervention below, they have only sugar water in the syringe. No one told them, apparently, that placebos don’t have a high success rate in emergency rooms.

The pink paper continues with this surreal account:

The European Union’s estimate of the necessary recapitalisation effort compares with a recent Inernational Monetary Fund report that identified a €200bn hole in banks’ balance sheets stemming from sovereign debt writedowns. It also falls far short of analyst estimates that banks might have a capital deficit of up to €275bn.

People familiar with the outcome of an emergency stress test of Europe’s banks said the European Banking Authority, which ran the exercise, had suggested that about €80bn should be raised.

So we know where this absurd figure came from, the Eurzone’s phony stress tests. They are now making the mistake of believing them. And get this part:

A fierce political debate has started over almost all the main assumptions used in the analysis but people familiar with the discussions expect any changes to reduce, rather than increase, the estimated shortfall…

There is duly discouraged coverage in a separate FT story that recaps the current state of play, in case you like studying self-immolation. The key section:

To meet the challenge, Europe’s leaders are trying to solve three simultaneous problems by Sunday night: putting Greece on a solid foundation through a second bail-out; re-establishing confidence in Europe’s largest banks by ordering them to raise capital; and giving the newly empowered €440bn eurozone rescue fund more firepower so it can ensure Greek difficulties do not spread to Italy and larger financial institutions.

But as the summit gets closer, senior European officials are warning that the complexity of the three interlinked problems are so enormous, the differences between Paris and Berlin so large, and the time so short that a credible deal may prove out of reach.

One senior European official, noting that Berlin has begun playing down expectations, says: “They’d rather talk it down now than explain why there’s a disaster on Sunday.”

The faulty logic is that this disaster is the result of recent actions. It was bound to happen when the banks were not brought to heel in the wake of the 2008 crisis. But even now, no one seems to be drawing the right lessons or focusing on the real issues.

In ECONNED, we discussed four possible reasons for the failure to undertake fundamental reforms. The last one was:

Paradigm breakdown, meaning key elements of the current system are no longer viable, but that is a possibility that no one is prepared to face, since the old system seemed to work well for a protracted period. Thus the authorities reflexively put duct tape on the machinery rather than hazard a teardown…

The situation we are in now echoes that of the Great Depression. Although scholars still debate its causes eighty years later, a persuasive view comes from MIT economics professor Peter Temin. Temin, in his Lessons from the Great Depression, first sets forth the prevailing explanations and explains why each falls short. He argues that the culprit was the impact of World War I on the gold standard.

Recall that starting roughly in the 1870s, major European economies increasingly adopted the gold standard, and a long period of prosperity resulted.74 The regime was suspended in the UK and the major European powers during the war. Afterward, they moved to restore it, sometimes at considerable cost (England, for instance, suffered a nasty downturn in the early 1920s). But the aftereffects of the war meant the Edwardian period framework was unworkable. The deflationary forces they set in motion could have been countered by countercyclical measures after the Great Crash. But that was impossible with the gold standard. Indeed, as Temin notes, “Holding the industrial economies to the goldstandard last was about the worst thing that could have been done.”

Now readers may have trouble with that comparison, particularly since the conventional wisdom is that our policy responses have been so much better than those of the early 1930s. But the key point here is that the institutional framework locked the major actors into a particular set of responses. They were not able to see other paths out because they conflicted with an architecture and a set of beliefs that had comported themselves well for a very long time. It’s hard to think outside a system you grew up with. And remember, the gold standard did not break down overnight; the process took more than a decade.

If this view is correct, we are in a protracted period of muddled and futile to damaging policy actions until the old system is proven to be beyond redemption. If we are lucky, a combination of new thinking and successful experiments will put us on the road to a new order. But at this juncture, it’s hard to find reasons to be optimistic.

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  1. jjohannson

    I feel like sometime in the mid- to late ’90s the hyper-digitization of capital transfer and management overtook the capacity of the international regulatory framework.

