Mervyn King: “The crisis in the euro area is one of solvency and not liquidity.”

'Systemic' crisis looms for Europe's banks

 December 2, 2011 - 7:59AM

Bank of England Governor Mervyn King urged banks to enhance efforts to bolster their defences against the euro area’s debt turmoil, which now looks like a “systemic crisis”.

“An erosion of confidence, lower asset prices and tighter credit conditions are further damaging the prospects for economic activity and will affect the ability of companies, households and governments to repay their debts,” threatening banks’ balance sheets, King told reporters in London.

“This spiral is characteristic of a systemic crisis.”

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The US Federal Reserve cut the cost of dollar funding for European financial institutions yesterday in a coordinated move with other central banks. That measure came two days after King said there are “early signs” of a credit crunch in the euro region, where leaders face increasing pressure to resolve intensifying turmoil.

“Sovereign and banking risks emanating from the euro area have intensified and remain the most significant and immediate threat to UK financial stability,” the central bank said in its Financial Stability Report. It said that if banks’ earnings aren’t enough to build capital, they should limit payments of bonuses and dividends and “give serious consideration” to raising external capital.

Credit squeeze

The central bank’s Monetary Policy Committee restarted bond purchases in October to aid the recovery and cut its growth forecasts this month. Officials warned today that the strains in interbank markets could threaten economic growth.

“Against a backdrop of slowing global growth prospects, concerns about the sustainability of government debt positions of smaller economies have broadened to larger euro-area economies,” the central bank said. “The current funding pressures facing banks could lead to a renewed tightening in credit conditions for real economy borrowers.”

The central bank also published the recommendations of its Financial Policy Committee, which met on November 23. The panel said the Financial Services Authority should encourage banks to disclose leverage ratios to investors by the start of 2013, two years earlier than Basel rules originally required.

The Bank of England said in the FSR that UK banks have 140 billion pounds ($215 billion) of term funding due to mature in 2012, concentrated in the first half of the year. It said short-term money market funding conditions have “been fragile over the past few months, with banks finding it harder to roll over all of their maturing funding and tenors shortening.”

Contingency plans

UK authorities are working on “a wide range of contingency plans” to deal with a further intensification of the crisis, including a possible breakup of the euro, King said. The central bank is working with the Financial Services Authority and the government on plans, he said.

After a series of stop-gap accords failed to protect Italy and Spain from surging bond yields, Europe is under growing pressure from US leaders and international financial markets. European leaders will meet next week to discuss the next steps in resolving the debt crisis.

The cost for European banks to borrow in dollars fell for a second day after the coordinated central bank action. The three-month cross-currency basis swap, the rate banks pay to convert euro payments into dollars, was 118 basis points below the euro interbank offered rate in London. The gap had widened to 162.5 below Euribor yesterday, the most in three years, before the Fed move.

Underlying problems

King said the central bank measure was “designed to deal with clear evidence that there were problems in banks around the world finding difficulty in accessing dollar funding in particular.” Still, he added it can only provide “temporary relief” and is not a “solution to the underlying problems.”

He also said that said resolving the wider problems of global financial imbalances are beyond the UK authorities to deal with on their own and “only the governments directly involved can find a way out of this crisis,” referring to the euro-area debt turmoil.

“The crisis in the euro area is one of solvency and not liquidity,” he said. “Here in the UK we must try and find a way to bolster the resilience” of the financial system.

While Britain’s banks have 15 billion pounds of exposure to sovereign debt in the most vulnerable euro-area economies, they have “significant” exposures to the private sectors of Ireland, Spain and Italy, the Bank of England said. This amounts to about 160 billion pounds, or 80 per cent of their core Tier 1 capital.

“UK banks have made significant progress in improving their capital and funding resilience,” the bank said. “But progress has been set back recently and they have been affected by strains in bank funding markets.”

Bloomberg

Read more: http://www.smh.com.au/business/world-business/systemic-crisis-looms-for-europes-banks-20111202-1o9s3.html#ixzz1fKaV6Jr2

A common Euro currency defies common sense

Martin Feldstein

December 2, 2011

The politicians who introduced the euro ignored warnings that it would create serious problems.

EUROPE is now struggling with the inevitable adverse consequences of imposing a single currency on a very heterogeneous collection of countries. But the budget crisis in Greece and the risk of insolvency in Italy and Spain are just part of the problem caused by the single currency.

