A Reminder Of The Tragic Errors That Let Europe Get To This Point, And A Look At What's Next

Pie, fail

Photo: Flickr/Seth Lemmons

While two potentially promising policy responses to the eurozone crisis circulate, EU leaders are still failing to do what the market needs them to do in order to restore confidence and stem contagion.That’s the gist of what BTIG’s Chief Global Strategist Dan Greenhaus says in his new strategy report on the eurozone, criticising policymakers for failing to make bank recapitalizations their top priority.

According to Greenhaus, policymakers are likely to take one of two approaches:

– Either the European Central Bank or a Special Purpose Vehicle would be used to buy peripheral sovereigns’ assets, and the EFSF would cover the first 20% of losses on those purchases. The ECB will probably oppose this measure, because it “would effectively place them even further in the realm of fiscal policy as purchases on this scale would almost certainly be framed as monetization of peripheral debt,” but it probably wouldn’t require an amendment to the current agreement.

– Something along the lines of that plan CNBC reported on earlier this week: “The EFSF would purchase bonds, sell them to an SPV (or perhaps the EIB) which could then use the securities as collateral for even larger loans which would then allow the SPV to go ahead and purchase additional bonds.” This would requre the EFSF to gain bank status, and would likely entail an alteration of the EFSF agreement being passed right now.

Both of these plans still entail manifold problems. According to Greenhaus, the size of the EFSF is just not sufficient to deal with the magnitude of problems at hand, and any kind of leveraging plan will necessarily require the support of the ECB.

While the ECB might be averse to further involvement, the main obstacle to getting a solution passed remains EU leaders themselves. Even the Americans did better!:

– Policymakers have done nothing to convince markets that the banking sector is properly capitalised, keeping markets aflutter. In the U.S., on the other hand, “Whether it was TARP, TALF, PDCF, CPFF or AMLF, policymakers did anything and everything to say to markets that systemically important financial institutions would be here tomorrow, the day after and the day after that.”

– “By refusing to acknowledge the deteriorating situation, policy makers allowed the crisis to spread. Instead of ring fencing Greece, Portugal and Ireland, we now worry about the stability of the Italian and Spanish bond markets.”

– euroTARP involving substantial bank recapitalization will be a component of any euro endgame, and that’s probably going to cost $400-670 billion at this point.

– A Greek credit writedown/haircut/default will probably happen by the summer or fall of next year.

Greenhaus had a few more closing predictions about the ECB:

– The ECB will cut rates by 25 or 50 bps on October 6.

– A 6- or 12-month liquidity operation could be launched at the ECB’s next meeting.

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