Wait And See Mode On Europe... Possibly For 6 Weeks

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Includes: FXE
by: Cullen Roche

News out of Europe this weekend is all over the place. If anything, this all goes to show that European leaders are having trouble coordinating their efforts. Just yesterday, there were rumors of a Euro TARP plan that would focus its efforts on enlarging the size of the EFSF in order to provide bank recapitalization and stability to the periphery countries. Then today there are comments out of Christian Noyer, head of the Bank of France, saying there is no secret plan to recaptalize banks:

Asked to comment on reports about a plan to recapitalise French banks, Noyer said: “There is no plan, and we don’t need one”.

So, it’s difficult to make any substantive conclusion from all the rumors that are flying. But based on what we’ve heard, we can provide some broad thoughts:

  • The Euro TARP rumors and the G20 comment from last week both stated that the plan had to be announced in its entirety (if there really is a plan). This means we have to wait a full 6 weeks until November 4th for the announcement. The way this crisis is developing, I am not so sure we have 6 weeks, but that’s better than rumors from last week about a July 2012 resolution….
  • Let’s be frank about a Euro TARP as is rumored – it’s a bank bailout. This is essentially more of the same – the core saves itself from implosion while imposing austerity and pain on the periphery. In a move eerily as misguided as the USA bank bailouts, a Euro TARP would use a leveraged EFSF to recapitalize European banks. We have to remember though that the key to the bailout in the USA was that it was combined with a massive fiscal effort. The crisis in the USA was perceived as a banking crisis, but it was a household crisis. So, in order to sustain the recovery in the banking sector the USA required a household fix. The fiscal package helped provide this while TARP helped stabilize the banks (but it did not save them). And as we’ve seen the household sector weaken as the ARRA effect has waned, we’ve seen signs of stress in the American banking system again. If Europe wants to create a sustainable fix to their own crisis they MUST provide a fiscal package. Instead, their efforts are going to enforce austerity and bailout banks. As we should expect from the brain trust of Tim Geithner – this plan is just a rehashed American bank bailout – it stops bankers from going bankrupt, but it does not fix the economic problem. More importantly, it does not fix the true root of the problem which is the lack of a balancing mechanism within the currency union.
  • Enlarging the EFSF is not the answer. The problem in Europe is not that the EFSF is not large enough or that the ECB is not supplying enough liquidity. The problem in Europe is that there is no balancing mechanism in the currency union. This is clear from the case of Greece where the size of the EFSF has not been a primary concern. In addition, ECB funding has not been the panacea that many assumed it would be. The central bank has stepped in on multiple occasions to stem the bleeding. But the underlying economic trends have persisted. The fix in Europe is not throwing more money at the EFSF or increased bond purchases by the ECB. The fix is going to come in some form of fiscal package that serves to improve the real underlying economic trends.
  • Rumors of allowing a Greek default are both troubling and confusing at this juncture. The way they’re arranging this “firebreak” is to avoid contagion to Spain and Italy. But that means Portugal and Greece are thrown to the wolves. Now, again, George Osborne has tried to squash these rumors of a managed Greek default in the last 24 hours, but it’s hard to imagine that Greece won’t require some sort of write-down given the magnitude of their economic problems. The problem with these rumors is that the current plan is calling for “tens of billions” for recapitalization. That’s woefully shy of what would be necessary. French banks alone have $57B in Greek debt so any plan involving a Greek write-down is going to likely require something far larger than “tens of billions” and possibly into the trillions. Is their political will for this? Again, it’s impossible to tell.
The bottom line – a Euro TARP that is not focused on essentially recapitalizing the sovereigns misses the point here. It could certainly be bullish in the near-term, but the rumors out this weekend are more proof that European leaders are misunderstanding the cause of their own crisis. A true fix to the Euro crisis is going to require Europe writing a check to the periphery nations and arranging a balancing mechanism through some form of a central Treasury and/or E-bonds. And no, kicking the can via enlarged EFSF, further ECB funding or bank recapitalization does nothing to fix the crux of the issue. If they do decide to implement a recapitalization plan, it will have to be combined with a fiscal package in the same way the American plan was implemented.
In short, this looks like more can kicking (a good sized kick for what it’s worth), but not a true fix. And if implemented (these are ALL rumors right now) incorrectly (for instance, with a Greek default and undersized recapitalization), this could quickly devolve into something closely resembling Lehman Bros. The good news is that European leaders are putting something together and we can expect a plan in the coming 6 weeks. The bad news is that they still don’t seem to understand the root cause of the issue. Further, none of this helps the fact that the European economy is likely to remain weak (as austerity is imposed) and the rest of the global economy (specifically, the BRICs) continue to deteriorate.