24/2/19: Eurozone's Corporate Yields are not quite in a crisis territory... yet...

Euro area high yield corporate credit rates are under pressure to continue moving:

But they are far from being dramatic, even though banking sector margins have now surpassed ex-crises averages:

The problem, however, is what awaits on the horizon. So far, the ECB is planning on hiking rates in the second half of 2019. If it does, with one 25 bps hikes to the end of 2019, we are looking at high yield rates jumping close to a 7 percent mark:

That is a bit more testing than the current above-the-average yields.

20/7/17: Euro Area's Great non-Deleveraging

A neat data summary for the European 'real economic debt' dynamics since 2006:

In the nutshell, the Euro area recovery:

1. Government debt to GDP ratio is up from the average of 66% in 2006-2007 to 89% in 2016;
2. Corporate debt to GDP ratio is up from the average of 72% in 2006-2007 to 78% in 2016; and
3. Household debt to GDP ratio is down (or rather, statistically flat) from the average of 58.5% in 2006-2007 to 58% in 2016.

The Great Austerity did not produce a Great Deleveraging. Even the Great Wave of Bankruptcies that swept across much of the Euro area in 2009-2014 did not produce a Great Deleveraging. The European Banking Union, and the Genuine Monetary Union and the Great QE push by the ECB - all together did not produce a Great Deleveraging. 

Total real economic debt stood at 195%-198% of GDP in 2006-2007 - at the peak of previous asset bubble and economic 'expansion' dynamism, and it stands at 225% of GDP in 2016, after what has been described as 'robust' economic recovery. 

1/7/16: Sunday Night Bailout: Italy

As I have noted on Twitter and in comments to journalists, Brexit has catalysed investors' attention on weaker banking systems. As opposed to the UK banks, that are doing relatively well, given the circumstances, the focal point of the Brexit fallout is now Italian banking system, saddled with excessively high non-performing loans risks and with assets base that is, frankly, toxic, given their exposure to Italian debt and corporates.

Take a look at Kamakura Corporation's data on default probabilities across European financial institutions:

Nine out of twenty five top European financial institutions suffering massive increases in default probabilities over the last 30 days and 90 days are Italian, followed by five Spanish ones. Of five UK institutions on the list, only two are sizeable players worth worrying about.

Not surprisingly, as reported by the WSJ (link here) the EU Commission has approved, quietly and discretely, over Sunday last, use of Italian government guarantees "to provide liquidity support to its banks, ...disclosing the first intervention by a European Union government into its banking system following the U.K. vote to leave the EU." The programme includes EUR150 billion in Government guarantees and is supposed to ease the short term concerns about Italian banks that, based on Italian officials estimates will require some EUR40 billion of new capital.  No one quite has any idea who on earth will be supplying capital to the banks heavily weighted by high NPLs, burdened with massive fallouts in equity valuations and faced with low returns on their 'core' assets (especially Government bonds).

As WSJ notes: "Italian banks have lost more than half of their market capitalization since the beginning of the year, as investors fret about some EUR360 billion in bad loans still logged on their balance sheets. That drop in market value compares to an average decline of less than one third for European lenders. Some Italian banks have seen their shares plummet by some 75% in the first half of the year." Anyone looking into buying into their capital raising plans needs to have their heads examined.

Of course, we know that there is only one ready buyer for the Italian banks 'assets' - the Italian state. Back in April this year, Italy announced the creation of the Atlante fund, designed to "buy shares in Italian lenders in a bid to edge the sector away from a fully-fledged crisis".

As noted in an FT article (link here): "the fund... can also buy non-performing loans." The background to it is that "Italian banks have made €200bn of loans to borrowers now deemed insolvent, of which €85bn has not been written down on their balance sheets. A broader measure of non-performing debt, which includes loans unlikely to be repaid in full, stands at €360bn, according to the Bank of Italy. So is Atlante — with about €5bn of equity — really enough to keep the heavens in place?"

