15 Oct 2011

Europe set for biggest bailout in world history

A day of riot and recapitalisation in this eurozone crisis. That’s the view from the G20 finance meeting in Paris.

Protests against banks, in a week that I believe will end with the biggest bailout in world history, of the single currency, and also of the Eurozone’s banks.

This paradox is abundantly clear from the words of Wolfgang Schauble, the German finance minister.

He said after the meeting that he understands “that people are angry and demonstrating all over the world. Politcians need stronger rules [for the banks].  But he also said that: “Banks need fresh capital and if it is not possible” it is going to be forced upon them.

And that is what we are heading towards in this momentous week for Europe, the euro and the world economy. New stress tests which Goldman Sachs believe will see 50 banks with insufficient capital given sovereign default.

Those banks will be obliged to raise extra capital, and that will come from Governments if necessary. So a proportion of that few dozen will end up at least partly nationalised.

At current eurozone bank share prices, that “part-nationalisation” could end up being a rather hefty chunk for some banks. Small wonder that French and German bankers feel the dead hand of the state on their shoulder. This is very much doing for the eurozone what happened in Britain in October 2008.

The likes of the Chancellor George Osborne and the US Treasury Secretary Tim Geithner were assuaged by the promise of some “decisive action” next Sunday in Brussels. Its why the eurozone finance ministers in Paris were given a little “forebearance” at this meeting.

George Osborne told me: “The  pressure is on the eurozone here to sort their problems out and were hopeful that in the next couple of weeks that will happen.”

He added: “first and foremost the eurozone needs to sort out their problem.. They need to Increase the resources of their bailout fund from eurozone members.  they need to deal with their banks. And they need to decide what to do with greece and then stick to their decision.”

So then there’s the question about whether Europe alone can save the day, or whether a supplementary “Bazooka” is required.

A global increase in the funding of the IMF, pushed for by France and some BRIC nations. My sense is that this will happen.

But right now other G20 nations did not want any lessening of the pressure on the eurozone.

“I think theres a Separate decision about IMF. Building up resources of IMF should not be a substitute for the eurozone building up their bailout funds,” Mr Osborne told me, though confirming that he was looking into whether more funding was required.

For Britain it is crucial that any extra funding for the IMF is not perceived as a backdoor euro bailout. Mexico for example has a standby facility.

With this padding of the eurozone banking system in place, it’s then possible to have a serious conversation about Greek default or reprofiling or whatever it is that they pretend it is. As has been well covered the 21 per cent haircut for the Greek bondholders could turn into 50 per cent.

The French finance minister Francois Baroin still thinks it won’t count as default. “We will refuse any situation that will lead to a credit event,” he said.

That means he thinks that European banks can be coaxed or forced into voluntarily accepting the hit.

The smoke signals from the Bankers’ lobby the IIF suggest not. That is one of the moving parts of the detail of a deal over the next 7 days.

So that’s why, despite some incremental optimism about an ultimate solution to this crisis, IMF chief Christine Lagarde still professed gloom.

“Even if the markets have improved over the last days,” she said in Paris, “it’s more likely that the [economic] situation has worsened over the last three weeks than improved” – pointing specifically to huge concerns from emerging economies.

Much still to play for. But the prize is in sight.

Watch Faisal’s full report from Paris here or follow him on Twitter @faisalislam