The fragility of the major European banks, high unemployment rates, and the large intra-European trade imbalance (Germany's $US200 billion current-account surplus versus the combined $US300 billion current-account deficit in the rest of the euro zone) also reflect the use of the euro.

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European politicians who insisted on introducing the euro in 1999 ignored the warnings of economists who predicted that a single currency for all of Europe would create serious problems.

The euro's advocates were focused on the goal of European political integration, and saw the single currency as part of the process of creating a sense of political community in Europe.

They rallied popular support with the slogan "One Market, One Money", arguing that the free-trade area created by the European Union would succeed only with a single currency.

Neither history nor economic logic supported that view. Indeed, EU trade functions well, despite the fact that only 17 of the union's 27 members use the euro.

But the key argument made by European officials and other defenders of the euro has been that, because a single currency works well in the US, it should also work well in Europe.

After all, both are large, continental, and diverse economies. But that argument overlooks three important differences between the US and Europe.

First, the US is effectively a single labour market, with workers moving from areas of high and rising unemployment to places where jobs are more plentiful. In Europe, national labour markets are effectively separated by barriers of language, culture, religion, union membership, and social-insurance systems.

To be sure, some workers in Europe do migrate. In the absence of the high degree of mobility seen in the US, however, overall unemployment can be lowered only if high-unemployment countries can ease monetary policy, an option precluded by the single currency.

A second important difference is that the US has a centralised fiscal system. Individuals and businesses pay the majority of their taxes to the federal government in Washington, rather than to their state (or local) authorities.

When a US state's economic activity slows relative to the rest of the country, the taxes that its individuals and businesses pay to the federal government decline, and the funds that it receives from the federal government (for unemployment benefits and other transfer programs) increase.

Roughly speaking, each dollar of gross domestic product decline in a state such as Massachusetts or Ohio triggers changes in taxes and transfers that offset about 40¢ of that drop, providing a substantial fiscal stimulus.

There is no comparable offset in Europe, where taxes are almost exclusively paid to, and transfers received from, national governments.

The EU's Maastricht Treaty specifically reserves this tax-and-transfer authority to the member states, a reflection of Europeans' unwillingness to transfer funds to other countries' people in the way that Americans are willing to do among people in different states.

The third important difference is that all US states are required by their constitutions to balance their annual operating budgets. While "rainy day" funds that accumulate in boom years are used to deal with temporary revenue shortfalls, the states' "general obligation" borrowing is limited to capital projects such as roads and schools.

Even a state like California, seen by many as a poster child for fiscal profligacy, now has an annual budget deficit of just 1 per cent of its GDP and a general obligation debt of just 4 per cent of GDP.

These limits on state-level budget deficits are a logical implication of the fact that US states cannot create money to fill fiscal gaps.

These constitutional rules prevent the kind of deficit and debt problems that have beset the euro zone, where capital markets ignored individual countries' lack of monetary independence.

None of these features of the US economy would develop in Europe even if the euro zone evolved into a more explicitly political union.

Although the form of political union advocated by Germany and others remains vague, it would not involve centralised revenue collection, as in the US, because that would place a greater burden on German taxpayers to finance government programs in other countries. Nor would political union enhance labour mobility within the euro zone, overcome the problems caused by imposing a common monetary policy on countries with different cyclical conditions, or improve the trade performance of countries that cannot devalue their exchange rates to regain competitiveness.

The most likely effect of strengthening political union in the euro zone would be to give Germany the power to control the other members' budgets and prescribe changes in their taxes and spending.

This formal transfer of sovereignty would only increase the tensions and conflicts that already exist between Germany and other EU countries.

Martin Feldstein, professor of economics at Harvard University, was chairman of Ronald Reagan's council of economic advisers and is a former president of the National Bureau for Economic Research.

Read more: http://www.smh.com.au/business/a-common-currency-defies-common-sense-20111201-1o940.html#ixzz1fKXkPP7N

'Ten days to rescue euro' as leaders call for IMF funds

Europe faces a crucial ten days to save the eurozone, a leading EU monetary chief warned after finance ministers from the currency bloc admitted they may need IMF help to increase the firepower of their bailout fund.