Sh*t no. Not even close to being enough. Which means the State is now fully hooked in banks risks. As the FT article details, the idea is that the Italian Government will buy lower-seniority tranches of securitised trash [sorry: assets] at knock-down prices, leaving senior tranches to private markets. In other words, the Italian Government will spend few billion euros borrowed from the markets to subsidise higher valuations on senior tranches of defaulting loans.

An idea that such schemes are anything other than Italian taxpayers throwing cash at the burning building of the country banking system is naive. Despite all the European assurances that the next bailout will be 'different', it is clear that little has changed in Europe since the days of 2008.

4/5/16: Canaries of Growth are Off to Disneyland of Debt

Kids and kiddies, the train has arrived. Next stop: that Disneyland of Financialized Growth Model where debt is free and debt is never too high…

Courtesy of Fitch:

Source: @soberlook

The above in the week when ECB’s balancehseet reached EUR3 trillion marker and the buying is still going on. And in the month when estimates for Japan’s debt/GDP ratio will hit 249.3% of GDP by year end

Source: IMF

And now we have big investors panicking about debt: http://www.businessinsider.com/druckenmiller-thinks-fed-is-setting-world-up-for-disaster-2016-5. So Stanley Druckenmiller, head of Duquesne Capital, thinks that “leverage is far too high, saying that central banks and China have allowed for these excesses to continue and it's setting us up for danger.”

What all of the above really is missing is one simple catalyst to tie it all together. That catalysts is the realisation that not only the Central Banks are to be blamed for ‘allowing the excesses of leverage’ to run amok, but that the entire economic policy space in the advanced economies - from the central banks to fiscal policy to financial regulation - has been one-track pony hell-bent on actively increasing leverage, not just allowing it.

Take Europe. In the EU, predominant source of funding for companies and entrepreneurs is debt - especially banks debt. And predominant source of funding for Government deficits is the banking and investment system. And in the EU everyone pays lip service to the need for less debt-fuelled growth. But, in the end, it is not the words, but the deeds that matter. So take EU’s Capital Markets Union - an idea that is centred on… debt. Here we have it: a policy directive that says ‘capital markets’ in the title and literally predominantly occupies itself with how the system of banks and bond markets can issue more debt and securitise more debt to issue yet more debt.

That Europe and the U.S. are not Japan is a legacy of past policies and institutions and a matter of the proverbial ‘yet’, given the path we are taking today.

So it’s Disneyland of Debt next, folks, where in a classic junkie-style we can get more loans and more assets and more loans backed by assets to buy more assets. Public, private, financial, financialised, instrumented, digitalised, intellectual, physical, dumb, smart, new economy, old economy, new normal, old normal etc etc etc. And in this world, stashing more cash into safes (as Japanese ‘investors’ are doing increasingly) or into banks vaults (as Munich Re and other insurers and pension funds have been doing increasingly) is now the latest form of insurance against the coming debt markets Disneyland-styled ‘investments’.

17/5/15: Public Debt, Private Debt… Someone Thinks There Might Be Consequences

Remember last year vigorous debate about whether debt (in particular real economic debt - as I call it, or non-financial debt - as officialdom calls it) matters when it comes to growth? Well, the debate hasn't die out… at least not yet. And some heavy hitters are getting into the fight. Òscar Jordà, Moritz HP. Schularick and Alan M. Taylor paper, "Sovereigns versus Banks: Credit, Crises and Consequences", Working Paper No. 3: http://ssrn.com/abstract=2585696

Ok, so some key preliminaries: "Two separate narratives have emerged in the wake of the Global Financial Crisis. One interpretation speaks of private financial excess and the key role of the banking system in leveraging and deleveraging the economy. The other emphasizes the public sector balance sheet over the private and worries about the risks of lax fiscal policies." The problem is that the two 'narratives' "…may interact in important and understudied ways", most notably via debt and debt overhangs.

The authors examine "the co-evolution of public and private sector debt in advanced countries since 1870. We find that in advanced economies significant financial stability risks have mostly come from private sector credit booms rather than from the expansion of public debt."

