Tuesday, January 17, 2012

Clowns at play

Is there anything that the EU could have done or could yet do to make the euro crisis worse?

  • Begin by stating that an obviously insolvent Greece is actually just fine and those who disagree don’t understand Europe;
  • When Greece can no longer borrow in the market, admit that it has a temporary problem that can be fixed by a touch of austerity plus a generous portion of Brussels happy talk;
  • Concede that, in addition to pinch of austerity, Greece may need substantial official loans to finance its huge deficits “until it regains market credibility”;
  • Make sure that such loans are small, late, and contingent on ever-tighter austerity targets;
  • “Restore” market confidence by asserting that default by a eurozone member is unthinkable and that such bonds are risk-free;
  • Announce that any further bailouts must include partial bond default (“private sector involvement”) and that no one should have ever seen them as risk-free;
  • When Italian and Spanish yields rise to junk-bond levels, announce that future bailouts will not require public sector involvement, adding that neither Italy nor Spain actually require bailouts;
  • As eurozone government bond pricing becomes increasingly affected by market-access and credit-risk concerns, denounce market participants who raise these issues;
  • As eurozone government bond prices steadily fall, invent accounting schemes that prevent eurozone banks from having to show mark-to-market losses

Which brings us to the latest, and most humorous development: the assault upon the rating agencies for beginning to reflect in their ratings the scale of the stresses facing eurozone governments and banks.

There are three prongs to this assault:
1. Accusations of incompetence, irresponsibility, and “foreign influence”;
2. Another attempt to create a “European” rating agency to counter the malign anglosaxonism of the Big Three; and
3. The push for regulations to prohibit the publication of irresponsible and/or disruptive ratings.

The first prong (jawboning) is the usual Brussels Orewellianism, which market participants ignore. The second (a European rating agency) is a 25-year old chestnut that has reared its head many times. The idea is that a tame house-agency would produce different market outcomes than the current system. A good analogy is that by controlling the weather bureau one can control the weather. It also ignores the continued existence of the Big Three and their uncontrolled opinions.

The third prong, ratings blackouts, would reduce market disruption during periods of sovereign stress:

“Some members of the [European] parliament are in favour of banning publication of negative ratings," Wolf Klinz, a German Liberal member of the European Parliament said. "Some of the socialists and conservatives say it's a good thing to have the option to ban the publishing of ratings if they do come at the wrong moment," Klinz told Reuters.
The original blackout proposal was intended to cover only publication of negative ratings of countries receiving bailouts. But some politicians could now go further and ask for publication to be banned if it comes at an 'awkward' moment for the country concerned.  (Reuters, 2/17/12)

This is the option that I find most humorous. I very much doubt that this proposal will ever actually be implemented, but I wish that it would be, as an object lesson in market behavior.

The idea is that, when a country is in negotiations for a bailout or is otherwise under stress, the EU would promulgate a decree temporarily banning the publication of any rating opinion on the country. Thus, the agencies would issue press releases stating:

The government bond rating of France has been temporarily suspended in accordance with the EU’s blackout order. Until such time as the blackout period is lifted, we will have no rating opinion with respect to France’s government bonds.

During the blackout, French bonds would, by law, be unrated by any recognized agency. Since many institutional investors are not permitted by their clients’ guidelines to hold unrated bonds, the blackout directive would cause market chaos.

I do not mean to imply that the EU has exhausted its options with respect to further exacerbating the euro crisis. Within the next month, as the Greek bond default negotiations proceed and as Italy seeks to issue billions in bonds, we will entertained with many more such gaffes, blunders and magic tricks.