An ESM European bond insurance scheme would make Eurozone sovereign debt crises bigger and more likely

Sir, Michael Heise, chief economist at Allianz writes: “An idea that might be capable of preventing or at least mitigating bond market dislocations is a European bond insurance scheme [operated by the European Stability Mechanism]… It avoids the heavy political burden of debt mutualisation and austerity regimes, actively encourages private sector lending and reduces contagion between sovereign debtors.” “Insurance tackles danger of sovereign bond shockwaves” December 4.

Heise explains:“A critical issue would be the setting of the premiums… A simple formula could apply: the triple A refinancing costs of the ESM, plus a risk premium that reflects both the rating of the country and any progress it has made on its public finances.”

It all sounds very rational, and such an insurance scheme would obviously be very useful for some in the case of a sovereign debt emergency. The harder and more important question though would be whether the existence of such scheme makes a sovereign debt crisis more likely or not.

For the purpose of the risk weighted bank capital requirements EU authorities assigned a 0% risk weight to all those sovereigns within the Eurozone, even though these de facto do not have their public debt denominated in a local domestic (printable) currency, the euro.

That stopped the markets from sending the correct signals and helped caused for instance Greece to contract public debt way in excess of what it should have done. 

Heise correctly states: “Set the insurance premiums too low and it degenerates into a disguised eurobond, a bond whose liability is jointly shared by eurozone countries.”

Sir, there is no doubt in my mind that those insurance premiums would be set way too low by any Eurocrats, and so in fact an ESM European bond insurance scheme would act as another non-transparent sovereign debt pusher, and thereby make any crises likelier and bigger. And that’s not the way to go about solving the challenges posed by the Euro twenty years ago.

@PerKurowski

Italy’s mostly domestic debt is denominated and must be served, in a mostly foreign currency, the euro.

Sir, Isabelle Mateos y Lago informs that “the bulk of sovereign debt is owed to Italian residents rather than eurozone governments.” “Greek debt crisis echoes resound in Italy’s face-off with Brussels” October 25.

EU’s authorities assigned to all sovereigns using the euro, by means of something called “Sovereign Debt Privileges”, for purposes of the risk weighted capital requirements for banks, a 0% risk weight

The only way one could foreseeable defend such outright statist idiocy, is with the argument that nations are always able to nominally pay their debt by printing themselves out of too much debt. Unfortunately these euro nations do not have their own euro-printing machine.

The challenges with the adoption of the euro twenty years ago were immense and surely known by many. Myself, far away from Europe, in Venezuela, in November 1998 published an Op-Ed titled “Burning the bridges in Europe”. In it I wrote: 

“The possibility that the European countries will subordinate their political desires to the whims of a common Central Bank that may be theirs but really isn’t, is not a certainty. Exchange rates, while not perfect, are escape valves. By eliminating this valve, European countries must make their economic adjustments in real terms. This makes these adjustments much more explosive.”

So here we are with mindboggling little having been done to solve the euro challenges. Pushing more debt on needing sovereigns basically just kicked the can containing the euro’s problems down the road.

Mateos y Lago concludes: “Italy is too big and strong to be pushed around. So Italians will decide their own fate. The others should redouble efforts to survive this potential wrecking ball. This means adopting European Stability Mechanism instruments that would allow near instant access to OMT to well-run countries suffering from contagion, and provide some form of collective insurance against bank runs for institutions that meet agreed criteria” Indeed but that is again just pushing the euro challenge forward upon the next in line.

That, to me, sounds just like “Let’s kick the euro-problem can down the road again!”

Sir, as I’ve told you many times before, it is also mindboggling how in all the overheated Brexit/Remain discussions, so little attention has been given to the EUs very delicate conditions

@PerKurowski

Europe needs an urgent explicatory mea culpa from Mario Draghi and colleagues.

Sir, Martin Wolf, in “Draghi alone cannot save the euro” September 12, writes the following: 

“But the risks of a breakup [of the eurozone] cannot be eliminated. If these are to disappear, citizens of debtor countries must see a credible path to growth, while citizens of creditor countries must believe they are not throwing money down a bottomless pit… Is there any way the ECB on its own could make it more credible that the eurozone will last?” 

Yes there is. Mario Draghi could do a mea culpa, and explain to Europe how he, and his regulator colleagues, messed it all up by distorting the markets with their capital requirements for banks based on perceived risk, which helped create and finance much of the existent “bad equilibrium”. 

That regulation made the banks run for the “absolutely-no-risk” areas, because there was where they could leverage their equity the most, and this not only caused some fairly safe havens to become dangerously overpopulated, like Greece and real estate in Spain, but also stopped small businesses and entrepreneurs from accessing bank credit at competitive rates. 

And then so as to explain how much they understand how wrong they did, he should ask his regulating colleagues, to start looking in at capital requirements for banks with a purpose, like based on job creation potential ratings. 

Then Europe would know why it all went so wrong and therefore be able to believe in why it can be saved… but, again, that of course requires a fair dose of humility from Mario Draghi and colleagues. 

Mr. Draghi is just naturally scared, shooting into the dark night.

Sir, “Why has Mr. Draghi done it?” asks Gideon Rachman with respect to ECB’s announcement of “unlimited” purchases of bonds, “Democracy is the loser in the struggle to save the euro” September 11. 

The real answer is of course Mr. Draghi is scared, as we all should be of course, but, because he does not really understands what is happening, he has no other option than to massively and blindly shoot into in the dark night. 

Again, I repeat anyone who does not understand the extent of distortion and damages produced by the capital requirements based on perceived risk does not know how we got here or how we get out of it. 

 And yes, if democracy is going down the tube, so is transparency. Article 32 of the Regulations of the European Financial Stabilisation Mechanism, ESM, states: “The archives of the ESM and all documents belonging to the ESM or held by it, shall be inviolable.” 

Does Europe really have to step back into the dark ages in order to go forward in the 21st Century?

An essential part of the narrative on the eurozone crisis is withheld, among others, by FT

Sir, Wolfgang Münchau, in “Why Weidmann is winning the debate on policy”, September 10, writes the following: “The German public has bought into the narrative that the crisis was caused by profligate southern European and consumers who had wasted the first decade of their membership of the eurozone indulging in a debt financed housing and consumption boom. It is a false morality tale, mostly devoid of economic reasoning. But this has not stopped it from becoming the dominant narrative. Not enough politicians, certainly not enough journalists and commentators are pushing against this narrative” 

And I ask again why is it that FT resists to present my argument of that this crisis was doomed by the regulators, some of them Germans, to happen? The fact is that for instance a German bank, was allowed to lend to a Greece holding only 1.6 percent in capital, making it possible for it to leverage its equity 62.5 to 1 with Greece´s risk-adjusted returns, while, when lending to a German small business or entrepreneur, it was required to hold 8 percent in capital, meaning it could only leverage its equity with those risk-adjusted returns, 12.5 to 1. If you do not think that this fact is an essential part of the real narrative of what has gone wrong, I just do not understand you. 

(Would it really hurt the FT´s ego so much acknowledging that little me, who has written hundreds of letters to you about it, was correct, and so that you prefer to shut up about it? Poor Europe... with friends like that)

Are you, FT, Ok with this?

Sir, are you Ok with Article 32 of the Regulations of the European Financial Stabilisation Mechanism, ESM, which states the following: 

“The archives of the ESM and all documents belonging to the ESM or held by it, shall be inviolable.” 

Is that not taking Europe back, fast, to the dark ages?