Time for Krugmanites to pop some champagne? Err, not too fast: "However, we find evidence that high levels of public debt have tended to exacerbate the effects of private sector deleveraging after crises, leading to more prolonged periods of economic depression."

Wait, what? A state indebted to the point of losing its shirt (or rather default on pay awards to trade unionised workers and retirees) imposes cost on private sector that can be detrimental during private sector own deleveraging? Yeah, you betcha. It is called power of taxation. Just as during the current crisis the Governments world wide gave no damn as to whether you and I can pay kids schools fees, health insurance and mortgages, so it was thus before.

"We uncover three key facts based on our analysis of around 150 recessions and recoveries since 1870:

1. in a normal recession and recovery real GDP per capita falls by 1.5 percent and takes only 2 years to regain its previous peak, but in a financial crisis recession the drop is typically 5 percent and it takes over 5 years to regain the previous peak; 
2. the output drop is even worse and recovery even slower when the crisis is preceded by a credit boom; and 
3. the path of recovery is worse still when a credit-fuelled crisis coincides with elevated public debt levels. Recent experience in the advanced economies provides a useful out-of-sample comparison, and meshes closely with these historical patterns. Fiscal space appears to be a constraint in the aftermath of a crisis, then and now."

Now, take a more in-depth tour of the changes in fiscal and private non-financial debt across 17 advanced economies since 1870s:

Oh, yeah… 1950s and 1960s public deleveraging was done by leveraging up the real economy. And it didn't stop there. It got much much worse… instead of deleveraging one side of the economy, both public and private sides continued to binge on debt. Through the present crisis.

So "what does the long-run historical evidence say about the prevalence and effects of private and public debt booms and overhangs? Do high levels of public debt affect business cycle dynamics, as the public debt overhang literature argues? Are the effects of either variety of debt overhang more pronounced after financial crisis recessions?"

So here are the results:

So the results provide "…a first look at over 100 years of the inter-relationships of private credit and sovereign debt. We end with five main conclusions":

1. "…while public debt has grown in most countries in recent decades, the extraordinary growth of private sector debt (bank loans) is chiefly responsible for the strong increase of total liabilities in Western economies. About two thirds of the increase in total economy debt originated in the private sector. ...Sovereign and bank debts have generally been inversely correlated over the long run, but have increased jointly since the 1970s. In modern times, the Bretton-Woods period stands out as the only period of sustained public debt reduction, both in expansions and recessions."
2. "…in advanced economies financial stability risks originate primarily in the private sector rather than in the public sector. To understand the driving forces of financial crises one has to study private borrowing and its problems. In the very long run, if we run a horse race between the impact of changes or run-ups in private credit (bank loans) and sovereign debt as a predictor of financial crisis and its associated distress, private credit is the more significant predictor; sovereign debt adds little predictive information. This fits with the events of 2008 well: with the exception of fiscal malfeasance in Greece most other advanced countries did not have obvious public debt problems ex ante. Of course, ex post, the fierce financial crisis recession would wreak havoc on public finances via crashing revenues and rising cyclical expenditures."
3. "…with a broader and longer sample we confirm that private debt overhangs are a regular feature of the modern business cycle. We find that once a country does enter a recession, whether it is an ordinary type or a financial-crisis type of recession, if it carries the legacy of a large private credit boom then the post-recession output path of the economy is typically adversely affected with slower growth."
4. "…our new data also allow us to see the distinct contribution of public debt overhangs. We find evidence that high levels of public debt matter for the path of economies out of recessions, confirming the results of Reinhart et al. (2012). But the negative effects of high public debt on the performance of the economy arise specifically after financial crises and in particular when private borrowing also ran high. While high levels of public debt make little difference in normal times, entering a financial crisis recession with an elevated level of public debt exacerbates the effects of private sector deleveraging and typically leads to a prolonged period of sub-par economic performance." In other words, not too fast on that champagne, Krugmanites… 
5. "…from a macroeconomic policy standpoint these findings could inform ongoing efforts to devise better guides to monetary, fiscal, and financial policies going forward…" blah… blah… blah… we can stop here.

