27 Oct 2011

Brussels 5am: Half a bazooka unleashed

At least I can say I was there, when weary eurozone leaders put pen to paper on what they claimed was their “Bazooka”. Unfortunately, we’ve all been here too many times not to be a little wary of some of the claims made for the plan.

On the upside, there were more numbers than we were expecting. As EU President Herman van Rompuy said on his way out of the building: “the deal was better than most people expected”.

Greek haircut

The high drama was mainly about the side deal with bankers on Greek debt. At midnight the bankers’ lobby the IIF released a statement saying nothing had been agreed. Charles Dallara was then invited into a side meeting with “Merkozy”, where the haircut, discount, write off in the value of Greek debt was eventually agreed “voluntarily” at 50 per cent.

This changes Greece’s debt dynamics. Greek debt will now be at about 120 per cent of GDP in 2020 rather than 153 per cent. A significant change, though hardly Greece out of the woods. Fifty per cent also suggests more ‘hair-loss’ than haircut. But it might not be the end of things.

It’s not just that, the deal will be subject to a kind of bond holders’ vote. It took all sorts of negotiating tricks to get 90 per cent of the bankers to accept a 21 per cent snip. There are many things that could go wrong with actual bankers rather than their negotiators.

An important detail here is that the supposedly “voluntary” nature of this means that all parties including ISDA can pretend that this is not a “credit event” – a key French demand. That means the Credit Default Swaps will not be triggered. Hurrah, you might think. But what on earth is the point of his market when the insurance doesn’t pay out on technicality and legalism surrounding coercion?

Bank recapitalisation

This part of the deal was part announced by the European Banking Authority – 106bn euro of fresh capital to be met by next June. If not from the markets, then from national governments or then the EU’s own bailout facility. Many banks will be handing out a cap to China or the Gulf nations in an attempt to copy Barclays in maintaining their self determination from part nationalisation. Many will fail, I predict, and be part nationalised. Britain appears to have hogged much of this capital by being first in the queue.

Again details will be ironed out by finance ministers probably next week.

‘1 trillion euro’ bazooka

This was announced with a flurry last night by President Sarkozy and the EU council and Commission President. The European Financial Stability Facility (EFSF) based in Luxembourg (again see my report from its offices) will be supersized, but not through the European Central Bank. Actually, and tellingly, the 1tn euro figure is not actually mentioned in the Eurogroup summit statement. The “leverage effect…could be four or five times,” said the communique. It depends on the precise methodology. Leaders agreed to explore two different methods. Firstly, the German-style first loss insurance scheme. This is not a free lunch, the greater the leverage the higher the likelihood of actual losses here. How far can this be pushed without crushing France’s AAA?

Second, a pot pourri of Special Purpose vehicles to be jointly invested in by the EFSF (itself a Special Purpose Vehicle) and sovereign wealth funds and, I presume, the IMF. There can be no coincidence that Sarko will call Hu Jintao today, and the head of the EFSF is flying to China tomorrow.

It looks like my recent report about whether France could be saved by Chinese Sovereign Wealth Funds was rather appropriate. Viewers may recall that the head of the China SWF, was rather conditional about his support for Europe, lambasting the work ethic on this continent.

All of which leaves the IMF. Germany tried to push this at the G20 finance minister’s meeting in Paris a fortnight ago. The US and Britain pushed back, basically arguing it was up to Germany and the eurozone to maximise its bailout, before diverting the resources of the IMF.

I saw Christine Lagarde at about 4.30am. She was rather tight lipped. The truth is that a 1tn euro bazooka is not enough to calm markets about Italy and Spain. There is a presumption of funding from the IMF and the Bric nations that still makes next week’s G20 summit a vital moment.

‘Emergency oxygen’ to Italy

One last point: towering above all of this, was the continuation of the ECB’s backdoor bailout to Italian and Spanish bonds. Many Germans think this is illegal, unconstitutional and dangerous. But it is the only thing that has prevented Italian yields spiralling out of control.

The German government may have protested, and Merkel may have changed the language agreed by officials in the communique. But make no mistake Germany gave a nod and a wink on this, and lo and behold, incoming ECB president Mario Draghi confirmed that the bond purchases would continue.

There will be a political backlash against this in Germany. But it means the emergency oxygen supply to Italy continues, even if the surgery has been postponed.

So to conclude, I was mildly impressed. But this could still unravel on the detail. And it needs the goodwill of the rest of the world.

As I heard from outgoing ECB President Jean-Claude Trichet upon leaving his last European Summit:  “there is no room for complacency. There is hard hard work ahead,” as he exited into the early morning, and stage left.