The World Economic Crisis

Europe's Rescue Plan Falters

Europe's bold program to defuse its financial crisis by injecting cash into the banking system is running out of steam

WSJ,

26 April, 2012

The European Central Bank's roughly €1 trillion ($1.31 trillion) of emergency loans caused interest rates of troubled euro-zone countries to plummet earlier this year, easing fears about Europe's debt crisis. But lately rates have again been marching higher.

One big reason: After months of using that cash to buy their government's debt, banks in Spain and Italy have little left, say analysts and other experts.

The banks' voracious buying had helped bring down the interest rates, providing relief for troubled countries that need to issue tens of billions of euros of bonds this year. But the banks, lately the primary buyers of Spanish and Italian government bonds, no longer have much spare cash to continue such purchases.

That is sending rates back up, rekindling investor fears about Europe's ability to arrest the three-year-old sovereign-debt crisis and return the region to health.

The ECB had handed out the emergency three-year loans to at least 800 banks in two helpings, one in December and the other in February. Banks used a big chunk of the money to snap up their governments' bonds, spurring sighs of relief from global markets.

The current strength of the ECB's rescue mission may be tested Thursday, when Spain, one of the euro zone's most troubled economies, auctions €2.5 billion of its bonds.

Despite a surprisingly strong sale of treasury bills on Tuesday, some experts worry that Spanish banks could be less active this time around, leaving Spain stuck with lackluster demand for its debt.

That adds to worries that one of Europe's biggest economies might eventually need to seek financial aid from the international community.

"Eventually the liquidity extended [by the ECB] will be fully deployed, and at that point Spanish and Italian banks will either have to stop buying sovereign bonds, removing the largest buyer from the sovereign market, or sell bonds" to raise cash for their own needs, said Alan Broughton, an analyst at RBC Capital Markets.

The chief purpose of the ECB bailout was to keep the banks themselves well-funded. They have tens of billions of euros of their own debt coming due this year.

In that sense, the loans have succeeded: They have greatly reduced the risk that a European bank will suddenly run out of money and become an albatross around the neck of a weak country.

But the ECB's Long-Term Refinancing Operations, or LTROs, had a broader purpose: to get more money out into the wider economy, and especially to finance governments that had trouble borrowing on their own.

The cash "means that each state can turn to its banks, which will have liquidity at their disposal," French President Nicolas Sarkozy said in December, just after the first LTRO was announced.

In financial circles, the practice of banks' borrowing from the ECB in order to lend to their governments was dubbed the "Sarkozy carry trade."

In early March, ECB President Mario Draghi called the LTROs an "unquestionable success." Banks, he said, are having an easier time funding themselves, and international investors are tiptoeing back in.

"Certainly, we see many signs of a return of confidence in the euro," he said, adding that the loans offered European governments breathing room to get their fiscal houses in order.

European stock and bond markets stormed ahead in the first quarter, a sign of greater desire for riskier assets. By mid- March, European bank shares had rallied as much as 15% from the start of the year.

Bond yields in fiscally troubled European countries tumbled, a sign of waning investor fear, with Spain's 10-year bonds dropping from about 7% last November to below 5% in early March.

Weeks later, that confidence has ebbed.

Despite the new money sloshing around Europe, the fundamentals of the debt crisis are little changed: Spain and Italy both need sustained access to financing to cover their deficits.

If foreigners stay away and local banks run out of firepower, both countries will be back where they started before the LTRO.

A growing array of analysts and others worry that the flood of ECB loans in some ways could be counterproductive. The cheap money has reduced the urgency with which some banks are cleaning up their balance sheets, a trend that some critics worry could delay the industry's return to health.

Banks counter that what some see as foot-dragging is simply their trying to avoid a chaotic deleveraging process that could hurt the European economy.

"The market has been treating the LTRO as a panacea," said James Ferguson, head of strategy at Westhouse Securities in London. "It's absolutely better than what would have happened without it, but that doesn't mean it's a fix."