Economic and Monetary Affairs Commissioner Olli Rehn said the EU had little time to conclude its crisis response. 

By Martin Strydom

10:45AM GMT 30 Nov 2011

"We are now entering the critical period of 10 days to complete and conclude the crisis response of the European Union," Economic and Monetary Affairs Commissioner Olli Rehn said on Wednesday as EU finance ministers met in Brussels.

His comments came as Gerard Lyons, chief economist at Standard Chartered, said: "The euro cannot survive in its present format."

"Throughout the year I have stressed that the world economy could suffer a double-dip if it was hit by one of three factors: an external shock, a policy mistake or a loss of confidence. Unfortunately, in recent months, the euro area has been hit by all three. And that is why the euro area will slip back into recession in 2012," he said in his Economic Outlook for November.

He warned that the scale of the downturn will be determined by eurozone leaders' policy actions and the extent to which confidence is hit.

Confidence in Europe remained low in financial markets on Wednesday on disappointed at attempts to increase the firepower of the eurzone bailout fund.

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Italian and Spanish borrowing costs continued to rise and stock markets fell after Wolfgang Schauble, Germany's finance minister, said Europe's "big bazooka" rescue fund is not ready and won't stem the region's debt crisis.

Eurozone finance ministers, who were meeting ahead of the Ecofin summit today, acknowledged the €440bn (£376bn) fund would not win support to leverage it up to €1 trillion. Its capacity would be between €500bn and €700bn instead – a total that is unlikely to be big enough to rescue Spain and Italy.

"The situation in Europe and the world has significantly worsened over the past few weeks. Market stress has intensified," said Christian Noyer, France's central bank governor and a governing council member of the European Central Bank.

On Wednesday, Swedish finance minister Anders Borg renewed pressure on the European Central Bank to help halt the debt crisis.

"We need to keep all options on the table, to my mind price stability is secured in Europe - therefore there is some room also for the central bank to maneouvre on this issue," Mr Borg said as the 27 EU ministers gathered to pick up the thread of overnight eurozone ministerial talks.

He also said IMF contributors had to raise their input.

Belgium's Didier Reynders said finding a solution that would deliver a big enough pot of money to deal with debts that easily dwarf existing bailouts for Greece, Ireland and Portugal would need "the (European) central bank as well as the IMF".

The call for a bigger role for the ECB will lead to a clash with Germany which opposes such a move and last week got France and Italy to agree to stop pressuring the central bank to help.

Christine Lagarde, the head of the IMF, warned in September that its $384bn (£248bn) war chest designed as an emergency bail-out fund is inadequate to deliver the scale of the support required by troubled states.

Members of the IMF have agreed to increase the fund's resources but a senior G20 official in Asia told Reuters on Wednesday that no progress had been made so far.

The United States has insisted that the European Union has enough resources to stem the crisis without outside help.

http://www.telegraph.co.uk/finance/financialcrisis/8925250/Ten-days-to-rescue-euro-as-leaders-call-for-IMF-funds.html

Financial Crisis: German push for Greek default risks EMU-wide 'snowball'

Germany is pushing behind the scenes for a "hard" default in Greece with losses of up to 60pc for banks and pension funds, risking a chain-reaction across southern Europe unless credible defences are established first.

German Chancellor Angela Merkel and Greek Prime Minister George Papandreou. Officials in Berlin told The Telegraph it is 'more likely than not' that investors will suffer fresh losses on holdings of Greek debt Photo: AFP

By Ambrose Evans-Pritchard

9:13PM BST 10 Oct 2011

456 Comments

Officials in Berlin told The Telegraph it is "more likely than not" that investors will suffer fresh losses on holdings of Greek debt, beyond the 21pc haircut agreed in July.

The exact level will depend on findings by the EU-IMF "Troika" in Athens.

"A lot has happened since July. Greece has fallen back on its commitments, so we have to assume that the 21pc cut is no longer enough," said one source.

Finance minister Wolfgang Schäuble told the Frankfurter Allgemeine that the original haircuts were "probably" too low, saying banks must have "sufficient capital" to cover greater losses if need be. Estimates near 60pc have been circulating in Berlin.

The shift in German policy has ominous echoes of last year when Chancellor Angela Merkel first called for bondholder haircuts, setting off investor flight from Ireland and a fresh spasm in the EU debt crisis.

