That’s the tongue in cheek question posed
by Wolfgang Münchau yesterday, in a column that raises some pointed
questions about the European debt crisis.
Is the eurozone insolvent? In the past few weeks, we have all focused on the solvency of Greece, Spain and Portugal. But we never seriously questioned the solvency of those who actually guarantee all those southern European debts.
Münchau argues that the question cannot be answered by reference to the debt-to-gross domestic product ratios of eurozone countries, because those numbers exclude contingent debt and the interconnectedness of financial flows, and the biggest category of contingent debt are the guarantees the eurozone has been making over the last few years.
European Union governments have effectively guaranteed the liabilities of their entire banking sectors. They have guaranteed all bank deposits up to a certain limit. The eurozone member states guaranteed Greek debt for the next three years, and then extended the scheme to the rest of the eurozone. And those guarantees will probably have to be doubled again. . . .
International Monetary Fund estimates suggest that the eurozone is well behind the US in terms of writing off bad assets.
How far behind and how bad are the assets? Hard to know, but the chart at right by Alphaville’s Tracy Alloway shows the net foreign asset position
of banks in Germany, France, Italy and Spain. It indicates that German banks’ accumulation of foreign assets
has been growing substantially, likely due to developments in Landesbanken —
Germany’s public sector banks — in the first half of the last decade. According to Alloway, in 2001, the
European Commission abolished
state guarantees for the Landesbanks, but the institutions were granted a
four-year adjustment period.
To counter, or prepare for the loss of the state guarantees, the Landesbanks went on something of a shopping spree — snapping up high-yield assets, the effect of which you can see in the chart.
Finally, Gillian Tett reports on the release last week by Barclays Capital of “the latest part of a long-running survey of Japanese bond investors, which tries to determine attitudes towards dollar and euro bonds.” The report revealed that two-thirds of Japanese investors fear that the latest €750bn aid package will have “not much” impact on the eurozone’s problems – up from just one-third of investors that expressed skepticism two weeks ago (when the package emerged).
Investors also expressed fear about euro bonds:
at the start of the year almost 80 per cent of the survey’s respondents preferred euro debt to dollar debt, but that proportion is now below 30 per cent.
Japanese investors are not just worried about debt issued by the peripheral economies of Portugal, Italy, Ireland and Greece; they seem pretty uneasy about German bonds too.
Münchau concludes that
As long as the eurozone governments can generate sufficient tax revenues, all is well. But if that were to stop, the eurozone’s debt edifice might break down like a house of cards. Even a 150 per cent debt-to-GDP ratio would be feasible if the eurozone had an intelligent growth strategy. But it never did, and it still does not.
Meanwhile, Germany has proposed extending its short selling ban to all German stocks and certain euro-currency derivatives. (A hearing on the draft is scheduled for May 27 in Berlin.) And the European Central Bank announced that it purchased another €10bn of government bonds in the last week, bringing its total purchases to about €26.5bn in the past two weeks.
Like I said, that should fix everything.
I guess some folks, God help them, actually believe that bans on short selling, the suspension of mark-to-market accounting, and shifting the risk of European periphery debt from individual European financial institutions to the central bank will fix Europe’s ills.
I’ll be back later with more about the ECB bond purchases, particularly the potential impact on a debt restructuring.
Image source: The
Economist
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