  2. YankeeFrank

    The old system is only going to be “proven to be beyond redemption” only if the jokers in charge die off, which could take decades, or if the people just won’t take it anymore. Otherwise, it seems they will just keep shoveling money into the banks and letting everyone else starve. Of course Europe is the big question mark — will Germany “come around” at the last minute, or let it fall down?

  3. larry

    There are few reasons if any to be optimisitic other than that VIPs, even among the Euroskeptics, are now saying that it would be a disaster of immense proportions were the Eurozone to fail. This hasn’t yet led to a rethink about the structure of the Eurozone, but it might. Rumblings have been heard, offstage as it were.

  4. SidFinster

    I am just a cat (love the feline Antidotes, BTW) but the other problem with nationalizing Eurobanks is that doing so would torpedo Eurosovereigns’ Eurocredit ratings.

    Still, nationalization, consequences and all, would be infinitely preferable to the deal that will get announced Sunday, which will be another triumph of paper-pushing of one form or another, but which will do nothing to make the underlying bad debt problem go away. One way or another, the deal will just shuffle nominal risk around a bit without making the financial institutions eat too much of that turd pie that they baked for us.

    And there will be a deal come Sunday, albeit a “deal” that will strain the credibility of a toddler. The Europoliticians will announce that their ingenious mechanism of sprinkling cinnamon on a turd has turned that turd into a cinnamon roll. Markets will briefly soar, especially if some icing is added.

    Garans ballbarans.

  5. SidFinster

    n.b. the “cinnamon roll” bit is sadly not original to me, but I find it so beautiful and warm and cutting to the heart of the bullshit that I think it should elevated to the status of a meme so I use it every chance I get and you should too.

  6. Swedish Lex

    This may sound strange, but I am more optimistic or at least less pessimistic than I have been for the past three years. The insight that the euro has profound and urgent existential problems has finally dawned on Europe’s leaders. It only took three years. Still 2-3 months ago, the degree of collective denial was still very high. Bank recapitalisation was looked at with ridicule as late as end of August.

    The EU leaders will continue to do too little too late but to smaller and smaller degrees, step by step. They are now catching up fast – by EU political standards. Expect the coming week end’s summit to be the first of a new string of many summits at which the full range of necessary and profound issues will be debated. One example of a big shift is the German political leadership’s wish to move ahead with changes to the Treaty as fast as possible. Until recently, the German Government saw no need to Treaty changes for a couple of decades.

    So, even the EU supertanker has begun changing its course, it will still be a long time before something resembling a coherent and overreaching approach will become visible. Continued uncertainty and fire fighting in the meantime, unfortunately.

  7. timotheus

    Re Pulp Fiction: great cinema, but not very helpful from a public health point of view. A simple, intramuscular injection of naloxone will arrest opioid overdose, and there’s no need to get all dramatic with trying to find the heart muscle–the fleshy part of the upper arm will do fine. Here in NY State, lay persons can get a simple two-hour training in the procedure and carry a small kit to use in such emergencies even without any medical credentials. It’s important as there are two fatal opioid overdoses per day in the city.

  8. Jim Haygood

    It’s like the Woodstock of euro banksters:

    Luxembourg Prime Minister Jean-Claude Juncker, who chairs the group of euro-area finance ministers, indicated an impromptu meeting of European leaders in Frankfurt last night failed to resolve differences. “We are still meeting,” he said as he departed.

    French President Nicolas Sarkozy, whose wife was reportedly giving birth to his first daughter, jetted into Frankfurt to meet with officials as they attended an event to honor outgoing ECB President Jean-Claude Trichet. Sarkozy, German Chancellor Angela Merkel and International Monetary Fund Managing Director Christine Lagarde left the event at the Frankfurt Opera House without commenting.

    Also attending the event in Frankfurt last night were Mario Draghi, who replaces the retiring Trichet on Nov. 1, European Union President Herman van Rompuy and European Commission President Jose Barroso. French Finance Minister Francois Baroin and German finance minister Wolfgang Schaeuble were there as well. No statement was issued.