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"This could set off a snowball effect," said Andrew Roberts, credit chief at RBS. "The markets will instantly switch attention to Portugal, where two-year yields are already 17pc".

Although Greece's 10-year bonds are trading at a 60pc discount on the open market, European banks do not have to write down losses so long as there is no formal default and the debt is held in their long-term loan book. The danger arises if banks are forced to "crystallize" the damage before raising their capital buffers.

Marchel Alexandrovich from Jefferies Fixed Income said Germany risks opening a "Pandora's Box" by unpicking the Greek deal.

"It would be a complete disaster, a signal that sovereign debt is not safe. Investors would pull their deposits out of Portugal, Ireland, Spain and Italy and set off bank runs across Europe," he said. "The French are against doing this and so is the European Central Bank. They know banks need more time to adjust. We don't think Europe will pull the trigger."

Mrs Merkel and French president Nicolas Sarkozy vowed over the weekend to do "all that is necessary to guarantee bank recapitalisation", promising a package for Greece and the eurozone by the end of the month. The pledge was vague.

"No details of the plans were released, presumably because they haven't actually got any yet. That in itself is astonishing," said Gary Jenkins from Evolution Securities. "Nothing has really changed and we still expect that the most likely outcome will be a comprehensive package – that circles the wagons around the sovereigns and the banks – that will only be agreed at one minute to midnight when the alternative is that the market is about to implode on the Monday morning."

France and Germany have yet to agree on how to beef up the banks, or on the scale of the threat.

Antonio Borges, Europe chief for the International Monetary Fund, said lenders may need up to €200bn to cope with losses.

France wants banks to be able to tap the EU bail-out fund (EFSF) directly if they cannot raise enough capital on the open market. This would avoid any further strain on the French state, already at risk of losing its AAA rating.

Mr Schäuble said the EFSF should be the last resort when all else fails – "Ultima Ratio" – and deployed only under the strictest conditions. He said the fund should not buy the debt of states in difficulty (presumably Italy and Spain) until they implement tough reforms under "tight control", signalling that Germany will not endorse blanket purchases of EMU debt to cap yields.

He ruled out any attempt to leverage the EFSF beyond €440bn by letting it act as a bank: "That would be to monetise European state debt. That is not acceptable."

The apparent German veto on any expansion of the EFSF leaves it unclear how Europe's debt crisis can be contained if the region tips into a double-dip recession, which would play havoc with debt dynamics. City analysts say the fund needs €2 trillion to restore confidence.

"We think Europe is going to struggle to escape market pessimism until we see the emergence of a lender-of-last resort, whether a much larger commitment from the ECB to buy bonds [ideally QE] or a significantly revamped EFSF," said Graham Secker from Morgan Stanley.

Whether the EFSF can safely be increased is unclear. Yield spreads between German Bunds and 10-year EFSF debt have widened from 66 to 112 basis points since early July. If yields creep much higher, the fund itself may become a problem.

Critics say Germany is making a policy blunder by treating the crisis as a Greek morality tale, losing sight of EMU's deeper structural woes. Portugal is as vulnerable as Greece, with higher levels of combined private and public debt and an equally large trade deficit. Spain is still in the early phase of its housing bust. Italy has lost 40pc in unit labour competitiveness against Germany since 1995.

Pulling the plug on Greece risks bringing a much bigger crisis to a head all too quickly.

http://www.telegraph.co.uk/finance/financialcrisis/8819195/German-push-for-Greek-default-risks-EMU-wide-snowball.html

The Four Big Threats to Your Wealth in 2011 (MoneyWeek Magazine)

UK Housing threat
UK Stock market threat
Drop the Euro before it collapses
The "bond bubble" is about to burst


The fact is we're in unchartered territory ... and it's a very dangerous and unstable situation.

Does a 40% rise in the FTSE and a 9% rebound in property prices over the last 18 months seem right to you?

The way we see it, these aren't healthy markets at all ... they're not even recovering markets ...
...these are grossly inflated markets, pumped up by desperate government intervention.

Will the UK economyh sink into deflation if the Government follows through its pledge to rein in our national debt? ...

... Or, with the Bank of England's furious attempts to keep the ball rolling, is it inflation we have to fear?


