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Satyajit Das on European Debt


Satyajit Das: Europe’s Debt Crisis Refuses To Die

Efforts to secure a new package [for Greece] of Euro 115 billion have stalled. German insistence on token participation by private banks and investors has proved divisive. A French plan, Gallic in complexity, appeared and disappeared. Slanging matches between Greek Prime Minister and the EU, the EU president and the German Chancellor and the European Central Bank (“ECB”) President and the Chancellor have taken the place of substantive progress.

In the meantime, contagion has become a reality. Financial markets recognised belatedly that the authorities are not in control of the situation and there are no real solutions to the problems.

Greek 2-year debt now trades at over 30% per annum while both Ireland and Portugal are above 20% per annum – loan shark territory. Spain’s benchmark 10-year bonds now command around 6.50% per annum. Interest rates demanded by markets are above that before the announcement of the recent measures to “assist” Greece in June 2011. Most alarmingly, Italy has been drawn into the ever-widening net of infection.

Given the size of its debt and economy (the third largest in the Euro-zone), Italy like Spain is probably too big to save and too big to fail.

On Friday 15 July, European banking regulators issued the result of a stress test of some 90 banks. The test, the second in 2 years, was designed to reassure investors that the European banking system was sound. It failed miserably. While the test showed that only 8 banks “failed” by having insufficient capital, the basis of the tests was fatally flawed.

Crucially, the stressed scenario consisted of a 15% loss on Greek sovereign bonds whilst market prices suggests around 50%.

In fact, the stress tests were being performed on the wrong entities – the banks. As most large banks are “too big to fail”, it was really the ability of individual countries to stand behind their banks should problems arise that remained the issue.

A debt restructuring plan for Greece, Ireland and Portugal needs to be drawn up and implemented. A significant portion of the current debt would be written-off, to enable the countries to have some chance of attaining solvency. All lenders, private sector banks and investors as well as official lenders, must bear the losses. Debt restructuring should entail lengthening the maturity of debt and renegotiating terms to try to ensure the ability to service the debt.

The primary problems of European growth, intra-European financial imbalances and competitiveness of some countries will also need to be addressed. Europe will either need to move to greater financial and economic union or restructure its monetary and currency arrangements.

The alternative is a radical restructure of the Euro and Euro-zone itself.

The combination of the European debt crisis and the theatre of the absurd, that is the debate over the US debt ceiling playing in Washington, conditions have rarely been more uncertain since the start of the global financial crisis in 2007. The global economy faces a future of prolonged stagnation or financial catastrophe as sovereign debt problems escalate rapidly. Let us hope the masters of the universe make the correct choices. ‘

You must read the complete article, of course.

It’s incredible that in the face of all this, markets are going up. We are, like in 2007, a massive turkey being fattened up for slaughter.


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