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Tuesday November 23, 2010 - 18:40:41 GMT
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Irish Contagion Given, Liquidity no Fix for Solvency (FXA)

Irish Contagion Given, Liquidity no Fix for Solvency


Granted the political crisis unfolding in Ireland has complicated the financial crisis there. However, I can’t help but think that EU-IMF bailout for Ireland is in the bag, even if it means a new government in January and yet Irish bond spreads to Bunds are blowing out, Portugal bond spreads over Bunds are near post euro launch wides and Spain’s are the widest since the January 1999 euro launch.  I find it highly unlikely that the Dail will vote down the Cowen budget on December 7 or sooner if Fine Gael, the main opposition party, gets its way.  Contagion fires are burning despite a deal is in the bag. 


Just maybe markets are already trading Portugal…ya think?  The Greek bailout and period of relative calm the EU-IMF bought with the May rescue package this time around is no longer a reason to go home and buy euros and risk assets.  There is no peace.  Markets have moved right to Portugal and Spain.  At this rate we should have a Portuguese bailout in a matter of weeks.  How far can Spain be behind Portugal?  The argument that Ireland is not Greece, Portugal is not Ireland and Spain is not Portugal is logical.  However it does not apply when bond yields are soaring (rising debt service to point where countries can’t go to markets to raise funds because it is too costly or worse bond auctions fail) and GDP is weak.  Spending cuts and tax hikes simply can’t keep up with the hole digging machine that is rising borrowing costs (run on sovereign debt), run on bank deposits and weak growth.  Ireland’s austerity measures in 2009 were the flagship for fiscal prudence in the aftermath of the Great Recession and financial crisis…if only Greece were more like Ireland.  But when Ireland’s government guaranteed all bank deposits and all bank debt holders, the admirable austerity measures of 2009 by 2010 looked vastly under gunned.   With more demands on Irish resources (assuming EU-IMF program instituted) ahead to pay for bailout costs (another EUR80-90bln), the choices Ireland has to pay this new creditor are limited…Sophie’s Choice comes to mind.   


There are two ways to get Ireland back to meeting its financing needs…stronger growth (the top deficit and debt reduction channel) and increased confidence (lower bond yields or borrowing costs).  How is Ireland going to grow more when the EU is calling for higher tax rates (corporate tax rates) and government spending is contracting at a significant pace all the while it is stuck with a strong currency whose rate is set on fundamentals mainly in place in Germany and France?  On the confidence side, the markets seem now to view a bailout as reducing confidence not rebuilding it.  It is the liquidity not solvency “fix” for all to see and now not even convincing enough to kick the crisis down the road. 


And what is the leadership’s (Merkel and Sarkozy) answer on confidence?  A permanent resolution body that spreads the cost of future fiscal and banking malfeasance among more parties, not just governments…like bondholder haircuts and equity holder liquidation.  This is like a permissive parent setting up a new set of consequences when counting to 10 to correct bad behavior…no child would think of bad behavior if he or she knew it meant a loss of cell phone or Nintendo DS.  And it sounds an awful lot like the Frank-Dodd bill…well Dodd-Frank is a 5 count versus a 10 count for Euro Zone sovereign.


What should be clear to all observers is that too-big-to-fail is still the starting point to any systemically significant entity, whether it is a bank(s) or a sovereign state, officials in G20 will go to any length to prevent debt restructuring and or liquidation.  These kinds of resolutions we are told apply to future hypotheticals not to present practicals.    Never again Lehman seems to be the clarion call of all senior policy makers and yet the more bailouts we see the less impact they seem to have on market confidence.  I am not arguing for cold turkey on this Thanksgiving week, just something other than taxpayer sponsored methadone treatments.  It is time for a fresh rethink and perhaps plowing the kinds of funds officials are channeling directly and indirectly into sick banks and sick governments might be better spent as actual job-creating fiscal stimulus. 


Debt crises get solved by a combination of restructuring, and devaluations which usually lead to large current account surpluses (more exports).  However, current policy is ruling out debt restructuring and devaluations in favor of liquidity buying time….is it any wonder why G7 officials are so exorcized over the need to get emerging market economies to shift from an export-led to more import-driven economic model…that is some economic fantasy.  It seems far more practical for the Euro Zone to split…a two tiered system…remember ERM 1 and ERM 2?    


David Gilmore




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