Thursday, June 21, 2012

21/6/2012: IMF Article IV on euro Area: a massive miss, but loads of passion

So having penned the G20 response to the euro area crisis (see post here) last night, tonight, IMF decided to issue another missive on the topic (here). Which makes you wonder if the IMF has become so frustrated with the euro area's lack of real leadership, it has now resorted to the tactic known as blanket bombing the EU with gloomy assessments.

Here are some interesting extracts [comments and emphasis are mine]:

"Downward spirals between sovereigns, banks, and the real economy are stronger than ever

As concerns about banks’ solvency have increased—because of large sovereign exposures and weak growth prospects in many parts of the euro area—the effectiveness of liquidity operations has diminished. [It is clear that the IMF is seeing the entire euro area response policy as a set of liquidity supply measures, rather than solvency and structural reforms set of measures.]

Sovereigns, in turn, are struggling to backstop weak banks on their own. Absent collective mechanisms to break these adverse feedback loops, the crisis has spilled across euro area countries. Contagion from further intensification of the crisis—including acute stress in funding markets and tensions involving systemically-important banks—would be sizeable globally. And spillovers to neighboring EU economies would be particularly large. 

A more determined and forceful collective response is needed."

So far so good. In the nutshell, the IMF is saying that the euro crisis is now threatening the EU itself. In other words, were some nut eurosceptic to invent a tool for undermining the EU, he couldn't have done much better than inventing the current euro zone.

So what are the IMF proposals for the euro area more forceful collective response? Why, of course it is integrate more and grow.

"Completing EMU: Banking and Fiscal Union to Support Integration

A strong commitment toward a robust and complete monetary union would help restore faith in the viability of EMU. This should encompass a credible path to a banking union and greater fiscal integration, with better governance and more risk sharing. However, achieving this goal will take time and hence requires a clear timeline, with concrete intermediate actions to set the guide posts and anchor public expectations."

Err... Mr IMF, I have a question: suppose we have a banking union. Which means all banks will be regulated under singular umbrella. Note - this does not mean having a proper regime for shutting down currently insolvent banks, nor does it mean a unified system of banks assets workout. It means, however, joint deposits protection scheme. Good thing, deposits protection. Confidence improving. Alas, last time I checked, Greek banks are sick because of the sick sovereign, bonds of which they hold & of the sick economy. Spanish and Irish banks are sick because they made bad loans. In all cases so far, banks are sick not because they lack regulatory unification, and not because they lack deposits protection, but because they have bad assets. How can a banks union make these assets any better?

Good news, IMF says: "The proposed EU framework for harmonized national bank resolution processes is a necessary first step. But it needs to go further. ...A common bank resolution authority is also needed. It should be backed by a common resolution fund to ensure burden sharing and to limit fiscal costs. These efforts should be supported by a common supervisory and macro-prudential framework to forestall further financial fragmentation. While a banking union is desirable at the EU27 level, it is critical for the euro 17."

Bad news: there are absolutely no proposals even discussed yet to cover banks resolution mechanism. IMF is exceptionally silent on what should be done to achieve such 'resolution' and EU has shown no willingness to allow shutting down of a single bank. Thus, common resolution mechanism in the IMF parlance means preciously little, but in the EU vocabulary it means simply 'burden sharing'. In other words, 'banks resolution' mechanism is more about shafting bad banks debt onto all of the euro zone collectively. While this might help individual countries, e.g. Ireland, it does nothing to change the reality that euro area combined Government debt is going to be 90% of GDP this year alone. In other words, relabeling, for example, Irish banks debt an EA17 debt, instead of the Irish Government debt, will not achieve any net improvement in terms of breaking the links between banks and sovereigns (the sovereign here, thus becomes EA17 instead of national) and it will do absolutely nothing to restore functioning banking in EA17. 

My suggestion would be for IMF to be more forthright and tell exactly what this 'resolution mechanism' should look like.

IMF goes on with lofty dreamin: 

"More fiscal integration, with risk sharing supported by stronger governance, can reduce the tendency for economic shocks in one country to imperil the euro area as a whole. Ultimately, this could mean sufficiently large resources at the center, matched by proper democratic controls and oversight, to help insure budget shortfalls at the national level. Getting to this endpoint will take time. But the process can start with a commitment to a broad-based dialogue about what a fuller fiscal union would imply for the sovereignty of member states and the accountability of the center. This should deliver a schedule for discussion, decision, and implementation."

Wait, aside from the desirability of such a solution (which is open to a debate), the IMF says that the solution will take time. Lots of time. And yet, this is supposed to be a response to the ongoing acute crisis? Or does IMF honestly believe that 'a commitment to a broad-based dialogue' will do anything to compensate for the fact that euro area peripheral states are currently insolvent? How? By telling the markets that they are 'broadly-speaking talking to each other'?

I do note that the IMF is clearly stressing the need for democratic systems reforms in line with integration. I wonder, however, what they have in mind, exactly. Are they saying EU is currently not democratic enough? After all, if EU is democratic, then 'proper democratic controls and oversight' would exist already and would simply need to be deployed to a new structure...

The IMF also offers an interesting insight into its perception of the euro bonds ideas: 

"Introduction of a limited form of common debt, with appropriate governance safeguards, can provide an intermediate step towards fiscal integration and risk sharing. Such debt securities could, at first, be restricted to shorter maturities and small size and be conditional on more centralized control (e.g., limited to countries that deliver on policy commitments; veto powers over national deficits; pledging of national tax revenues). Common bonds/bills financing could, for example, be used to provide the backstops for the common frameworks within the banking union."

Interesting, isn't it? On one hand, IMF foresees limited common debt issuance. On the other it foresees this common debt being used to 'backstop ... banking union'. Now, wait - I thought banking union backstop would have to be enough to deal with current acute problems in Greece, Ireland, Portugal, Spain and Italy. That would be what? €300 billion? €500 billion? And that would have to be 'cheaper' and 'more stable' source of funding than ECB already provides. So it cannot be 'limited' and it cannot be 'short-term' (LTROs are already €1 trillion-large and 3-years long and they are not working).

In short, I see loads of frustration from the IMF side, but no real tangible solutions to the euro are crisis. 
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