    Well, of course they left the Frankfurt Opera House without commenting — the fat lady hadn’t sung yet! mwa ha ha ha …

    Meanwhile, that French-German bond spread just keeps blowing wider to fresh records. ‘Brownie, you’re doing a heck of a job …’

    And what a cinematic moment, as Sarkozy and Bruni’s daughter is born, just as Europe’s financial elite are struggling to midwife a desperate rescue plan.

    To demonstrate Europe’s ironclad resolution, Sarko and Carla should consider naming their baby daughter ‘Eurolia.’

  9. Finance Addict

    The following is an important piece of the puzzle explaining why the headline recap number has shrunken to €90 billion and much less than required. From (my version of) the FT article:

    “Officials said the main reason for the different numbers was the EBA’s inclusion of the positive impact on banks’ capital position of applying market values to the region’s better performing sovereigns, such as Britain and Germany, offsetting the peripheral ‘haircuts’.”

    How very interesting. Surely, UK and Germany sovereign prices will continue to go up under a scenario of extreme market stress caused by problems in the Eurozone. Right? Right?!

    1. Jim Haygood

      Dunno, but Italian bond yields hit 6.00% again, at the end of the European trading day.

      If Spanish and Belgian yields can catch up, our 6-6-6 plan will be in place!

  10. Jim Haygood

    ‘Officialdom could patch up things for quite a while if the powers that be let the ECB monetize the debt (eventually, you could have an inflation problem, but with the EU and global economy so slack, “eventually” will take quite a while to show up).’

    To paraphrase Rodney King: ‘Can’t we all just print?’

  11. lee

    “Now readers may have trouble with that comparison, particularly since the conventional wisdom is that our policy responses have been so much better than those of the early 1930s. But the key point here is that the institutional framework locked the major actors into a particular set of responses.”

    The last sentence is spot on. I do not have any trouble at all with the comparison to gold. In my mind the problem is exactly the same as before (which is not an original concept). The Euro is the exact same thing as gold for the peripheral European countries. They have no sovereignty over their currencies. Since they do not have the power to devalue (just as with gold) they will deflate and eventually default. Rigid exchange rates are extraordinarily dumb and you’d think the finance lords would have that figured out by now. But they haven’t. It’s really sad.

  12. Lew Glendenning

    We exist within huge interacting systems, economic, social and political.

    By the nature of laws and regulations, government builds static institutions which they pretend will last for all times. The increasing differences between the reality of the evolving systems and the assumptions, rules and regulations of the static institutions mean that all govs are in a permanent state of crisis.

    This is why we should be experimenting with minimum government and maximum Freedom, why all large-government systems will fail.

    Freedom means that very many people and businesses are simultaneously testing ‘routes’ into the evolving future. It means there are many small failures and successes that individuals can learn from.

    Big government’s static structures threaten civilization when they fail : world wars, world-wide economic depressions, sometimes both at once. Every war or depression costs their society a generation’s accumulation of wealth, and the culture, science, medicine that wealth represents.

    Big government has made us poor.

    This is not a theoretical argument : There are no socialist governments that have succeeded over 50 years. There are no countries run by Keynesian policy that have succeeded over 50 years.

    All of the countries in the world, bound by their best and bright’s mono-culture groupthink learned at the finest of our planet’s education systems, have fell into the same hole at the same time.

    It is way past time to re-think the fundamentals. Ron Paul is doing that. Of course they hate him.

    1. Anonymous Jones

      All small-government systems have failed too.

      While we’re at it, all systems, everywhere, have failed or will eventually fail.

      I don’t hate crazy people. Ron Paul is alternately weird and amusing and sometimes when he says there will be less fraud with no government, you really really want to believe in him, and if we all clap, I guess Tinkerbell will be alive too. Then again, if you open your eyes, you’ll realize nothing is really there.

    2. Joe Rebholz

      “Big government’s static structures threaten civilization …”

      What about big banking’s static structures?

      Or maybe it should be: What about big banking’s erratic and uncontrollable dynamic processes?

