Europe chooses closer integration to fix euro crisis

LOS CABOS, Mexico: Europe's major powers moved towards greater financial integration on Tuesday, in a G20 summit declaration aimed at boosting confidence in the bloc's plans to fix its spiraling debt crisis.

"We support the intention to consider concrete steps towards a more integrated financial architecture, encompassing banking supervision, resolution and recapitalization, and deposit insurance," the joint G20 statement said.

Backed by key EU members including Germany, France and Britain, the communique followed two days of talks in the Mexican beach resort of Los Cabos in which European leaders came under strong pressure to take firm and quick action.

Beyond the moat-ringed conference center in the hills above San Jose del Cabo, bond markets jacked up rates on Spanish and Italian debt amid self-fulfilling fears that the debt crisis that sank Greece was spreading once again.

The G20 statement said eurozone members will "take all necessary measures" to stabilize the single currency bloc, including moves to "break the feedback loop" that has weak governments piling on more and more debt to bail out their banks.

In addition, should economic conditions worsen, the countries with more financial flexibility "stand ready to coordinate and implement discretionary fiscal actions to support domestic demand," it said.

The United States, the International Monetary Fund and the European Central Bank have all urged greater banking integration in Europe, hoping to instill more confidence as banks falter in some of the worst-hit nations.

US President Barack Obama, worried Europe was not moving resolutely enough to contend with the debt crisis, huddled in a special meeting with European leaders, fearful that economic turmoil could torpedo his hopes of re-election in November.

Obama met Tuesday with Germany's Angela Merkel, France's Francois Hollande, Spain's Mariano Rajoy, Italy's Mario Monti and Britain's David Cameron as well as European Union chiefs Jose Manuel Barroso and Herman van Rompuy.

Shortly after the Obama-EU meeting, the wording of the final G20 communique was confirmed but there were few clues given about the path forward -- perhaps because Europe's leaders gather in Brussels at the end of the month.

The new element was the move towards a banking union. Europe-wide guarantees on deposits and a central authority to close banks that go bust are seen as a way to promote the flow of cash through the system and give more confidence to lend.

Supporters believe union would break a cycle in which banks are obliged to rely on their own troubled countries' governments and central banks, creating a vicious cycle of mounting debt that brings down all of the institutions.

Germany, the largest economy in Europe, has resisted debt burden-sharing out of concern that its own comparatively healthy system will be obliged to help out weaker banks in countries that have lacked discipline.

Merkel remains the driving force behind the eurozone's determination to privilege austere deficit busting over stimulus spending, although US officials say her position is softening.

"In Los Cabos the seeds of a pan-European recovery plan were planted," said IMF managing director Christine Lagarde.

"European leaders committed to take all measures necessary to safeguard the integrity and stability of the euro area and break the feedback loop between sovereigns and banks," Lagarde said.

"Their intention to consider concrete steps towards a more integrated financial architecture is important."

The G20 summit followed hot on the heels of Sunday's pivotal polls in debt-ridden Greece, where parties committed to the terms of their EU and IMF-led bailout held off a strong challenge by a leftist anti-austerity party.

The IMF has indicated that it could now be open to a renegotiation of Greece's 130-billion-euro ($165 billion) bailout program.

But hopes that the Greek vote had helped the single currency bloc turn a corner in the crisis were dashed as attention moved onto the fragile economies of other EU members and Spanish borrowing costs soared to record levels.

US officials have called for Greece to be given more time to get its affairs in order, but Merkel remained unmoved.

"Elections cannot call into question the commitments Greece made. We cannot compromise on the reform steps we agreed on," she told reporters on Monday.

Progress was made in Los Cabos in boosting the resources available to the IMF to help protect vulnerable countries from the backwash of the eurozone crisis.

China led emerging powers in topping up pledges to bring the new pool for emergency loans up to $456 billion (361 billion euros), though only in exchange for a greater say in Fund affairs.

Europe’s Failure to Solve Bank Crisis Returns to Haunt Markets

Aug. 23 (Bloomberg) -- Four years to the month since the global credit crisis began, European lenders remain dependent on central bank aid, plaguing markets and economies worldwide.

Emergency steps such as unlimited loans from the European Central Bank are keeping many banks in Greece, Portugal, Italy and Spain solvent and greasing the lending of others, while low interest rates and debt-buying are containing borrowing costs. Such aid is needed as concerns about slowing economic growth and sovereign debt prompt banks to curb lending, stockpile dollars and hoard cash in safe havens. 

“I’m not sleeping at night,” said Charles Wyplosz, director of the Geneva-based International Center for Money and Banking Studies. “We have moved into a new phase of crisis.” 

Central bankers rescued financial firms after the collapse of Lehman Brothers Holdings Inc. in 2008 by providing limitless funding of as long as a year. While they treated the symptom --a lack of ready cash -- politicians, regulators and bankers in Europe have proved unable to cure the root cause: some European lenders are at growing risk of insolvency. 

The tremors, the biggest since Lehman’s collapse, were triggered by European governments’ continuing inability to stop the sovereign debt crisis from spreading beyond Greece, Portugal and Ireland to question the Italy and Spain. Renewed signs of economic weakness globally and the downgrading of U.S. debt by Standard & Poor’s rekindled concern about the quality of all government debt. 

Bank Stocks Tumble 

The signs of distress are widespread and mounting: Banks deposited 105.9 billion euros ($152 billion) with the ECB overnight on Aug. 19, almost three times this year’s average, rather than lending the money to other lenders. The premium European banks pay to borrow in dollars through the swaps market increased yesterday for a fourth straight day. 

European bank stocks have sunk 22 percent this month, led by Royal Bank of Scotland Group Plc and Societe Generale SA. Edinburgh-based RBS, Britain’s biggest government-controlled lender, has tumbled 45 percent, and Paris-based Societe Generale, France’s second-largest bank, dropped 39 percent. 

