Once again we are headed for another non-productive summit of EU and eurozone leaders that will do nothing to improve confidence in financial markets.
Prospects for a convincing agreement to resolve the crisis in the eurozone once and look forlorn, despite media reports overnight of some sort of deal.
Markets were cautious for most of the session overnight, but Wall Street jumped in late trading when rumours spread that China would play a role in the financing of the deal.
Those reports were unconfirmed, but that didn’t worry American investors who once again bought hot air and silver linings and ignored the reality of the talks in Brussels.
Disagreement remains between Germany, France, Italy and other EU and eurozone members, and inside Italy and Germany on just what can and should be done to get an agreement.
The tone of media leaks and reports is based on the lowering expectations of a breakthrough by EU and eurozone officials briefing journalists.
Was it only a week or 10 days ago that Angela Merkel of Germany and France’s Nicholas Sarkozy promised that a "comprehensive solution" to the two years of debt crisis (that erupted over Greece and has now enveloped all the eurozone and the rest of Europe) would be found by the end of the month.
That was after the G20 finance ministers told the eurozone leaders they had six days to sort out an agreement: well it’s now 10 days and still counting.
Earlier reports reckon the European banks will need a minimum of 110 billion euros of new capital, but harder headed analysis claims it should be 180 to 200 billion to be sure.
That would enable a Greek default to be met and cuts in the value of sovereign debt from Spain, Italy and Belgium (and even France).
But the banks are playing tough and Germany and Spain want widened rules about capital to allow their broken provincial banks )Landesbanks in Germany) to raise as little capital as possible.
Bloomberg said a statement issued after a meeting said:
"European Union leaders have set a deadline of June 30, 2012, for banks to have core capital reserves of 9 percent after writing down their holdings of sovereign debt.
"The reserves must be of the “highest quality,” the leaders said in a statement after a summit today.
"Lenders are expected first to tap private sources to make up any capital shortfall and “should be subject to constraints regarding the distribution of dividends and bonus payments until the target has been attained.”
"The statement doesn’t give an estimate of total capital EU banks must raise to comply with the rule."
Who will fund this and how it will be financed have always been the 440 billion euro questions.
There’s the 440 billion euro bailout fund, known as the European Financial Stability Facility, which is now down to 280 billion with the existing bailouts of Greece, Portugal and Ireland.
Then there’s the ‘haircut’ (losses) holders of Greece’s 360 billion or so euros of debt will have to wear in any deal.
Reports say Germany wants to see Greek debt cut by a third, to 120% of GDP by 2020m from 186% estimated in 2013. That would see banks and other holders of Greek debt cop a 50% cut in the value of their bonds.
But will that cut be in the face value (around 360 billion euros), or net present value, which is much lower? Cutting the face value will have no impact because Greek bonds have dropped sharply.
Much of this debt is now held by banks, insurance companies and other investors. (Or is with the European Central Bank as collateral for funding).
Banks in Cyprus also hold debt. Haircuts of 60% have been mentioned, with some talk of it being 50%, which would be inadequate and will mean Greece has to come back for a third bailout, according to a report done for the IMF, European Central Bank and EU last week.
Two big French banks, Credit Agricole and Societie Generale, own two Greek banks and would need extra capital to withstand the losses.
France and its President don’t want to be made to have to put in a lot of fresh capital into the country’s banks and into the expanded bailout mechanism because it would undoubtedly see France’s credit rating cut from the present AAA.
France has a presidential election next May- June and a credit rating downgrade would be highly damaging to President Sarkozy’s already weak chances of re-election.
EU leaders will consider two methods for scaling up the EFSF, one by using it to offer guarantees to purchasers of new euro zone debt, and the other using part of its capacity to set up a special purpose investment vehicle that would attract money from sovereign wealth funds and other investors to buy debt. They could also agree to combine both options.
That will involve a lot of financial engineering, derivatives and the creation of special investment vehicles (SPIVs) that were common in the lead up to the GFC.
That will in turn increase risk and mean that a recession could very well scuttle the whole lot, and the rest of the global economy for good measure.
Standard & Poor’s has already warned that a recession would see France’s AAA rating cut by one or two levels. If that happens the Stability Fund loses its financial strength, or Germany and the remaining four AAA rated countries (all tiddlers) would have to put up more money.
And in reality that means Germany, hence the reluctance of Mrs Merkel and her government in the current negotiations.
Reuters carried some interesting quotes overni
