The Eurozone deal laid bare the fact that national sovereignty in Europe is a thing of the past. But if that was the price paid for a stronger Europe, a safe currency union and a stronger economy, maybe we could have a reasonable argument about the costs and benefits. But the countries on the periphery, like Italy, Spain, Portugal and Greece, who gave up the ability for their governments to make certain decisions in the interests of the people they represent, in favor of unelected bureaucrats led by the nose of the markets, don’t even get the exchange of greater economic opportunity. The truth is that the financial crisis, and the three years of sloth spent failing to respond to clear imbalances caused by the adoption of the euro, have put the continent on a course for recession, a long and grinding one to match the recession of just a couple years before:
Our economists believe the sovereign debt and banking crises are causing a renewed recession in the Euro Area. Beginning in 4Q 2012 [Sic], they forecast real GDP to contract for 6 consecutive quarters. It is expected to be an especially protracted recession. Not even in Japan, during its lost decades, did real GDP decline for 6 consecutive quarters. Our economists’ Euro Zone forecasts imply real GDP will be some way below the trend established during the first 10 years of Euro inception (Figure 3) and not get back to previous peak levels for many years to come.
That analysis comes from Citigroup, and it comes off a recession of about that size in 2008-09, from which the Eurozone did not recover with any catch-up growth. So the crisis, and more important, the austerity measures implemented as a result, will put Europe in an incredibly deep hole, out of which it will take the rest of the decade to make up, if they’re lucky.
And add to that the fact that the banking system is also a wreck. That’s really the proximate cause of this crisis, by the way, not sovereign debt but an inability for the banks in the region to absorb any losses. They made the bad bets, and now they need hundreds of billions in order to survive.
European Union banks must raise 114.7 billion euros ($152.8 billion) in fresh capital as part of measures introduced to respond to the euro area’s sovereign-debt crisis.
German banks need to raise an additional 13.1 billion euros, Italian banks 15.4 billion euros, and Spanish lenders 26.2 billion euros in core tier 1 capital, the European Banking Authority in London said yesterday. The capital shortfalls include 15.3 billion euros for Spain’s Banco Santander SA (SAN) and 7.97 billion euros for Italy’s UniCredit SpA. (UCG)
European leaders are demanding the region’s banks bolster capital to withstand writedowns after they agreed to take losses on Greek bonds. The EBA estimated two months ago that the region’s financial institutions needed 106 billion euros to increase their core Tier 1 capital to a target of 9 percent of risk-weighted assets by mid-2012, after marking their sovereign bonds to match market prices.
The capital requirements keep rising for the European banks. It wasn’t so long ago – just last year – that Eurobanks were told they needed just €3.5 billion in capital. Now we’re at a number 33 times that amount. And it’s completely unclear how the banks will raise this much capital:
And even with this overdue recognition that the Eurobanks need more equity, pray tell where are they gonna get it? Sovereign wealth funds have been cool on bank equity since they were burned in 2007 when they were asked to be the fillup of near last resort. Bank stock prices are sufficiently low that banks will be loath to issue shares even under duress (and will the investors even take up shares on the scale needed? When I was a kid, you could do tech IPOs only two or three years out of five, the market simply was not there otherwise. There may not be a price at which, say, Unicredit could sell €8 billion worth of shares in the next two or three months) [...]
The big banks have threatened to shrink their balance sheets to reach target equity levels, but that seems questionable in the current environment. Who exactly is gonna buy their riskier assets now (unloading riskier assets would have the biggest effect on reducing capital needs)? Even if there was some appetite among institutional investors for this trade, there isn’t enough in aggregate.
The one country which refused to submit to this loss of sovereignty, Britain, could see its ruling coalition crack apart over the decision. So what, in the end, did any of these countries gain? They did not solve the core problems of bank insolvency and sluggish growth – in fact these have been extended. They did not solve their debt crises, since they are tied to growth. They didn’t even coax the European Central Bank out of its shell to lend freely. They did nothing but sign themselves over to Germany, as playthings to keep the euro value sufficiently low so the Germans can sell their exports.
Once everybody figures this out, I predict the markets will begin their cycle anew. Give it a week or two.