Funny how no one can get the right idea, though - the reason public debt matters is because the state always has a first call on all resources. As the result, the state faces a choice at any point of deleveraging cycle:

• (A) leverage up the State to allow deleveraging of the real economy; or
• (B) tax there real economy to deleverage the State.

In the US, the choice has been (A) in 2008-2014. In Europe, it has been (B). The thing is: both Europe and US are soon going to face another set of fine choices:

• (Y) reduce profligacy in the long run to deleverage the State; or
• (Z) get the feeding trough of pork barrel politics rocking again.

No prizes for guessing which one they both will make… after all, they did so from 1970s on, and there are elections to win and seats to occupy...

7/2/15: Euro Area's Debt Addiction

Europe's debt addiction in one chart: the following chart plots total domestic and cross-border credit to non-banks, at constant end-Q2 2014 exchange rates, in per cent of GDP:

Source: BIS: http://www.bis.org/statistics/gli/gli_feb15.pdf

In the above:

• The solid lines are actual outcomes, 
• The vertical lines indicate the 2007 beginning of the global financial crisis and the 2008 collapse of Lehman Brothers. 
• Figures include government. 
• The dashed lines reflect long term trend, calculated as for the countercyclical capital buffer in Basel III using a one-sided HP-filter.

Two obvious conclusions emerge from the above:

1. Since the start of the Global Financial Crisis, debt addiction expanded both in the US and the Euro area, with US addiction rising faster than the Euro area's.
2. The gap between Euro area and US dependency on debt at the end of 2014 stood at a similar level as at the start of the Global Financial Crisis and above the pre-crisis level. That is despite the fact that in the US, most recent manifestation of the debt addiction has been associated with much higher economic growth and jobs recovery than in Europe.

10/1/2015: Where did Europe's EUR3 trillion worth of debt go?

You know the Krugmanite meme… Euro area is doing everything wrong by not running larger deficits. But here is an uncomfortable reality: since 2007, Euro area countries have managed to increase their debt in excess of 60% of GDP by a staggering EUR3 trillion.

So here's the crux of the problem: where did all this money go?

We know in terms of geographic distribution:

EUR1.6 trillion of this debt increase went to the 'peripheral' countries, and EUR39.2 billion went to the Easter European members of the Euro area. EUR517 billion went to the 'core' economies. And a whooping EUR759.9 billion to France. Now, across the 'periphery' some 20-25% of the debt increase is attributable to the banks measures directly, but the rest is a mix of automatic stabilisers (e.g. increases in unemployment benefits due to higher unemployment) and old-fashioned Keynesian policies.

It might be that Euro area is not spending enough in the right areas of fiscal policy. But to make an argument that it is not spending enough across the board is bonkers. We have allocated some EUR3 trillion in borrowed spending and we will continue to run the debt up in 2015. And still there is no sign of growth on the horizon.

So, again, where is all this money going?

1/11/2014: Few Signs of Fiscal Reforms in Europe

My article on Euro area Government debt levels - the lack of any moderation in thereof - is out: http://www.compasscayman.com/cfr/2014/10/31/Few-signs-of-fiscal-reform/

21/10/2014: Of Statistics: Ireland and ESA2010

Eurostat released a handy note showing revisions to euro area debt and deficit figures that arose as the result of conversion to ESA2010 methodology (yes, yes, that infamous inclusion of illicit trade and re-classification of R&D spending as investment, and much more).

You can read the full note here: http://epp.eurostat.ec.europa.eu/portal/page/portal/government_finance_statistics/documents/Revisions-gov-deficit-debt-2010-2013.pdf

And the effects are:

Government deficit revisions:

Click on chart to enlarge

One clear outlier in the entire EU28 is... Ireland. We had the largest, by far, downward revision in our deficit/GDP ratio of some 1.5 percentage points, pushing our deficit down from 7.2% of GDP (ESA95) to 5.7% of GDP (ESA2010) overnight. No austerity, just accounting.

