If anyone is surprised that things in Europe will get massively surreal before this is all over, we suggest finding another thread. In the meantime, for the latest example of the utter chaos and "make it up as we go along" we go to the ECB which has just, in very polite terms, warned Belgium that its bailout-cum-nationalization plan may not be quite feasible.From Bloomberg: "The European Central Bank advised Belgium not to backstop Dexia SA’s interbank deposits and to avoid providing guarantees on debt maturing within three months because it risks interfering with the central bank’s monetary policy." Reading between the lines here, it means that the ECB is effectively telling national governments to not try and become their own central banks under the ECB's umbrella, which would likely result in not only in various sovereign downgrades (that is guaranteed) but in loss of conviction in the European Central Bank, something which the insolvent European continent and the insolvent hedge fund in its core, aka Jean-Claude Trichet Capital et Cie. which holdings hundreds of billions of Greek bonds at par, can certainly not avoid. It gets better: "The ECB also said the planned debt guarantees for Dexia may last as long as 20 years, which is inconsistent with European Union guidelines for national support measures to be temporary in nature, according to a statement published on the Frankfurt-based central bank’s website and dated Oct. 13. Belgium sought the ECB’s opinion on draft legislation that would grant state guarantees on Dexia loans." Oops: the ECB may have just scuttled the currently envisioned Dexia bailout plan. Oh well, just like with the Greek 50% bond haircut, so here to it is now back to the drawing board. More from Bloomberg: For those who may have already forgotten last weekend's key event, now largley forgotten and priced in, "Dexia obtained a pledge from the governments of France, Belgium and Luxembourg last week to backstop as much as 90 billion euros ($125 billion) of interbank and bond funding with maturities of as much as 10 years until 2021. The French-Belgian municipal lender, which is being broken up after concern over its European sovereign debt holdings caused short-term funding to evaporate, sought state guarantees to finance long-term assets including 95 billion euros of bonds with an average maturity of almost 13 years at the end of June." And the ECB just said that this whole plan may be against the Eurozon'e charter. Good work guys. One can be 100% certain the rating agencies are following this with great interest. By Craig Pirrong Oct 14, 2011, 2:21 PM Author's Website This exchange between Wolfgang Munchau and Iain Begg provides an interesting counterpoint to my weekend analysis of the Euro sov debt crisis. My post first discusses the theory behind “bazookas” as a means of preventing or deterring runs against sovereign debt (and a similar analysis holds with respect to banks too). I then point out that the credibility of the bazooka/backstop is of crucial importance. Begg’s reply to Munchau sets out the bazooka theory. Munchau’s argument is that the EFSF bazooka is not credible. It is not credible primarily because is based on the premise that countries like Italy will fund it, but countries like Italy are causing the problem too. That is, the EFSF is beset with wrong way risk. The Europeans are in effect aiming the bazooka at their own heads. That isn’t the most credible deterrent against runs. Indeed, the structure is highly unstable. If, say, Italy can’t perform on its obligations because it is the one being bailed out, that increases the burden on France, which could put France into jeopardy. I generally agree with Manchau. Biggs has it right when it comes to how a backstop can prevent liquidity crises, but that backstop has to be credible: I agree with Manchau that the EFSF mechanism is not credible, given its wrong way risk problem. Taking things to the next level, as I did in my post: what is the likelihood of negotiating a credible mechanism? Here I am again skeptical, for political economy reasons, as expressed in the post. On this issue, I was intrigued to see two posts touching on this issue in general. Tyler Cowen dismisses IS-LM in part because it ignores altogether political economy issues, which he identifies as a first-order macroeconomic factor. I agree completely. Indeed, it is kind of bizarre to discuss sovereign debt crises, banking crises in which there was a strong regulatory dynamic, and fiscal crises (all components of Financial Crisis I and II) without discussing political economy. Peter Boettke follows up on Tyler’s post, and emphasizes the centrality of political economy to macro problems, and in particular macro policies. I agree that political economy is the linchpin, and not just in macro policy but all of the regulatory issues that are currently of pressing importance. The reason that I am quite concerned about Europe is precisely because political economy issues there make it very difficult to devise a mechanism for allocating sovereign debt losses (and potential banking losses connected thereto). It is always hard to devise such sharing mechanisms, particularly after a chunk of the losses has already been realized. It is even harder given the institutional structure of the EU, which by design makes it difficult (and arguably illegal) to shift losses on one state’s debt to other member states. You will hear many plans of bazookas in coming weeks. All will differ in details. What you should focus on is whether these mechanisms are in fact credible, and politically feasible. The things we’ve seen so far, not so much–as Manchau emphasizes. Incredible political creativity–and perhaps, duplicity–will be required to create a credible mechanism. The economic destination is pretty well understood, but the political road to get there is unmapped, and indeed, is likely yet to be built.ECB Tells Belgium Not To Backstop Dexia Interbank Deposits,
Says Bailout Plan May Be Against The Euro Charter
The Bazooka Is Pointed the Wrong Way
Guarantees on interbank deposits “could entail substantial distortion in the various national segments of the euro-area money market by potentially increasing short-term debt issuance activity across member states,” the ECB said in the statement.
“It could also affect the transmission of monetary policy decisions.”
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