Who Is Next In The Eurozone?

by Claus Vistesen

The Eurozone seems to be the place where the party never ends these days, as one skeleton after the other comes rattling out of the closet. Indeed, one has the impression that history is in the making right now; and the only thing we can hope is that it will be for the better.

In truth however, I felt a good measure of sympathy for Ireland today as I read the Bloomberg report about how the country is now essentially on its way to accepting a deal that will have aid delivered from the EU, the IMF and, most painfully, from Britain.

Irish rebels fought for independence during World War I, boasting they served “neither King nor Kaiser.” Ireland may now have to do exactly that to qualify for a bailout partly funded by both Britain and Germany.  Prime Minister Brian Cowen is edging toward accepting a rescue package that may threaten the country’s low-tax policies and put voters on the hook to repay loans the central bank says may be worth “tens of billions” of euros. For critics of Cowen’s Fianna Fail party, which governed Ireland through its decade-long boom, national pride is at stake.  Cowen has “squandered” independence for a “German bailout with a few shillings of sympathy from the British chancellor,” the Irish Times newspaper said yesterday. The government should be “ashamed that Fianna Fail should be the ones to surrender sovereignty,” said Michael Noonan, finance spokesman for Fine Gael, the largest opposition party.

However, Ireland largely made the mistakes itself  – of which the biggest no doubt was to guarantee its banking system and essentially gamble that a) the economy could swallow the liabilities of its broken banks (which with a deficit of 32% of GDP in 2010 it obviously can’t) and b) that help could be found elsewhere.

Iza’s report yesterday over at FT Alphaville about just how much European governments have promised during the past 2 years makes an extraordinarily important point and it is well worth reading in its entirety;

As all eyes focus on what should be done about the Irish banking crisis, perhaps it’s time for the European Union, IMF and other related parties to take a closer look at some of the factors that may have exacerbated the problem.  After all, it’s now becoming abundantly clear that the dishing out of an elaborate 100 per cent deposit guarantee back in September 2008 was largely nothing more than a massive bluff designed to steal attract deposit flows from neighbouring states to for the purpose of propping up Irish banks.  Furthermore, as we’ve mentioned already, the EFSF is already turning out to resemble something like Paulson’s bazooka in its own right too.  Which means  — with everything becoming a high-stakes game of ‘Call my bluff‘ — it could be time to restrict the ability of sovereigns  generally to randomly guarantee things they clearly can’t afford to guarantee in the first place. (If confidence in the Eurozone is to be restored properly that is.)  After all, let’s just look at the dynamics of the Irish deposit guarantee itself.

So, this is about a debt and deposit guarantee – which, of course, is one of those guarantees on which a government never really can make due in the case of the ultimate rout à l’End of Days. Yet, the point has general validity far beyond the issue of debt and deposit guarantees. Basically, Ireland promised to make due for its banks … and now that it appears that she can’t, it is up to the rest of the Eurozone to pay.

No doubt this view is shared in principle as well as sentiment by the prowling Proell from Austria who recently fired two stray missiles into the raging debate on how best to deal with the issue of solidarity in the Eurozone. Earlier in the week, he raised serious questions about whether Austria would make due on its promise to spit into the common funding scheme for Greece now that it was obvious that the country was missing its budget target yet again and most recently, he said to Bloomberg reporters that he was very interested in talking with Ireland about its famously low corporate tax rate in connection with the bailout.

You know, quid pro quo and all that.

Now, before we get into the blame game I should note that I agree with the Economist in their most recent take on the Eurozone mess in which they implicitly highlight that, while timing is always difficult in politics, there is still a continuum between good and bad and Merkel’s sudden urge to remind bondholders that they too might take a loss falls in the latter category.

At an EU summit at the end of October the German chancellor won agreement that any future euro-zone rescue scheme should include a mechanism for an orderly sovereign-debt default. The principle was absolutely right: unless default is a possibility, bond investors have no reason to distinguish between good and bad credits. But the idea of making bondholders lose money when sovereign credits turn sour was aired without any guidance about how and when it might apply. Astonishingly, the Germans failed to put together a detailed proposal for the summit.

I should make it clear that I fully back the idea of bondholders taking their share of the loss since, if this is not a real possibility, there is no way in which to secure an orderly default which is inevitably coming sooner rather than later to some of the most vulnerable Eurozone economies. This is especially true when going back to Izabella’s point above; the practical distinction between using bailout funds for governments and not for banks is a mirage exactly because promises have been made and proverbial contracts have been signed with the electorate  – and, one is tempted to note, the devil herself. As I have said before, you may not like it. And I agree with Izabella that the EU and IMF would be wise to monitor just what promises are made in the future.

And speaking of promises, if Ireland seems to be mellow enough to be put into the bailout fold, there is another small country left in the waiting room in the form of Portugal. Again I think that the Economist has the right answer:

If only both sides gave up posturing, they would agree that the European rescue funds should be used to stabilise Ireland’s banks, insisting only on certain budget targets in return. Such a deal should satisfy Ireland’s euro-zone partners, which want an end to the uncertainty, and the European Central Bank (ECB), on which Ireland’s banks have become overly reliant for funding. It would also be wise to offer a similar deal to Portugal. Its banks are dependent on ECB support, and it too is in the bond markets’ sights.

I am not exactly aware of the actual difference between just pouring money into the banks or giving it to the sovereign, which then uses the funds to make due on a foolhardy promise to secure the entire domestic banking sector’s liabilities. But really, the distinction should be next to none I think. And if you think that all this about Portugal is just me trying to kick up a bad mood, Bloomberg pulled one better on me with this elegant report about how investors are turning their attention away from Ireland and over to … well, you guessed it I think:

The markets indicate that country is Portugal with 10-year bond yields of 6.88 percent, compared with 8.26 percent in Ireland and 11.62 percent in Greece, which received rescue funds in May from the European Union and International Monetary Fund. Portuguese Finance Minister Fernando Teixeira dos Santos said Nov. 15 that while “there is a risk of contagion,” that doesn’t mean the country will seek financial aid.  “Portugal isn’t in the situation that it is now because of Ireland,” said Steven Mansell, director of interest-rate strategy at Citigroup Global Markets Ltd. in London. “If Ireland reaches an agreement to tap the European Financial Stability Facility or some other mechanism to support its banking sector, I don’t think that will alleviate the pressure on Portugal.”

So, it seems as if the next stop might very well be the far western rim of the Eurozone and its beautiful Algarve coastline.