2011-07-14 european monetary union and financial crises

8/6/2019 2011-07-14 European Monetary Union and Financial Crises

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European Monetary Union and Financial Crises.

Should European citizens pay for bad management of

banks and public debt?Luis Castejn Martn

14 of Jully, 2012

Student of Liffey Group School of English


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Public debt market: bonds and spreads to German bund

Luis Castejn2

What does hate government bondsinvestors?: risk and volatility. Those investors are mainly private

pension fund managers who look forsafe returns (4% 10-y) and low risks.They avoid any risky investment andstart to sell their portfolios and theyleave to buy new issues. And they must

listen to rating agencies because theycannot invest anywhere (portfoliopolicies obliges them to invest in triple-A rated assets).

That's not the traditional environmentfor trading bonds, which were the saferbay for citizen pension savings.

Who will buy new issues of bonds andat what required interest?Less averse investors (stock traders,hedge funds, etc.) will require higheryields. It will increase the cost ofborrowing for States and induces a most

severe budget control


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The situation: risks of some States defaults and banking

repercussion

Greece's sovereign-debt crisis in may-10. In November-10: Ireland joined Greece.

April-11: Portugal followed suit.

Which country will be the next?.

Sovereign-bond spreads (the extra interest compared with bonds issued by Germany, thesafest credit) are now much higher in all three of the bailed-out countries then they were in

May 2010. Promises to tackle budget deficits through public spending cuts and tax increases have

offered little reassurance to bondholders, who know that austerity will take its toll on growth.

Much of such Public debt have been bought by banks, so default will involves seriousbalance problems for even more problematic European banks in terms of covering those withown funds (or new ones).

Banks do not lend money, besides private sector is shrinking due to slow growth economy,because it is more profitable and less risky to buy Public bonds (4-5% of yield).

Banks have needed (and will need) huge amounts of funds to cover losses provoked by realstate non-performing loans (housing and soil) and corporate debt defaults.

Fiscal policy in EU is quite different, we have same currency but different public budgetdeficits and cost disciplines.

We do not have a common issuing of public debt: Eurobonds, so each countries issues debt

at their own discretion.

Mixed array of problems presided by economicshrinking:

1. Huge Public debt.2. Banking difficulties related to real state andown financing needs.

The result: a vicious circle which all EU citizenscould pay unfairly.

Luis Castejn3


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European economic diversity: its main weakness

GDP picked up in most countries through 2010 but there were markeddifferences in performance:

Germany expanded by almost 5% 1Q'11.

GDP in Greece has crashed under the weight of austerity;

Ireland contracted sharply in late 2010;

Spains economy is barely growing.

In many countries unemployment has not gone up.

Germany now has lower unemployment than before the crisis, thanks in part to ashort-time working scheme and flexible time arrangements in its manufacturing sector.

The worst-affected countries include Ireland and Spain, where a collapse inconstruction has swollen the dole queues. Youth unemployment is especially high inSpain.

Weak growth and high unemployment spell particular trouble for countries that

already have high levels of public debt. Greece was first to lose the confidence of the markets with a public-debt-to-GDP ratio

of 127% and a budget deficit of 15.4% of GDP in 2009.

Ireland had low public debt going into the crisis, but the state became crippled by itspledge to backstop its banks together with the hole that was blown in its tax revenuesby a combination of recession and housing bust.

Luis Castejn4


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The debate: citizens paying Public and banking

mismanagement

Greece and the euro; the abuses of austerity, plan to cut Greeces debt looks doomed to fail.

It will screw down too hard on ordinary Greeks: new taxes, spending cuts and a rushedprivatisation scheme.

It will almost certainly condemn Greece to recession, strife and an eventual debt default.

Ireland is also close to default, then it could happen to Portugal.

Spain and Italy are experiencing pre-intervention spreads in their bonds (Spain closes to 350bp last 11-jul).

All those cases will imply default situation, which could be solved:

Strictly private solution (Germany solution): no EU Governments intervention,renegotiating the payment of their debt (changing maturitiesof bonds) it causes severeproblems to banks and it will increase bond Government yields (+expensive).

Public solution (lefties): either ECB, or European facilities -European FinancialStabilisation Mechanism (EFSM)-, buying actual issued bonds to sustain spreads, and

buying new issues ensuring yields and amounts it involves new Public debt for theEFSM, increases risks in the euro currency and ECB balance.

What about banking restructuring?: Public money so our money- (FROB in Spain) is payingunbalanced balanced sheet (Spanish Cajas or Irish banks) provoked by no-performing loansderived from asset bubble and bad management of banking risk.

And now USA possible default: the safer bay is now experiencing default problems due tolegal restrictions on public spending imposed by Congress to the President. He cannot spend

more and if Federal Gvnmnt does not obtaining funds, next days will be in trouble to payPublic spending.

Luis Castejn5


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Some data: the Euro currency zone

Luis Castejn6


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Some data: Public debt as % of GDP

Luis Castejn7


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Some data: Public budget deficit as % of GDP

Luis Castejn8


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Some data: % annual GDP growth

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Some data: unemployment rate

Luis Castejn10


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Some data: GDP per person

Luis Castejn11


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Long term view: we are in the worsest situation since

many years

Luis Castejn12


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European Central Bank reference interest rate

Luis Castejn13

Mr Trichets message was a familiar one: the decision waswarranted because of upside risks to price stability. Consumer-price inflation has risen to 2.7%, above the banks target of

keeping it below, but close to, 2%. The surge is mainly becauseof higher energy costs. Leave them out and prices rose by only1.8% in the year to May. But the ECB worries that the higherheadline inflation may become entrenched through secondround effects as workers demand higher wages and firmsbecome readier to raise prices. The purpose of the monetarytightening is to ensure that the current surge in prices does notgive rise to broad-based inflationary pressures over the mediumterm.

ECB wants to cool euro area economy through an increase ofinterest rates, which translates to consumer through Euribor,

and increasing the cost of financing mortgages and so on..


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Voracity of State: needs of financing increased near a

20%

Luis Castejn14

2011-07-14 european monetary union and financial crises

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