Recapitalization Agreement Set at 108 Billion Euros; Krugman Argues for ECB Printing; Contagion Spreads to Insurance Sector

True to his form, Paul Krugman does not understand the difference between problems and solutions in Europe any more than he does in the US.

In Deck Chairs, Titanic Krugman states ...

OK, yes, European banks do need more capital. But their problems are a symptom of the underlying sovereign debt problem, which can only be resolved, if at all, with ECB lending AND a commitment to reflate. Without that, the losses on sovereign debt will blow right through any amount of newly raised bank capital.

The housing bubble came from the Fed's unwillingness to let the recession of 2001 play out to its normal end. Europe is in a bigger mess today because of foolish attempts to prevent Greece from defaulting.

In both cases, the proper solution is to let banks fail. Bondholders will take a hit, but so what? The world will not end when it isn't.

Printing Money Will Not Solve the Crisis

Bundesbank president Jens Weidmann disagrees with Krugman in an interview with the Bild stating Rescue Packages Will Not Solve the Crisis

Weidmann: Increased leverage increases the risk.

Bild: French President Sarkozy wants the EFSF to furnish a bank license, so as to have unlimited resources.

Weidmann: That would be a state financing by printing money and thus in my view a fatal way. It is forbidden for good reasons by the EU treaties. I am pleased that the federal government sees it the same way.

The 60-40 Violent Dispute

The Financial Times Deutschland discusses the Violent Dispute Over Haircut Percentages.

The euro countries and the banks have provided the EU crisis summit on Sunday a violent dispute over the amount of the debt waiver, you want to accept the services in Greece. According to FTD information provided bank representatives a loss of 40 percent, while the governments of the monetary union in the evening called for a cut of 60 percent debt.

The real difference between the two proposals is even greater, because the banks want to stretch the loss in the long term, while EU negotiators at a meeting with the Banking Association IIF on the edge of the summit demanded an immediate depreciation. The bank claims were "a joke", said a €-group representatives.

Contagion to Insurance Sector

The Financial Times Deutschland reports German watchdog Bafin fears contagion to insurance sector

The supervisory authority BaFin has asked the major insurers operating in Germany to disclose tell the exact amount of their deposits with banks. Companies must quantify all forms of investment in financial institutions as well as specify whether it is secured or unsecured loans. The papers include collateralized mortgage bonds.

A survey was conducted by BaFin in the spring showed the ten largest insurance companies have invested up to 55 percent of their deposits with banks. Rolf Wenzel, Assistant Secretary, Federal Ministry of Finance said "there is a risk of contagion".

The above links from the Euro Intelligence article Towards another agreement that won’t solve the crisis.

Here is a snip of their "half-time" report.

This is the half-term report of this marathon summit, which will run until Wednesday. Of the three main issues under discussion, agreement has been reached over the recapitalisation of banks, which is going to be around €108bn. Germany has refused demands by southern European countries that this should be funded by the EFSF, insisting that it should only come in as a last resort (that means we are back to the contagion between sovereign and the banking sectors in countries where this matters the most. The continued lack of a European solution, and the continuation of the policy that member states backstop their domestic banking sector means that one of the largest crisis propagators has been strengthened.)

There has been little progress on the Greek haircut. See more on this story below. On the EFSF, the number of options have boiled down to two – the much discussed Achleitner first-loss insurance option, and an SPV that could draw in foreign money (a monoline insurance plus a CDO – the two most toxic instruments of the credit bubble). The summit definitely rejected the French proposal to turn the EFSF into a bank, and Nicolas Sarkozy announced a tactical retreat from his demand (which means that he will make again at some point). Technical discussions are now going on today and tomorrow to sort out the remaining issues, especially the Greek haircut and the precise structures of those EFSF/IMF vehicles. Complex financial instrument are complex for good reason. The devil is in the small print. A final agreement is expected when the summit resumes Wednesday.

Full Speed Ahead to Nowhere

So far the only agreement that makes any sense is the victory of Merkel over Sarkozy regarding turning the EFSF into a bank. Unfortunately, Sarkozy has not given up on that point, he has only taken a "tactical" retreat.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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