Thursday, August 4, 2011

Does the EU have the capacity to solve its debt crisis? Update

Since the EU announced its latest strategy for addressing its debt crisis through the European Financial Stability Fund, the capital markets have been questioning does the EU have the capacity to solve its debt crisis.

The debt crisis has two components.  The first component is the banks.  The question here is which banks are solvent and which are not.  The second component is the sovereign.  The question here is can the host country pay its debts.

The two components become intertwined when the sovereign is no longer a potential source of capital for the banks it hosts, but is instead a contributor to their insolvency.

The EFSF is acquiring the authority that it needs to address this interconnection.  Once approved by the EU members, the EFSF will be able to a) help insolvent sovereigns and b) lend money through the sovereign to recapitalized insolvent banks.

The question the market is asking is how much money will the EFSF require to fulfill this mission.

Regular readers know that the only way to answer this question is by providing the market participants with the current asset and liability-level data from the banks.  With this data market participants can determine who is solvent and who is insolvent.  This also allows the market participants to figure out how much capital is required to restore solvency to the EU financial system.

More importantly, once this analysis has been done and the financial system recapitalized, the debt crisis is ended.

As predicted under the FDR Framework, without disclosure, the EU will not be able to put the debt crisis behind it.


A Telegraph article on EC president Barroso in which he describes the problems the EU faces and highlights the fact that the only way to "convince" the markets is to provide the data and let the markets confirm the facts for themselves.
The head of the European Commission urged the 27 European Union leaders to begin a "rapid reassessment" of the bloc's rescue mechanisms. 
He said governments should rapidly review "all elements" including the size of the €440bn European Financial Stability Fund (EFSF) and the €500bn European Stability Mechanism to "address the current contagion" in the eurozone. 
"It is clear that we are no longer managing a crisis just in the euro-area periphery," he said, adding that markets remain to be convinced that the EU is taking the appropriate steps to resolve the crisis. 
He said the July 21 agreements - which has yet to be ratified the individual member states - giving the EFSF the possibility of "precautionary use, recapitalisation of banks and intervention in secondary bond markets, are not having their intended effect on the markets." 
Investors have pushed yields on benchmark Italian and Spanish government bond to 14-year highs, reflecting "a growing scepticism among investors about the systemic capacity of the euro area to respond to the evolving crisis", he said. 
Mr Barroso attributed market pressure on euro states to slow global growth and US debt problems as well as to "first and foremost, the undisciplined communication and the complexity and incompleteness of the July 21 package".
Greece, Portugal and the Irish Republic - known as the eurozone's periphery countries - have needed bailouts. The fear is that the current rescue fund is not big enough to cover bailouts of Italy and Spain.

In short, by not providing the data, market participants could not use the facts to convince themselves that the EFSF would work and had adequate access to capital

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