A European commission has come up with a new proposal to shield taxpayers from the banking crisis via haircuts in senior bank bonds. The proposal only covers bank debt, not sovereign government debt, and supposedly it applies to some mythical time in the future, not now.

However, sovereign yields have hit new record highs in Greece, and are close to record highs in Portugal, Spain, and Ireland, I fail to see how the crisis can possibly be contained, and I fail to see why it takes a commission to decide that bank bondholders need a haircut. It should be perfectly obvious there is no other possible solution. The big fear is haircuts spread to sovereign debt.

It’s time to put the fears away and concentrate on the reality. Sovereign debt haircuts are coming. With that backdrop, please consider the Telegraph article EU plans for bondholder haircuts unsettles debt markets by Ambrose Evans-Pritchard.

Michel Barnier, the single market commissioner, will publish a “consultation paper” outlining ways to shield taxpayers from banking crises. It is the first stage of what will almost certainly become a binding law.

“We are pursuing the idea of a debt write-down or conversion to help stabilise a failing bank and reduce the need for public funds,” said an EU source.

Fears that this could evolve into a crusade against bondholders set off fresh jitters on EMU debt markets yesterday, pushing yields on 10-year Greek bonds to a record 12.59pc.

Portugal managed to sell €500m (£425m) of debt at a crucial auction but had to pay 3.67pc on six-month bills, double the rate in September. “It is an unsustainable dynamic,” said Lena Komileva from Tullett Prebon.

Credit Default Swaps on Irish bonds jumped 16 points to 620 after Switzerland’s central bank said it would no longer accept Irish debt as collateral.

The Commission paper refers only to bank debt, unlike Germany’s proposals for sovereign “haircuts”. Mr Barnier hopes to restrict burden-sharing to future debt only, fearing that a catch-all approach risks setting off a fresh EMU crisis.

Commission’s Vote Is Irrelevant

The idea that haircuts can be limited only to bank bonds, and not even the existing ones, but mythical bonds at some mythical time in the future is preposterous. You know it, I know it, and the bond market knows it. Why else would Greek bonds yields be at fresh all time record levels?

I find it amusing that a commission has gotten together to vote on such matters. It is not up to the commission to decide. The market has already cast its vote. Unless Germany decides to pony up more cash, the market wins.

The Telegraph continues …

However, Brussels may lose control once the process is unleashed. A populist backlash is gathering strength in most EU states, and regional elections in Germany may sharpen demands for retribution against cossetted monied elites.

“It is no coincidence that Chancellor Angela Merkel lost her majority in the Bundesrat two days after the Greek bail-out,” said Andrew Roberts, credit chief at RBS. “Peripheral debt woes have not gone away. This will go on until Germany chooses whether to dilute its own credit rating by funding the system, or decides ‘enough is enough’.”

I seldom agree completely with Pritchard but I think he has this one stone cold. It is not even clear the German courts will find bailouts constitutional. A crucial vote is coming up next month.

German Bonds Lose Luster

Bloomberg reports German Bunds Lose Allure for Europe Fund Managers.

Germany has pledged more cash than any nation to bail out debt-ridden states such as Ireland and the country’s fixed- income market is vulnerable, assuming Deutsche Bank AG analysts are right and the European Central Bank starts to increase interest rates as soon as June.

“When you look at the whole setup, Germany seems to be the ultimate guarantor of the whole region,” said Robin Marshall, director of fixed-income at London-based Smith & Williamson Investment Management, which oversees $20 billion for customers. “You have to ask yourself why bund yields are so substantially below other countries. They aren’t fully reflecting the risk.”

“Bund yields may continue to fall in an early part of next year,” said Rainer Guntermann, an analyst at Commerzbank AG in Frankfurt. “People are likely to continue to seek safety that German bonds represent as credit deterioration drags on.”

Andre de Silva, the Hong Kong-based head of Asia-Pacific interest-rate research at HSBC Holdings Plc, isn’t so sure. German bonds may lose their status as “the golden benchmark,” he said.

“The more we go the bailout route and the more Germany, as a large contributor, has to stump up, the less German bonds can be claimed as a risk-free asset,” de Silva said. “We are not saying Germany will lose its top credit rating, but the allure of its bonds is tarnished.”

While Germany has one of the lowest deficits in the 17- member euro region, it has earmarked 119.4 billion euros to the European Financial Stability Facility for countries in need of bailouts. The contribution, the biggest by any nation, amounts to 27 percent of the fund.

“It’s a difficult situation for Germany,” said Kind of Frankfurt Trust. “Credit dilution, perceived or real, will push yields higher. It’s no longer the case of the majority bailing out the minority in the euro region, but the other way round.”

China to Buy More Spanish Debt

Please consider Top Chinese official promises to buy Spanish debt

Chinese Vice Premier Li Keqiang vowed to buy more of Spain’s government debt on a three-day visit to the country, delivering a significant vote of confidence in the battered economy.

The visit came as Spain battled market concerns that it may need an Irish or Greek-style international rescue because of a debt refinancing crunch this year.

“We believe Spain, with its government and people working together, will surely overcome current economic and fiscal difficulties,” Li reportedly told Spanish Finance Minister Elena Salgado after his arrival on Tuesday.

The above deal was announced on Monday, ahead of the trip. The Euro rallied for a day then sold off as did Spanish bank stocks.

Spanish Bank Stocks on Funding Costs

Bloomberg reports Spanish Bank Stocks Drop on Funding Cost

Spanish banking stocks fell, led by Banco Bilbao Vizcaya Argentaria SA, on concern raising funds will become more difficult in European nations with large budget deficits.