So ... what should you do?
Survival Action #1 Buy defensives and "bear market protectors"

Defensive stocks: These kinds of companies don't need economic growth to make money, because people have to spend on their products out of necessity. In short, they're specifically suited to keep your portfolio ticking over in times of upheaval ... and GROW when the market truly recovers.


Survival Action #2 Get the right dividend players into your portfolio now

But since the bust up of 2008, investors have rediscovered the appeal of dividend cheques. This is for three reasons ...

1. Dividends outperform bond yields. According to Bloomberg, by the third quarter of 2010 more U.S. stocks were paying dividends that exceed bond yields than any time in the last 15 years.
2. Dividends can't be fudged - they have to be paid with real money.
3. Dividend-payers are excellent stocks to own in times of unprecedented uncertainty.
Dividends contribute to share price stability. If the share price of a dividend-paying firm falls, it is likely to fall less sharply than a pure growth stock. That's because as the price falls, the yield tends to pick up, encouraging investors to buy back in.


Survival Action #3 Ride gold all the way to $2,230 .. or even more!

... you're talking an eye-popping gold spike to $23,450 per ounce. And during times of confusion, gold often performs better than most other assets. Consider this ... adjusted for inflation, the 1980 gold peak of $850 gives you a price of $2,230 still on the horizon today.

Pimco says 'untenable' policies will lead to eurozone break-up

Pimco says 'untenable' policies will lead to eurozone break-up
Pimco, the world's largest bond fund, has called on Greece, Ireland and Portugal to step outside the eurozone temporarily and restructure their debts unless the currency bloc agrees to a radical change of course.

Pimco said current policies are untenable in the absence of fiscal union and will lead to a break-up of the euro 

By Ambrose Evans-Pritchard 7:00PM GMT 20 Dec 2010

330 Comments

Andrew Bosomworth, head of Pimco's portfolio management in Europe, said current policies are untenable in the absence of fiscal union and will lead to a break-up of the euro.

"Greece, Ireland and Portugal cannot get back on their feet without either their own currency or large transfer payments," he told German newspaper Die Welt.

He said these countries could rejoin EMU "after an appropriate debt restructuring", adding that devaluation would let them export their way back to health.

Mr Bosomworth said EU leaders were too quick to congratulate themselves on saving the euro last week with a deal for a permanent bail-out fund from 2013.

"The euro crisis is not over by a long shot. Market tensions will continue into 2011. The mechanism comes far too late," he said.

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The bond fund argues that the EU strategy of forcing heavily indebted countries to undergo draconian fiscal austerity without offsetting stimulus is unworkable.

The austerity policies are stifling the growth needed to stabilise debt levels.

"Can countries inside a fixed exchange-rate system like the euro grow and tighten budget policy at the same time? I don't think so. It didn't work in Argentina," Mr Bosomworth said.

Pimco also gave warning that the bond vigilantes have lost faith in the policy and are trying to liquidate their holdings of peripheral EMU faster than the European Central Bank (ECB) can buy the debt, causing a relentless rise in yields, and a vicious circle.

Despite this, the ECB said on Monday that it had cut purchases of government debt last week, settling €603m (£509m), down from €2.68bn a week earlier. The withering comments from the world's top investor in EMU sovereign debt is a blow for Portugal and Spain. Both nations are hoping bond spreads will start to narrow before they face a funding crunch in the first quarter of next year.

Jacques Cailloux, chief Europe economist at RBS, agreed that last week's European summit had failed to grasp the nettle.

"None of the policy responses put in place in Europe since the start of the crisis provides a credible backstop to prevent further contagion," Mr Cailloux said.

"We remain most concerned about an escalation of the sovereign debt crisis hitting larger economies in the euro area. Markets continue to underestimate the potential disruption via financial transmission channels that such an event could trigger."

Meanwhile, Spain must cut harder and deeper to rein in its finances, the OECD has warned, calling for an overhaul of its labour laws and employment practices. Madrid is already in the midst of harsh austerity measures, but the influential Paris-based think-tank said more must be done. The Spanish economy should be able to shrink its budget deficit from 11pc of GDP last year to the 6pc target next year, the OECD believes.

http://www.telegraph.co.uk/finance/financetopics/financialcrisis/8215358/Pimco-says-untenable-policies-will-lead-to-eurozone-break-up.html