    3. Don Delgado

      If capitalism is the best we could do we might as well light the planet on fire and start singing

  13. TC

    It seems that, per any financial dislocation’s causes (whether considering the present instance or the period leading to the Great Depression) more crucial than financial system architectural flaws simply is the matter of confidence in the viability of securities permeating finance. Once confidence is compromised, it’s over; the system is doomed to fail.

    Thus do present day attempts to stave off write down of bloated core securities make sense (today it’s sovereign debt, tomorrow it might be municipal debt). Venturing to buy time that confidence might be resurrected, maintaining prospects that a debt, indeed, will be successfully extinguished apparently is believed crucial to restoring confidence. In this process, however, is the question of due diligence exercised in the debt’s creation raised, particularly as streets fill with dissent among those effected by the hit on confidence and efforts to sustain status quo arrangements once maintained when confidence was not an issue.

    The present conflict between those supposing the primacy of finance must be maintained at all costs versus those whose very posterity is threatened takes us to the border separating sound banking adequately imbued with appropriate measures for exercising due diligence from a criminal fraud whose underlying character implies that all debt more or less is created equal — an aspect of today’s financial arrangement well-exemplified by the explosion of sub-prime mortgages a few years back (not to mention credit card debt over the past forty years). All the more criminal is today’s open and active effort among financial authorities to abrogate the notion of a sovereign nation’s right to self-determination. It’s in this context that, present-day actions of euro-zone financial authorities should be regarded as particularly offensive. Destruction of sovereign power readily appears the very intention of today’s vain effort to sustain a failed financial regime employing zero due diligence (a principle plainly still guiding authorities, as “solutions” obviously doomed to fail well-testify).

    If you’re looking for reasons to be optimistic, read Article 1, Section 8 of the U.S. Constitution. It’s for days like these such power was given our nation’s Congress. Likewise in the reading will the criminal culpability of a President who signed into law a Joint Select Committee on the budget be exposed. Our fascist-in-chief would rather have us believe all debts are created equal than provide leadership based on sound American principles. Not that this man requires more reason to be impeached — he’s cornered the market — but thousands taking to the streets in dissent reveal this administration utterly incapable of upholding precious principles eloquently spoken in the U.S. Constitution’s Preamble. Obama must go, and as more Americans realize this in the context of the hopelessly insolvent, anarchist free market system he defends, then there will be more reason for optimism.

    1. Nathanael

      If G. W. Bush wasn’t impeached, why would you expect Obama to be impeached? They both committed *the same* crimes.

      The rot goes deeper than that. Look at the Senate; try to get a 2/3 majority to do anything in that cesspool, and you’ll fail. We need to get rid of the Senate, but to do that requires a Constitutional amendment…. one which the Senate will refuse to pass.

      So, perhaps if state governments call a Constitutional Convention under Article V we might get some reform “within the system”.

  14. Hugh

    Never forget the kleptocratic angle. The only way this is going to get fixed is at the expense of the rich. They’re the bondholders behind all this and the political classes they own are doing everything to protect them: keeping the big banks afloat, pushing austerity on to the periphery, on to ordinary Europeans, and doing nothing to change mercantilist trade patterns. European leaders don’t have a paradigm problem so much as an Upton Sinclair one. They are paid not to understand what’s wrong and they are not understanding it with a vengeance.

  15. tz

    Monetizing debt does NOT create inflation. The money supply is cash plus CREDIT. Credit inclludes derivatives and mortgages. The inflation happened – houses which should cost 200 went up to 500 all financed.

    Credit is going poof. That is deflationary. If my visa spends like cash both are part of the money supply. No visa, i can’t spend the same.

    The great depression was caused by the identical credit expansion – loans that could not all be repaid (in gold-backed currency).

    One of my big problems with the theokeynesian modern monetary theology is when credit is expanding and greater fools and foolishness is in vogue, most are silent about this boom – binge. The addict suffers from withdrawl symptoms, but the problem is the original addiction and habituation. But ‘we are all emaciated junkies now’ looking for uncle pusher for the next fix.

    1. F. Beard

      But ‘we are all emaciated junkies now’ looking for uncle pusher for the next fix. tz

      False analogy. The population was driven into debt by what is essentially a government enforced/backed counterfeiting cartel.

