SOC GEN: Europe's Leaders Have 6 Policy Options To Stem The Crisis

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Many proposals have been floated by European technocrats in order to stem the tide of capital outflows that is underway in the eurozone. Bets against the euro are at record levels and fears of bank runs in the periphery persist.

With fears of a Greek exit from the eurozone on the horizon, many feel that the ECB and the EU need to be ready to step up to the plate soon with some major policy measures that will be viewed as adequate by markets in addressing the political and economic issues the eurozone faces.

Société Générale’s chief European economist James Nixon chalks up the eurozone’s ongoing woes to “two fundamental problems: one political and one economic.”

He lays out the options on the table for policy makers in Europe going forward, giving colour on some of the more popular ideas being discussed at the moment.

#1: European Banking Resolution Fund

#2: European Deposit Insurance Scheme

A European deposit insurance scheme would hope to assure depositors that their euros were safe in peripheral countries with troubled banks. Depositors are bailing on the Greek banking system as uncertainty about the future of the country's membership in the euro rises. Concerns abound that if the situation is not handled properly in Greece, bank runs could spread to larger peripheral countries like Spain and Italy as well.

On this proposal, SocGen writes:

The main problem with deposit insurance is that the risk depositors are mainly trying to avoid is the risk of euro break-up. In such a scenario, it is not obvious how deposit insurance would apply or whether it would insure depositors against the associated exchange rate risk. Either way, both banking resolution or deposit insurance would imply the genesis of cross-border fiscal liabilities and as such continue to be opposed by Germany.

Source: Société Générale

#3: Further Longer Term Refinancing Operations (LTRO)

The LTROs back in November and February were widely hailed as effective in reducing the tail risk of a bank failure by offering banks the short-term funding that they need to finance themselves. The markets for primary debt issuance have been largely shut to financial institutions for some time as the opacity of their exposure to Greece and other troubled sovereigns makes private lenders unwilling to lend to the banks. With the LTROs, the ECB stepped in to fill this gap.

The LTROs have, of course, had a number of longer term negative effects as well. Many banks used LTRO cash from the ECB to purchase sovereign bonds of their respective countries, effectively increasing their exposure to risky sovereigns. Furthermore, the LTROs have had the perverse effect of making the financial institutions even more dependent on the ECB for future funding. Some have dubbed this the 'LTRO stigma.'

On LTROs, Nixon writes (emphasis added):

Indeed, with €3⁄4trillion being deposited in the ECB's deposit facility one could argue that the banks are awash with cash. We therefore find it hard to believe the ECB has much appetite for another LTRO in the immediate future. It is well aware that the LTRO makes heavy use of the banks' collateral pool and implicitly subordinates existing bond holders. This would seem to restrict the use of the LTRO to a tool used to address the potential re-emergence of systemic tensions.

Source: Société Générale

#4: Reactivating The Securities Markets Program

#5: The Compact For Growth

Project bonds were all the rage last week, as was a proposal to increase funding for the European Investment Bank (EIB) as part of a larger growth compact to promote policies that would facilitate economic growth in the eurozone. Supranational entities like the EIB finance infrastructure projects via new debt raises but maintain strict, highly collateralized lending standards in order to minimize the risk of default in its loan portfolio.

Ultimately, many agree that the problems in Greece stem largely from a lack of competitiveness and growth vis-a-vis the rest of the Euro area, especially economic powerhouses like Germany. The emphasis on growth is seen as vital to getting to the root of the fundamental economic problems that afflict the eurozone.

SocGen sees obvious problems with these proposals as well (emphasis added):

Much needed as these new initiatives are, the main weakness is still one of scale. The proposal to increase the capital of the EIB by €10bn is expected to facilitate a €15bn increase per year in spending on infrastructural projects over the next three years. Hence the compact for growth looks likely to inject as much into the whole EU27 European economy as the Spanish consolidation measures threaten to withdraw in a single year. At the same time, far-reaching structural reform continues to be necessary to boost competitiveness but is unlikely to boost growth in the short run.

Source: Société Générale

#6: Granting The ESM A Banking licence

The European Stability Mechanism (ESM) will be the EU's flagship bailout fund once it goes into effect as early as this summer. Its purpose is to assist sovereign states who are shut out of public markets and unable to finance themselves--like the situation Greece faces right now.

One of the major existential problems of the ESM is that it needs to raise debt in order to partially finance its operations. This can be problematic if investors don't see the ESM as sustainable in the long term and are thus unwilling to lend. If the ESM were granted a banking licence, it would be able to borrow money from the ECB in the same way that other eurozone banks are able to do.

Nixon offers some grim comments on the likely road Europe faces ahead as it deleverages over time, conceding that official measures, like granting the ESM a banking licence, may have to be taken (emphasis added):

Extensive official financing may ultimately be required. This can either come directly from the ECB, through a further expansion of its balance sheet, or indirectly by granting the ESM a banking licence or through the introduction of Eurobonds. At the moment, all such initiatives are rejected as being akin to monetary financing of the deficit. Our central scenario continues to be that the euro endures, albeit with continued financial stress that may extend over many years. Ultimately, however, the euro's success or failure will rest on the answer to the political question of what conditions would have to be met for Germany to accept cross-border fiscal liabilities.

Source: Société Générale

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