As every woman who has ever had dealings with a man knows only too well, it is a lot easier for people to make promises than it is for them to keep them. And when Europe’s leaders met in Paris on the 12 October, a lot of fine promises (which were all, surely, very well intentioned) were made. The reality of having to live up to them, however, is turning out, as might only have been expected, to be much more complicated.
Basically, the kernel of the plan which is now being operationalised seems to have been thrashed out in Washington on 11 October, when key G7 leaders met with Dominique Strauss Kahn of the IMF, and it was decided to try and erect two great firewalls (corta fuegos) – at least as far as Europe is concerned. One of these was to be co-ordinated by the EU governments, and the other by the IMF, who were to act in the East. Both these parties essentially agreed to guarantee the banking systems in the countries for which they took responsibility, so the action, in a sense, moved from the banks (which are now, more or less “safe”) to the governments and the IMF (who is ultimately backed by cash from governments), and it is the “safety” of these institutions which is likely to be more or less tested by the markets, with the first trial of strength taking place right now in Iceland.
So the big question now is, do these various institutions have the resources to back up their guarantees, should the need arise?
Problem Selling Bonds
In this context the Financial Times had a very interesting article yesterday about the fact that the Austrian government had decided to cancel a bond auction.
Austria, one of Europeâ€™s stronger economies, cancelled a bond auction on Monday in the latest sign that European governments are facing increasing problems raising debt in the deepening credit crisis.
According to the FT article the difficulties Austria, which has a triple A credit rating, is facing only serves to highlights the extent of the deterioration in the sovereign bond market, where benchmark indicators of credit risk such as the iTraxx index hit fresh record spreads yesterday.
Austria now is the third European country to have cancelled a bond offering in the last few weeks – in the Autrian case the markets are getting more and more nervous over the exposure of some of its key banks (Erste, Raffeison) to the mounting disaster over in Eastern Europe – both Hungary and Ukraine received IMF loans this week (see below) and they certainly won’t be the last.
Austria seems to have dropped its plans for a bond launch next week due to the size of the premiums (spreads) investors seemed likely to demand, although the Austrian Federal Financing Agency did not give any explanation for the decision.
Spain, which alos currently has a triple A rating, and Belgium have both cancelled bond offerings in the past month because of the market turbulence, with investors again demanding much higher interest rates than debt managers had bargained for.
So really many European governments are now facing similar problems to those their banks faced earlier, they can get finance, but only at rates which they consider to be punitively high (remember, the interest has to be paid for from somewhere, in the present recessionary climate from cuts in services more than probably, since, remember, if we look over at Eastern Europe, investors are very likely to “punish” those governments who try to go down the easy road, and run large fiscal deficits over any length of time).
Market conditions have steadily deteriorated in recent days with the best gauge to credit sentiment, the iTraxx investment grade index, which measures the cost to protect bonds against default in Europe, widening to more than 180 basis points, or a cost of â‚¬180,000 to insure â‚¬10m of debt over five years, on Monday.
This is a steep increase since only as recently as Monday of last week, when the index closed at 142 base points. Also the cost of default protection on European companies has risen to record highs this week on investor concern that the global economic slowdown will curb company profits. The Markit iTraxx Europe index of 125 companies with investment-grade ratings fell 3.5 basis points yesterday to 166.5, after hitting a record high on Monday.
The FT cites analyst warnings that the there is now a huge quantity of government debt building up in the pipeline, and the government bonds due to be issued in the fourth quarter and early next year will only add to the problems some countries are facing, and particularly those countries like Greece and Italy who already carrying large amounts of debt that needs to be refinanced or rolled over.
It has been estimated that European government bond issuance will rise to record levels of more than â‚¬1,000bn in 2009 â€“ 30 per cent higher than 2008 â€“ as governments seek to stimulate their economies and pay for bank recapitalisations.
The eurozone countries will raise â‚¬925bn ($1,200bn) in 2009, according to Barclays Capital. The UK, which is expected to increase its bond issuance from the current â‚¬137.5bn in the 2008-09 financial year, will take the figure above â‚¬1,000bn.
Italy, and Greece, both with a debt-to-GDP ratios of over 100 percent, are certainly the most exposed to continuing difficulties in the credit markets, (with analysts forecasting that Italy alone will need to raise â‚¬220bn in 2009). At the present time the Libyans are lending the Italian government a helping hand (and here) in struggling forward, but even oil rich Libya doesn’t have the money to fund the long term needs of the Italian banking, health and pension systems.
IMF Have Only $250 Billion
On the other hand Bloomberg had an article yesterday on the growing pressure on the IMF’s somewhat limited resources, as one country after another in Central and Eastern Europe joins the “consultation queue” in the hope of getting a bail out.
Bloomberg report that the cost of default protection on bonds sold by 11 emerging-market nations has now either approached or surpassed distress levels, raising the very immediate likelihood that the International Monetary Fund’s ability to bailout countries may soon start to be put to the test.
Credit-default swaps on eight countries including Pakistan, Argentina and Russia have now passed the 1,000 basis points mark, the level which is normally considered to signify “distress”, according to data provided by CMA Datavision. Funding one basis point on a contract protecting $10 million of debt from default for five years is equivalent to $1,000 a year.