      And the population does not need a “fix”; it needs justice:

      1) Abolish the counterfeiting cartel.
      2) Bailout the entire population, including savers since they have also been cheated by the cartel, out of ALL private debt.

    2. Joe Rebholz

      “…when credit is expanding and greater fools and foolishness is in vogue, most are silent about this boom – binge. The addict suffers from withdrawl symptoms, but the problem is …”

      The problem is the money/banking system. The problem is inherent in lending/borrowing itself which produces the erratic and uncontrollable cycling of boom and bust. Fraud and lawless actions only speed up and make the cycles wilder. Banking/lending/borrowing — the whole scheme as we now know it — has got to go.

      1. F. Beard

        Banking/lending/borrowing — the whole scheme as we now know it — has got to go. Joe Rebholz

        Agreed. Common stock as money requires none of the above. But then it “shares” wealth rather than concentrates it.

  16. bmeisen

    Great title. I thought 80 billion was short. They missed a chance in 2008 to restore mediocrity to banking and now we are paying through the nose again. I love the energy at Occupy Frankfurt and they should be camping in front of Deutsche Bank, not the EZB.

  17. Jim

    Did the Fed consider dramatically increasing inflation in the US ten years ago so that Argentina could become more competitive? Then why should the ECB do so so that the southern European countries can?

  18. JohnB


    The proper response lies in adjusting the mechanics. If you want to kill speculation, you need to increase the cost of speculative credit. This is not yet the case, but two other flaws are now being adressed in Europe.

    CDS (credit default swaps) derivatives owners will have to have the paper the CDS insures. This seems insignificant, but until now banks could trade insurance policies for risk they where not exposed to (for instance other peoples life insurances). This meant they had an incentive to bring about the insured defaults! This also meant a huge credit expansion that resulted in a highly connected ‘financial system’ that could ‘collapse’, through the ‘suicide ribbons’ each bank held of other banks. Tirggering a CDS means such a payout for the owner, that this could immediately crash the banks involved, and because they own CDSes on each other, they would all be history within hours. Now these ribbons will be cut, the start of recovery…

    Naked short selling (selling short where the stock offered does not exist) will also be banned, it allows banks to trash a stock (by offering millions of shares for sale) without ever owning one share!

    In other news it’s announced that the European Commission will now raid financial companies unexpectedly to clamp down on percieved euribor cartel acitivity and derivatives irregularities. Didn’t know the EC could do that, but this is again a positive development.

    The EC also proposes to silence the rating agencies, which effectivly removes their ability to direct the market to put countries under financial stress.

  19. Don Delgado

    I see this the same way it happens in America: the banks whine about Certain Death when they see fit. They don’t mind appearing weak when the officials can be fooled again and again because they want to be fooled.

    Don’t get me wrong, Europe is weak. But they’ll talk more weak and less weak based on the proximity of the spigot, like bankers will. I think Goldman would probably be cooking its numbers if it didn’t see some benefit to looking like a poor beggar child above the fold.

  20. Nathanael

    Yves, there’s a nastier conclusion from the point you make.

    Another case in which the powerful policymakers were “locked into old paradigms” was the Metternich settlement after the Napoleonic wars. It was clear that there was a need and a demand for more responsive and democratic government, and for more linguistically and culturally unified states.

    And yet the power elites denied this repeatedly — even when it wouldn’t have hurt them much. Bismarck was smart enough to actually democratize Germany some, showing exactly how little it would have hurt them, and he actually assisted with the “culturally homogeneous states” project.

    Yet by the time we come to 1900, all of the crowned heads of Europe are incurably conservative and unwilling to consider a paradigm shift.

    In the end the paradigm broke with *World War I*.
    Refusal to change a non-viable paradigm can cause *disastrous* unravelling.

    So the refusal to make the paradigm shift you describe in this article is disastrous, but not as disastrous as some similar refusals to make paradigm shifts.

    Refusal to change the paradigms which give us fossil-fuel-dependent economies will probably kill billions of people, and may actually cause human extinction.

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