Raising money is getting more costly for banks in indebted euro nations as investors demand a higher return for taking the risk of holding their debt. Ireland in November followed Greece by seeking a bailout, while investors remain concerned about the growing debt burden in Portugal, Spain and Italy.

“The signals from the bond market are not very encouraging,” said Daragh Quinn, a banking analyst at Nomura International in Madrid. “It’s clear the next couple of months are going to be very tough for the Spanish banks.”

Only 41% of Germans Want to Stay on the Euro

Deutsche Welle reports Survey finds half of Germans want Deutschmark back

German daily Bild commissioned a survey by Cologne’s YouGov-Institute that found that 49 percent of Germans want the deutschmark back. Only 41 percent of those surveyed don’t.

Some 77 percent of the 1,068 people questioned by YouGov said they personally had not profited from the adoption of the euro.

Would they adopt the euro today?

If the country were currently not part of the eurozone, only 30 percent of those asked would today vote to adopt the euro and 60 percent would vote against such a move.

Will Chancellor Angela Merkel Lose Control?

With those kind of numbers, to suggest Angela Merkel needs to walk a fine line is an understatement. The German courts have to be aware of those numbers as well.

Literally everything that the German anti-Euro crowd said would happen years ago has now happened, and they are not too happy about it.

Major Constitutional Court Cases Coming Up

Euro Maverick Edin Mujagic discusses the court battles in Stop blaming the Germans

December 21, 2010

Karlsruhe, a pretty little town on the German-French border, is the home of German Constitutional Court. It can destroy the euro even if the troubles on the euro area periphery are to be resolved in a structural way (which is not very likely).

At the beginning of next year the judges of that Court will look into quite a few cases brought forward vis-à-vis the German participation in saving Greece and Ireland.

The German government wants to proceed with those operations and is ready to save other euro countries as well. But Berlin wants the emergency euro-shield, which is now only temporarily (until June 2013), replaced by something more permanent. In order to do that, European Treaties will have to be rewritten, a time-consuming and very uncertain endeavor as there is a risk that not all EU member states will ratify it.

Time is of the essence

Nevertheless, for Berlin time is of the essence too. The new mechanism should be in place before the judges in Karlsruhe sit down to look at at least five complaints that have been brought before the Constitutional Court. The plaintiffs claim that saving those two countries from defaulting constitutes a breach of both the European Treaties and the German constitution and want the Court to order immediate stop of German participation in the rescue.

The German Constitutional Court has some experience with these matters. In 1993 and 1998 it looked at two similar cases. Plaintiffs tried to prevent the euro to be introduced at all (in 1993) and wanted it delayed (in 1998). Back then the Constitutional Court threw the charges out. But that should not be taken as guarantee than it will do so again this time.

In its verdict from 1993 the Court acknowledged that economic stability must be the basis of German participation in a monetary union at all times. In case the judges decide that economic stability of the monetary union can no longer be guaranteed, that could be interpreted as the cessation of the basis for German participation in the euro zone, making the German participation in it illegal.


Whatever the ruling however, the damage to the euro and the European monetary union will be significant. It is highly likely that in the future many more cases will be filed at the German Constitutional Court. That will cause great uncertainty about the future of the euro. At the end of the day, any currency is as strong as it has support of the people actually using it every day. The euro was never really loved by many Europeans and that is increasingly unlikely to even become the case. Uncertainty about the survival of the euro in the long run is the last thing a currency that wants to be an alternative to the dollar needs.

P.S. Just to add one last-minute development. In a recent interview, French Economy Minister Christine Lagarde said that euro zone policymakers deliberately chose to “violate” the bloc’s rules in rescuing Greece and Ireland. The Greek and Irish bailouts and the creation of a temporary European rescue fund had been “major transgressions” of the treaty, according to Lagarde. “We violated all the rules because we wanted to close ranks and really rescue the euro zone,” Lagarde was quoted as saying.

Nice, this is just what German politicians needed, weeks from the moment that Karlsruhe-judges convene to look at the complaints.

Thoughts on the Outcome

My friend “HB” who lives in Europe offers these thoughts on the lawsuits:

The most likely outcome is a compromise. The court will probably not stop the bailouts, but may well proscribe the government’s freedom of action with regards to what it may contract for and what it may not contract for from here on out.

I expect some admonishment that the government must not overstep constitutional bounds.

The EU is not allowed to become a ‘transfer union’. Karlsruhe has already given Gauweiler a partial victory in his suit against the Lisbon treaty by opining that no parts of the treaty may conflict with the constitutions of the federal states (‘Länder’) or that of the Republic.

We don’t want no transfer union

Rounding out the discussion at long last, please consider The Economist article We don’t want no transfer union

Although the IMF and European Union are acting as co-rescuers of Ireland and Greece, Germans see themselves as rescuers-in-chief—and they resent it. “Will we finally have to pay for all of Europe?” asked Bild, a tabloid.

German behaviour is guided by more than petty politics. In adopting the euro the Germans thought they were joining a condominium, in which every member would keep order on their own property, and not a messy commune. Now the crisis threatens that understanding. The Greek bail-out and the €750 billion ($980 billion) war chest created in May to defend the euro look to many Germans like a violation of the “no-bail-out clause” in the Maastricht treaty that created the euro. The government insists it is not, because the aid is voluntary and temporary. The constitutional court is evaluating this claim. The proposed successor, a permanent facility plus procedures to impose losses on creditors of insolvent countries, needs a treaty revision to pass constitutional muster.

Assuming the “compromise” call comes in, another crisis is all but assured when Greece and Ireland default. That might take a while. In the meantime, eyes are on Spain and Portugal.

Italy is the unseen elephant, simmering in the background. Should a huge crisis erupt before the court makes a ruling, all bets could be off on what the court decides.

Mike “Mish” Shedlock
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