“The resources of the IMF may not be sufficient for wider bailouts if needed,” said Vivek Tawadey, head of credit strategy at BNP Paribas SA in London. “If it can’t raise the money, some of the more distressed emerging markets could end up defaulting.”
Ukraine, Hungary, and Iceland have already received IMF loans, while the fund is currently in “consultation” talks with Belarus, Turkey, Latvia, Serbia, Romania, Bulgaria and Pakistan, at the very least.
According to Simon Johnson, former chief economist at the fund the IMF only has up to $250 billion it can currently lend (as quoted in the Financial Times yesterday).
Credit-default swaps on Pakistan currently cost 4,412 basis points. Contracts on Argentina are at 3,650 basis points, Ukraine at 2,850, Venezuela at 2,400 and Ecuador costs 2,072. Default protection on Russia, Indonesia and Kazakhstan also costs more than 1,000 basis points, while Iceland costs 921, Latvia 850 and Vietnam 837. Contracts on Turkey cost 725 basis points.
The IMF agreed at the weekend to lend Ukraine $16.5 billion for 24 months and stated yesterday that they would contribute $12.5 billion towards a $25.5 billion loan for Hungary (with the other participants being the EU and the World Bank. Iceland got a $2 billion loan on Oct. 24 and Belarus has asked for at least $2 billion. Just how many more loans are now in the pipeline, and if the IMF does start to see its funds stretched, just who exactly is going to step up to the plate and fork the necessary money out? The sheer fact that they only put part of the cash for the Hungarian loan, and that the World Bank had to come on board with a symbolic $1 billion shows they are already aware that the problem may arise.
Well just after writing this, I see from reading the FT that Gordon Brown got there just before me. Beaten by a short head!
Gordon Brown on Tuesday spearheaded calls for a multi-billion pound “bail-out fund” to prevent the global crisis spreading to more countries, and warned of the need to stabilise economies “across eastern Europe”…..
The prime minister on Tuesday urged the oil-rich Gulf states and China to provide “substantial” funding to the International Monetary Fund, before flying to France for talks on an increase to the European Union’s bail-out fund. The government is keen to emphasise the link between global action and domestic voters’ interests, as well as portraying Mr Brown as a world leader.
The prime minister said it was “in every nation’s interests and the interests of hard-working families in our country and other countries that financial contagion does not spread”. While he did not rule out the UK making a contribution, he insisted the “biggest part can be played by the countries that have got the biggest [balance of payments] surpluses”.
The IMF’s $250bn (Â£158bn) bail-out fund “may not be enough” to prevent the crisis destabilising more countries, Mr Brown said. His spokesman added the UK was “looking at a figure in the hundreds of billions of dollars” for the IMF. Mr Brown called for “action on this new fund immediately”.
Also, another story in Bloomberg gives us a further glimpse of how the EU governments are planning to do all that financing. The German government, it seems, is going to print IOUs (sorry, bonds) and give them directly to the banks. That is, they are not going to auction bonds and give the proceeds, they are simply giving the paper, and presumeably paying a coupon (or interest). Oh yes, and the bonds will not be sellable, since this would, of course, damage the yield curve via the supply and demand process, but they will count as debt, which means that the German government is being very naieve here (assuming the report is accurate) since of course the rise in the debt may well mean a breach of the 2011 balanced-books commitment, and falling back on this will almost inevitably have an impact on the extra implied risk investors will be looking to get paid for holding the bonds.
Germany plans to finance part of its 500 billion euro ($636 billion) bank rescue package by issuing bonds to banks in exchange for new preferred stock, according to Finance Agency head Carl Heinz Daube.
“The banks will not be allowed to sell the injected government bonds,” Daube said in an interview in Tokyo today. “So far there’s obviously not a huge demand for any rescue measures, but this might change in the coming weeks.”
Germany’s rescue plan, approved by lawmakers on Oct. 17, amounts to about 20 percent of the gross domestic product of Europe’s biggest economy. Chancellor Angela Merkel’s administration pledged 80 billion euros to recapitalize distressed banks, with the rest allocated to cover loan guarantees and losses.
….Hypo Real Estate Holding AG, the Munich-based lender that’s already had a 50 billion euro bailout, today asked the Deutsche Bundesbank for 15 billion euros to cover short-term liquidity needs. ….Frankfurt-based Deutsche Bank AG may also need 8.9 billion euros of new capital, more than any bank in Europe, Merrill Lynch & Co. analysts Stuart Graham and Alexander Tsirigotis wrote on Oct. 20.
The bailout plan is still being discussed in Berlin and more information will probably be released at the end of this week, Daube said.
Germany may meet additional funding needs for its bank rescue by selling six-month bills before examining options for borrowing using longer-term securities, Daube said. The government plans to offer between 212 billion euros and 215 billion euros of debt through its 2009 program, about the same as the 213 billion euros scheduled for this year.
The debt-for-equity swap will probably have “next to no effect” on the country’s yield curve because the notes offered to banks won’t trade in the so-called secondary market, he said. The yield curve plots the rates of government bonds according to their maturities, and increases indicate higher borrowing costs.
“The government deficit of course will increase, the outstanding volume of bonds will increase as well,” Daube said. “The number of outstanding bonds available in the secondary market will stay exactly the same.”
Gentlemen, we are out of our depth here.