Wolfgang Münchau asks the same in this article. This is a must read article. Munchau is in top form. He has pointed the role German government has played in worsening the crisis.
He compares Eurozone SPV to a CDO product. Eurozone created a SPV to manage the bailout which is as complex as a CDO.
In last week’s column I remarked that it was no accident that the eurozone created a special purpose vehicle to manage this bail-out. It is not just the name that reminds us of those notorious financial structures that brought us the subprime crisis. There are in fact substantive parallels.
Like a dodgy subprime collateralised debt obligation, the eurozone’s SPV lacks transparency. The operational rules are not clear, and have been subject to disputes among member states since political leaders announced agreement. If you want to understand it, you had better read the small print.
One could also take a look at the debt the SPV insures. Colleagues at FT Alphaville dug up a brilliant report by the credit team at Credit Suisse, who pursued this question to the bitter end. Before the start of monetary union in 1999, EU countries borrowed at different interest rates, the spreads reflecting expectations about future exchange rate realignments and default probabilities. With the arrival of the euro, spreads almost disappeared. Just as subprime CDOs enjoyed triple A ratings because of the way they were constructed, the entire eurozone enjoyed a triple A rating on the back of Germany’s. This produced a massive credit boom in Spain and Portugal, and those credits were recycled through the eurozone banking system. Bankers in Düsseldorf, Munich and Paris bought those Spanish mortgage obligations and Greek sovereign bonds, proudly adding them to their fine collections of subprime CDOs.
Very well said.
He says though Eurozone has a lower debt than other economies, much of it is hidden.
Those numbers tell us that the eurozone is in a better position than the US, the UK or Japan. The problem is that those headline numbers exclude contingent debt and the interconnectedness of financial flows.
The biggest category of contingent debt is made up of the various guarantees the eurozone has been handing out in the last couple of years. European Union governments have effectively guaranteed the liabilities of their entire banking sectors. They have guaranteed all bank deposits up to a certain limit. The eurozone member states guaranteed Greek debt for the next three years, and then extended the scheme to the rest of the eurozone. And those guarantees will probably have to be doubled again.
In a very insightful piece, Paul De Grauwe says the same that though Eurozone debt is lower than others, the problem lies elsewhere. He points debt levels have zoomed in private and household sector.
Muncahu says Germany problems are far more than indicated. He even says if true, Greece might be asked to bail out Germany!!
I have heard credible reports suggesting that the underlying situation of the German Landesbanken is even worse than those estimates suggest. Last year, a story made the rounds in Germany, according to which a worst-case estimate would require write-offs in the region of €800bn – about a third of Germany’s annual GDP. If you were to add this to Germany’s public debt, you might jump to the conclusion that Greece should bail out Germany, not the other way round. While that is probably a little exaggerated, there are serious questions about whether the eurozone is still in a position to issue such massive guarantees.
So, given what happened to those subprime CDOs, what hypothetical rating should we then attach to that €440bn eurozone SPV? A triple A?
He ends saying:
I make no predictions here. But recent financial history teaches us that we must ask those questions and not blindly trust implausible promises, whether made by bankers or by politicians. I suspect that for as long as those Landesbanken and cajas stay unreformed, investors have good reason to treat the eurozone in the way they should have treated subprime CDOs.
Great stuff but quiet pessimistic as well.