We were similarly 'fortunate' on the debt calculations side:

Click on chart to enlarge

While revised actual debt levels rose, under new rules, the revised debt/GDP ratio fell due to GDP push up under the new rules. Lucky charms...

Per note, relating to deficit revisions: "Ireland (-3.1pp for 2010, -0.1pp for 2011, -0.1pp for 2012 and +1.0pp for 2013): the 2010 and 2011 deficits were  revised mainly for other reasons (than ESA 2010 introduction) and the 2012 and 2013 deficits mainly due to  introduction of ESA 2010. The deficit for 2010 was increased mainly due to reclassification of the capital injection  to AIB and the deficit for 2011 due to various reasons such as an adjustment to accrual calculation for PRSI,  health contribution and National Training Levy. The revisions in the deficit for 2012 and 2013 are mainly due to  the classification of the Irish Bank Resolution Corporation Limited (IBRC) to the central government. " 

Per note, relating to debt revisions: "Ireland (+12.2pp for 2011, +10.3pp for 2012 and +7.2pp for 2013): the revisions in the debt are mainly due to  introduction of ESA 2010: the classification of the Irish Bank Resolution Corporation Limited (IBRC) to the central  government as it became a government controlled financial defeasance structure in 2011."

So our actual debt rose. But our debt/GDP and deficit/GDP ratios fell:

Enron would be proud...

23/8/2014: Real Cost of Capital: Euro 'Periphery' Dilemma

Staying on the topic of debt (see earlier post: http://trueeconomics.blogspot.ie/2014/08/2382014-that-pesky-problem-of-real-debt.html) here is IMF research on real cost of corporate capital (linked to the cost of debt) in the Euro area 'periphery' (this is from an IMF July 2014 publication that accompanied its Article 4 paper on Euro Area).

I highlighted with the red the range of recent capital costs range in each country to trace out historical comparatives.

Starting with the Euro area as a whole:

Two points:

• Current real cost of capital across the euro area is relatively benign, compared to both 1990s - early 2000s period and shows low volatility in recent (crisis) years post 2009 peak
• 2009 peak is pronounced but moderate compared to the one found in some 'peripheral' countries.

In basic terms, this means that euro area's capital costs are benign - above the 2004-2007 trough, but historically well below those observed in the 1990s.

Spain:

 Two points:

• Current capital cost levels are consistent with crisis peak 
• Capital today is as expensive in real terms as in the pre-euro era.

Which means that Spanish real cost of capital is now as bad as in the pre-euro period and is much worse than during the credit boom of the late 1990s-early 2000s.

Italy:

 Two points:

• Just as in Spain, real capital costs in Italy are comparable with peak of the crisis and 
• Capital costs today are more expensive than in the 2000s, but less expensive than in pre-euro era.

Italy's overall real cost of capital is currently comparable to the one observed in the late 1990s, and is higher than the one experienced in the credit expansion period of the early 2000s. That said, the cost uplift on 2000s is relatively moderate.

Portugal:

Two points:

• Capital costs today is below the peak levels of the crisis in real terms, but is severely elevated relative to 2000s and on-par with pre-euro era costs;
• Capital cost volatility is high and it was high during the entire euro era.

Thus, Portugal's real cost of capital is highly volatile, but on average is higher today than in the entire period from 1997 through 2010.

Ireland:

Ireland is clearly 'unique' compared to both the Euro area and the rest of the 'periphery' when it comes to the real cost of capital.

• The crisis peak in real cost of capital is massively out of line with historical trends.
• Ignoring the crisis peak, current real cost of capital is running well above the pre-crisis historical levels;
• Since the introduction of the euro, real cost of capital in Ireland trended above the pre-euro period levels

In summary, real cost of capital across the euro area 'periphery' shows one simple thing: investment is still a very costly proposition for businesses, especially compared to the pre-crisis period. Worse, it is now as expensive than (or comparable to) the cost averages for the pre-euro area period.

The above puts stark contrast between the cost of funding the banks (low) and Governments (historically low today) and real businesses (high).