The extra yield investors demand to buy bank bonds instead of benchmark government debt surged to 298 basis points on Aug. 19, or 2.98 percentage points, the highest since July 2009, data compiled by Bank of America Merrill Lynch show. The cost of insuring that debt against default surged to a record yesterday. The Markit iTraxx Financial Index linked to senior debt of 25 European banks and insurers rose to 250 basis points, compared with 149 when Lehman collapsed. 

Greek Default Concern

 

It was the specter of government debt turning toxic that has revived the liquidity crisis policy makers had tried to stop in 2008. As speculation grew that European banks would have to write down their holdings of more governments’ debt after a Greek default, lenders pulled funding to those banks that held the most peripheral debt. It also raised concern European governments would struggle to afford a further bail out of their banks, because both the state and the lenders had failed to reduce their borrowings since the onset of the crisis. 

“The debt has been transferred from the banks to the sovereign, but it hasn’t actually been eradicated,” said Gary Greenwood, a banking analyst at Shore Capital in Liverpool. “Until the sovereigns get their balance sheets in order, then these concerns are going to remain.” 

Funding markets have seized up as investors speculate that sovereign debt writedowns are inevitable. Banks in the region hold 98.2 billion euros of Greek sovereign debt, 317 billion euros of Italian government debt and about 280 billion euros of Spanish bonds, according to European Banking Authority data. 

Euribor-OIS 

The difference between the three-month euro interbank offered rate, or Euribor, and the overnight indexed swap rate, a measure of banks’ reluctance to lend to each other, was at 0.67 percentage point on Aug. 22, within 3 basis points of the widest spread since May 2009. 

“The central bank is the only clearer left to settle funds between banks,” said Christoph Rieger, head of fixed-income strategy at Commerzbank AG in Frankfurt. “There is a mistrust between banks in general, between regions and with dollar providers overall.” 

Overseas banks operating in the U.S. may have cut dollar holdings by as much as $300 billion in the past four weeks as European banks faced a squeeze on funding and sought dollars, Jens Nordvig, a managing director of currency research at Nomura Holdings Inc. in New York said Aug. 18. Dollar assets declined by about 38 percent to $550 billion in the period, he said. 

‘More Nervous’ 

“Banks are becoming more nervous about being exposed to other banks as they hoard liquidity and become more suspicious of other banks’ balance sheets,” Guillaume Tiberghien, analyst at Exane BNP Paribas, wrote in a note to clients on Aug. 19. 

By contrast, banks in the U.S. are “flush” with liquidity, loan loss reserves and capital, Goldman Sachs Group Inc. analyst Richard Ramsden wrote in an Aug. 6 report. Large commercial banks combined holdings of cash and securities at large have climbed to 30 percent of managed assets, up from 22 percent at the start of the U.S. financial crisis in October 2007, Ramsden wrote, citing Federal Reserve data. 

The Federal Reserve, which provided as much as $1.2 trillion of loans to banks in December 2008, wound down most of its emergency programs by early 2010. One of the few exceptions was the central-bank liquidity swap lines that provide dollars to the ECB and other central banks so they can in turn auction off the dollars to banks in their own jurisdictions. 

Trichet, Bernanke 

Banks’ woes are again thrusting central bankers to the fore as ECB President Jean-Claude Trichet joins Fed Chairman Ben S. Bernanke and their counterparts from around the world in traveling this week to Jackson Hole, Wyoming for the Kansas City Fed’s annual policy symposium. 

After increasing its benchmark rate twice this year to counter inflation, the ECB this month provided relief for banks by buying Italian and Spanish bonds for the first time, lending unlimited funds for six months, and providing one unnamed bank with dollars to satisfy the first such request since February. 

In doing so, it’s maintaining a role it began in August 2007 when it injected cash into markets after they began to freeze. 

Coming to the rescue isn’t easy for the ECB. Its balance sheet is now 73 percent bigger than in August 2007 and its latest bond-buying opened it to accusations that by rescuing profligate nations it’s breaking a rule of the euro’s founding treaty and undermining its credibility. Policy makers are also divided over the best course of action, with Bundesbank President Jens Weidmann among those opposing the bond program. 

Economic Threat 

The central bank is acting in part because governments have yet to ratify a plan to extend the scope of a 440-billion euro rescue facility to allow it to buy bonds and inject capital into banks. Markets tumbled last week on concern policy makers aren’t acting fast enough. 

The funding difficulties of banks was one reason cited by Morgan Stanley economists Aug. 17 for cutting their forecast for euro-area economic growth this year to 0.5 percent next year, less than half the 1.2 percent previously anticipated. They now expect the ECB to reverse this year’s rate increases, returning its benchmark to 1 percent by the end of next year. 

The economic threat is greater in Europe because consumers and companies are more reliant on banks for funding than their U.S. counterparts, said Tobias Blattner, a former ECB economist now at Daiwa Capital Markets Europe in London. He says the ECB should eventually try to hand over fire-fighting duties either to governments, who would then inject capital into financial firms, or national central banks, who could provide short-term loans to lenders. 

Longer-term solutions may involve the restructuring the debt of cash-strapped nations in a way that doesn’t roil bank balance sheets, potentially in lockstep with a European version of the U.S.’s Troubled Asset Relief Program. 

Lena Komileva, Group-of-10 strategy head at Brown Brothers Harriman & Co. in London, said the central bank may have no option but to extend the backstop role it is playing for periphery banks to lenders elsewhere. Refusal to do so would risk a European bank default by the end of the year, she said. 

“Markets are back in uncharted territory,” said Komileva. “The crisis is a whole new story now.”