Tag Archives: eurozone

By Peter Boone and Simon Johnson

Some officials and former officials are taking the view that a large fund of financial support for troubled eurozone nations could be decisive in stabilizing the situation.  The headline numbers discussed are up to 2-4 trillion euros – a large amount of money, given that German GDP is only 2.5 trillion euros and the entire eurozone GDP is around 9 trillion euros.

There are some practical difficulties, including the fact that the European Financial Stability Fund (EFSF) as currently designed has only around 240 billion euros available (although this falls if more countries lose their AAA status in the euro area) and the International Monetary Fund – the only ready money at the global level – would be more than stretched to go “all in” at 300 billion euros.  Never mind, say the optimists – we’ll get some “equity” from the EFSF and then “leverage up” by borrowing from the European Central Bank.

Such a scheme, if it could get political approval, would buy time – in the sense that it would hold down interest rates on Italian government debt relative to their current trajectory.  But leaving aside the question of whether the ECB – and the Germans – would ever agree to provide this kind of leverage and ignoring legitimate concerns about the potential impact on inflationary expectations of such measures, could a, for example, 4 trillion euro package really stabilize the situation? Continue reading →

By Simon Johnson

In recent days, Greece’s parliament adopted new austerity measures and Europe’s finance ministers approved another round of Greek loans. So the European debt crisis is under control, right?

Probably not. One obvious reason is Standard & Poor’s July 4 threat to declare a default if banks roll over Greek government bonds coming due over the next year. That could force everyone back to the drawing board.

Less obvious, but no less worrisome, is Italy. With a precarious fiscal picture, it could be the next to come under pressure. And this time, U.S. banks are in the line of fire, with about $35 billion in loans to Italy and potentially more exposure to risk through derivatives markets.

U.S. regulators should call for a new round of stress tests that assume sovereign-debt restructurings in Europe and take a realistic view of counter-party risks in opaque markets such as foreign exchange swaps. Based on those tests, the biggest banks probably need to suspend dividends and raise more capital as a buffer against losses.

To read the rest of this post, click here (this link is to the full article on Bloomberg: http://www.bloomberg.com/news/2011-07-05/could-italy-be-next-european-domino-to-fall-commentary-by-simon-johnson.html)

By Simon Johnson

The big question of the week in Europe is deceptively simple – will any countries that share the euro as their currency default on their government or bank debts in the foreseeable future?  The answer to this question determines how you regard bonds from countries such as Portugal, Spain, Italy, and Belgium.

Answering this question is not as simple as it seems, however, because it involves taking a view on three intricate issues: What exactly is the eurozone policy now on bailouts, can big eurozone countries really be bailed out if needed, and what happens to the politics of these countries and of the eurozone has a whole as pressure from the financial markets mounts?

The prevailing consensus – and definite official spin – is that over the weekend European leaders backed away from the German proposal to impose losses on creditors as a condition of future bailouts, i.e., from 2013.  The markets, in this view, should and likely will calm now; there is no immediate prospect of any kind of sovereign default or (more politely) “reprofiling” on debt, including the obligations of big banks.

But a close reading of the Eurogroup ministers’ statement from Sunday suggests quite a different interpretation.  It’s a straightforward text, just 2 ½ pages long, but it has potentially momentous consequences – as it envisages dividing future eurozone crises into two kinds. Continue reading →

By Peter Boone and Simon Johnson

In the aftermath of the Irish bailout, the German proposal for a future sovereign and/or senior bank debt restructuring mechanism within the eurozone makes complete political sense to the electorate in stronger European countries.  They do not want to write “blank checks” to weaker countries and to out-of-control financial institutions going forward; creditors to countries that run into trouble will face likely losses.

While the details of this “burden sharing” approach remain to be hammered out (after Sunday’s announcements), there is no way for German or other politicians to backtrack on the broad strategic principles.  But once this arrangement is in place, say in 2013 or thereabouts, all eurozone countries will (a) be able to sustain less debt than has recently been regarded as the norm, and (b) become vulnerable to the kinds of speculative attacks in debt markets that we have seen in recent weeks – to reduce funding rollover dangers, they will all need to lengthen the maturity of their outstanding debt. 

The end point is clear.  Last week the markets began to work backwards to today’s debt profiles; major disruptions still lie ahead.

Ultimately, there will be a eurozone will greater shared fiscal authority, a common cross-border resolution authority for failed banks, and likely greater economic integration.  But there are four scenarios regarding who ends up in that eurozone – and how we get there. Continue reading →