23/8/2014: That Pesky Problem of Real Debt...

Again, revisiting IMF's Article 4 consultation paper for Euro Area, published in July 2014, here is a summary of the Euro area 'peripheral' countries debt overhang.

First real economic debt (debt of non-financial companies, households and public sector):

 Points of note:

1. Ireland's debt overhang is severe. More severe than of any other 'peripheral' country. Bet you forgot that little bit with all the 'best-in-class' growth performance droning in the media. Ah, and worse, remember, not the level alone, but the rate of debt increases over time, also matters. And by this metric, we too are the worst in the group, both for debt increases on 2003 levels and debt increases on 2008 levels.
2. Ireland's households' debt has declined over 2008-2013, more so than in Portugal and Spain. But it remains second highest after the Netherlands' and this decline masks true extent of debt problem because 2013 figure no longer counts household debts issued by banks that left Ireland and books of loans sold to investment funds. This also excludes some securitised debt.
3. Ireland's corporate debt problem is potentially overstating true extent of real debt in the economy, as it includes a small share of MNCs debt - debt issued by Irish institutions. This is likely to be relatively minor, in my view, as MNCs largely do not do debt intermediation via Irish domestic institutions. 

Now on to our household debt deleveraging in more detail:

Good news is, when it comes to our households, we are aggressively deleveraging compared to pre-crisis debt peak. As aggressively (in rate terms) as the U.S. Caveats mentioned above apply.

But there is a problem with all the debt legacy:

In the above 'PS' stands for private sector, not public sector. So private sector debt legacy is associated with negative subsequent economic growth, in general. But as above shows, for the peripheral countries, including the basket case outside Troika capture, Slovenia, and the rarely mentioned case of Finland (see chart below) it is also compounding structurally weak fundamentals other than debt alone.

So a timely reminder: that debt problem - it has not gone away. Not by any measure and most certainly not for Ireland.

Note: to see the problem in Finland consider the following chart:

28/1/2014: Decline in Debt and Regaining of Trust?

The following out this morning:

So is Herr Schaeuble correct? Did reductions of debt help 'regain trust during the crisis'? Were there actual reduction in debt?

Table summarises 2007-2013 maximum debt levels (for General Government Debt as % of GDP) attained by the euro area economies and the year when this maximum was attained:

Three observations:

1. With exception of two countries: Germany and Portugal, 2013 debt to GDP ratios are maximal for the entire period 2007-2013.
2. In the case of Germany, peak debt level attained in 2010 was 82.44% of GDP, while in 2013 estimated level of debt/GDP is expected to be 80.393% of GDP. The reduction is small. Meanwhile, German bund yields are not reflective of any specific reduction - they were low in 2009 and 2010 and they are low now.
3. Portugal's peak debt/GDP ratio is notionally at 2012 at 123.8% of GDP. Country 2013 expected debt/GDP ratio is 123.56%, which is statistically indifferent from 2012 levels, so we cannot call this material by any measure.

Here's evolution of debts over the period in two charts, confirming that there has been no reduction in debt levels relative to the earlier stages of the Global Financial Crisis:

And here is the chart showing how dramatic were the increases in debt levels over the course of the crisis:

But, of course, virtually the entire euro area bond yields have shown improvements in 2012-2013, which is really totally and completely divorced from the debt dynamics:

The IMF is not even projecting decline in debt until 2015...

27/3/2012: Two Sovereign Debt Crisis charts

Two interesting charts on the fundamental sources of risks relating to sovereign crises of the 2009-present. No comment needed, really...

1/1/2012: That debt overhang problem: replay

I am delighted to note that John Mauldin is also stressing the issue of total real economic debt overhang that I have been vocal about for some time now. Here's his 2012 predictions post: http://www.businessinsider.com/mauldin-collateral-damage-2011-12
that also contains this delightful chart:

And, spot the one country that stands out? Yep, that's Ireland - second to Japan in terms of total combined debt/GDP ratio, and well ahead of Japan when GNP is referenced in the above.

