Evercore Pan Asset

Just as we feared and forecast, the second phase of the Euro crisis has hit us. The first phase saw Greece at the centre of the storm. It ended with the announcement of a bail out for Greece, and the provision of general facilities in case any other country got into difficulties. The authorities told us that would end the crisis. Up to a trillion Euros were available as loans, guarantees and cash so that would take care of any member state getting into more trouble.
 
So why didn’t the bail outs work last time? The Greek bond market was not very impressed. Investors wanted to see evidence that the Greek budget deficit was coming down. They seek honest figures showing progress. They wished to see how the Greek economy would recover and grow, as some growth is essential to getting the deficit down more rapidly. Disappointment soon set in, and Greek bond yields have remained very high.
 
Ireland was making progress in cutting spending to cut its government deficit. Meanwhile the European Central Bank was quietly making facilities available to various EU banks, including Irish ones, as a Central Bank should at times of difficulty. The German Chancellor decided to float the idea that bondholders who had lent money to Euroland economies under pressure should have to share some of the costs of sorting out the problem.  She mused that “haircuts” or reductions in interest and capital repayments might be an appropriate way to share the pain of adjustment. This was bound to force up the price of borrowing for the Irish government and force down Irish government bond prices. Later a partial retraction was issued, saying the haircuts might only apply to future bonds and not to money already lent.
 
The EU let it be known that they thought Ireland should borrow money under one or more of the facilities on offer given the high cost of direct borrowing and the large borrowing needs. The official Irish position said they did not need to. It was then slipped into the media that the European Central Bank might wish to reduce its support for EU banks, at a time when Irish banks might lose deposits and be in need of extra liquidity. Finally yesterday it emerged the Irish government would accept financial help for its banks.
 
All of the public briefing and comment made the problem worse. Days of negotiation, proposal and denial led to a further loss of confidence in Ireland and its banking system. A Central Bank is the lender of last resort to ensure sufficient liquidity so no-one need worry about getting their cash back from any bank in the system. The European Central Bank has been performing that role and should continue to do so. The banks should be regulated strongly to ensure they are solvent at all times, that their total assets exceed their liabilities. If they have a sudden large withdrawal of money the Central Bank supplies the cash so they can meet it. The bank then should sell as many assets as needed to repay the Central Bank to an agreed timetable which is best kept private.
 
The European Central Bank appears to want unnamed Irish banks to raise more capital or have access to facilities outside the ECB. This of course involves the Irish Central Bank and government. The sooner they work out their respective responsibilities, the sums involved and issue a detailed package to the markets the better. They have talked themselves into a serious problem, and now need to dig themselves out by their deeds.
 
We have advised sterling and dollar clients to stay out of the Euro and to avoid Euroland government bonds for some time. We see no need to change that advice yet. We want to see the colour of the money, to find out who is paying the bills, and to assess whether it will then work. The truth is arranging facilities is only part of the answer. The Irish government has to continue its work of cutting spending and boosting revenues to cut its own borrowing needs. The Irish banks have to continue selling assets, finding more profitable business and restricting their risks and balance sheet size in the meanwhile. The markets will judge them by results.