Europe’s Eleventh Hour Fix
After keeping the world on edge and pushing up against the brink of a European recession, details of the European fix are trickling out. It is sure to be a headline filled Thursday, Friday, and weekend. I won’t focus on the specific details because many of them still aren’t known and the ones that have been announced are likely to evolve regardless. Europe has recognized the enormity of its financial crisis. The European financial system couldn’t fund itself, sovereign interest rates started to spiral out of control, and the Euro experienced a rapid and unhealthy correction. It seems absurd to highlight that Europe recognized that this was collectively a very big problem but at times, even right up until the end, European leaders at any moment could seem either cavalier or steadfastly ideological.
Given this backdrop, here is what we know:
- Greek debt will get a 50% haircut through a voluntary restructuring. This is on the low-end of some speculation of a 60-70% write down. Writing down a lesser amount helps the holders of Greek debt – the European financial system, but makes it more difficult for Greece to service the debt that remains.
- The disappointment over not writing down enough Greek debt is probably the lesser evil. Keeping the financial system as solvent as possible during the process of raising additional capital will probably instill more confidence. Greek interest rates will likely need to be continually subsidized and additional support of some form or another may be required just to service the half of the debt that remains but at a minimum, cutting half the debt seems like a pretty effective kicking of the can down the road.
- The European banking sector will get recapitalized. There has been a broad agreement to require banks to raise their core tier one capital ratios to 9% by the end of June. The capital will be raised first in the private markets, second by government ownership, and third and as a last resort by the EFSF. There is considerable uncertainty over how the capital will be specifically defined so this is another detail to be worked out. The statement from the EU heads calls out that dividend payments and bonuses could be delayed until capital ratios are up to par – which should help make sure this doesn’t get done at too European of a pace.
- Italy, which has the highest debt/GDP ratio in the Eurozone after Greece, has agreed to additional reforms. Silvio Berlusconi has sent a publicized letter to his EU counterparts that states; this isn’t 100% our fault, that the crisis relates to the nature of the euro construct, but that we will implement additional reforms across the board nonetheless.
- The EFSF will be leveraged through a structured investment vehicle (SIV) that will potentially have investors of all types around the world. China, Sovereign Wealth Funds, The Middle East, BRIC central banks, IMF, and private investment pools are all invited. It was reported that there will be a conference call between Merkel, Sarkozy, and Hu Jintao where Europe asks China to invest.
The implications of the above plan have been good so far. It is important at moments like these to not get too wrapped up in the details. The final (albeit 11thhour) European response is filled with the spirit of trying to put a financial crisis to rest. Europe collectively has always had the solvency to address the problem at any time but the obstacles were political and legal in nature. Now that there has been a work-around, regardless of whether it means creating more leverage upon leverage or begging developing nations for capital – the fix is in, and at first blush it looks to be inspiring confidence. The euro has rallied, European sovereign interest rates have traded down, EURIBOR rates have traded down, and global equity markets have rallied. Europe’s financial crisis has created stress, anxiety, heightened risks to the global economy, and volatility with respect to investment returns. Hopefully a redux of the 2008-2009 global financial crisis has been avoided and the global economy will be on surer footing as we move towards 2012. This would be a good outcome for most all of us.
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