In theory, lending the local banks money they could in turn lend to the government at a profit buys time for the governments to enact overhauls that can lure back foreign investors.

That is essential: Both the Spanish and Italian economies run deficits with the rest of the world; their businesses and citizens don't generate enough surpluses on their own to finance the government.

But enticing foreigners has proved hard. Spain has relaxed its fiscal targets amid worries about the effect of austerity on its economy, and the International Monetary Fund projected Tuesday that Italy wouldn't meet its 2012 deficit target.

Data from Spain and Italy suggest local banks bought the bulk of the governments' new debt, and picked up a chunk of what foreigners were selling.

In Italy, domestic banks increased their holdings of Italian government debt by 29% in the three-month period ended February 2012, which includes the first of the ECB's two cash injections but not the second.

In Spain, banks took about €200 billion in ECB loans, according to analyst estimates.

Those resources, along with funds freed up by reducing the banks' loan portfolios, were "substantially consumed" by a combination of buying government bonds, repaying old debts and the disappearance of roughly €65 billion of customer deposits, UBS analysts reckon.

That leaves about €21 billion in funds, according to UBS—or less than half of what Spain needs to borrow over the remainder of 2012.

Italian banks are in a similar situation, having burned through most of what they borrowed from the ECB, according to multiple analyst estimates.

The Italian government this year still needs to issue approximately €150 billion of bonds.

The banks' dwindling cash piles and the return of market turbulence has some experts, such as Citigroup chief economist Willem Buiter, predicting the ECB will be forced to make another round of loans later this year.

That is something the central bank's German faction is reluctant to do.

ECB hawks, especially the German contingent, are very wary of the inflationary impact of the program and already are pushing for the formulation of an exit plan.

There isn't enough money in the whole world to solve the global economic crisis.

-- You know what? I just find it unfathomable that anybody takes any of this financial crap seriously anymore. It's all lies laid upon delusion. -- MCR

IMF chief says has around $316 bln in funding pledges

The head of the International Monetary Fund said on Wednesday member countries had committed $316 billion toward new IMF resources to help contain the debt crisis in the euro zone.

Reuters,

19 April, 2012

"We have commitments in excess of $316 billion and I have more in the bag," IMF Managing Director Christine Lagarde told the Bertelsmann Foundation think tank, speaking before meetings of global finance chiefs in Washington.

The figure is more than the $286 billion tallied on Tuesday after Japan, Sweden and Denmark said they would contribute the IMF pot of money.

The meetings of the World Bank and IMF member countries, which officially start on Friday, will try to raise around "$400 billion for the IMF, an issue that has taken on new urgency given increased borrowing costs in Spain and Italy that has reignited fears that the euro zone crisis will flare again.

Lagarde did not say where the additional money had come from. On Tuesday, Japan pledged $60 billion to the IMF, becoming the first non-European nation to commit to strengthen the Fund's financial arsenal.

Sweden said it would commit $10 billion and increase the amount to $14.7 billion later, while Denmark said it would give $7 billion. Norway pledged $9.6 billion in December in addition to $200 billion from the European Union.

More countries are expected to pony up funds in coming days as the meetings get underway. The Group of 20 developed and emerging economies will meet on Friday, where IMF resources are likely to dominate discussions.

Emerging market countries, including China, Brazil and Russia, have so far not committed any funding. They have said that any new resources should be accompanied by more voting power in the global lender.

The United States, which is facing a general election in November, has said it will not be part of the fundraising effort. However, U.S. Treasury Secretary Timothy Geithner earlier on Wednesday threw its support behind the bid to boost IMF resources.

Lagarde said global economic conditions were fragile at best and "extremely unstable."

She said slightly stronger growth in the United States and improved policies in the euro zone to deal with the sovereign debt crisis meant risks to the global economic outlook had abated.

However, she added: "All of that together is giving a little bit of optimism but very tempered by instability that can be triggered by any development on the market.