I have highlighted the issue of debt overhang and the long term real growth drag exerted by it in a number of articles now, including articles in the Sunday Times, the Globe and Mail, Ireland's Village magazine and on this blog. At last, analysts are starting to pay attention to the issue.

19/12/2011: Relax, Keynesianistas!

My article for Canada's Globe & Mail in the Global Exchange section: here.

12/12/2011: Are debt repayments to be blamed for growth collapse?

Some of the paper have clearly reached a bizarre level of Keynesian paranoia. Behold one example - The Guardian today (link here) screaming "Debt repayment is driving the EU back to recession".

While I agree with the idea that EU (more like the Euro zone to be accurate - do note that, folks from the Guardian) is heading into another recession, I highly doubt the cause of this is 'debt repayment' (note that the tense suggests that it is currently ongoing repayment) fault. Here's why:

Table above, taken from the IMF WEO September 2011 database clearly shows that not a single euro area member state is currently repaying its debts.

And in fact, as the table below details, NOT A SINGLE euro area state will be repaying any of its debts until the earliest 2014, when Greece is expected to start paydowns on its debts (under very rosy assumptions, of course):

Interestingly, IMF expects that in 2015 and 2016 overall debt levels will continue rising in ALL member states except for Greece.

So, run by me again that headline from the Guardian?

24/11/2011: Insolvent Europe

The following link is to my article on EU-wide debt crisis for presseurope.eu (and no - not just that Government debt crisis  we've heard all about): here.

31/10/2011: Europe's latest blunder

This is an unedited version of my article in October 30, 2011 edition of Sunday Times.

This week was a fruitful and productive one for Europe’s leaders. Not because the battered euro block has finally produced a feasible and effective solution to the raging debt, fiscal and banking crises sweeping across the common area, but because they spent the entire week doing what they do best: holding meetings and issuing communiqués.

The latest plan, unveiled this Wednesday, shows once again that the EU remains incapable of actually doing what needs to be done.

The real European disease is debt. Too much debt. Based on the latest IMF forecasts and statistics from the Bank for International Settlements by the end of 2011, combined public, household and non-financial corporate debts will reach 280% of GDP in the US. In France, the Netherlands, Sweden and Belgium, this number will be closer to 330-335%, in Italy – 314%, in Greece – 290%, in Portugal 375%, in Spain 360%, and in Ireland a whooping 415%.

The composition of these debts, and in particular the weight of public sector debts in total non-financial debt overhang, may differ, but the end result is the same for all of the above. Per August 2011 research paper from the Bank for International Settlements, combined private sector debt in excess of ca 250% of GDP results in a long term (aka permanent) reduction in future growth rates. This reduction, in turn, puts under pressure the ability of the indebted states to repay their obligations.

Further compounding the problem, European banking systems have become addicted to Government bonds as a form of capital. In the past, this addiction was actively encouraged by the Governments, regulators and the ECB. With the latest proposals in place, we are likely to see even more Government/EFSF debt piling into the banks in the long term.

Having ignored basic risk management rules, banks across the Euro area are now fully contaminated with their exposures to sovereign bonds that are about as bad – from the risk perspective – as the adjustable rate mortgage borrowers in the US. Based on the second set of stress tests carried by the European Banking Authority this summer, Greek haircut of 75%, as suggested by the IMF, against the core tier 1 requirement of 9% will imply a capital shortfall of €180 billion. Failing to recognize this, the EU plan unveiled on Wednesday calls for just €100 billion recapitalization under a 50% haircut.

This, of course is far too little too late for Greece and for Europe overall. To bring public debt to GDP levels back to the point of fiscal stabilization (under 100% of GDP) will require ca 20% write-down in Portugal, 40% in Italy, and 30% in Ireland. Europe’s problem is at least €730 billion-strong. It can become bigger yet if – as can be expected – Greece fails once again to deliver on prescribed fiscal adjustment measures and/or the write-downs trigger CDS calls and/or the credit contraction triggers by the measures leads to a new recession. All in, Euro area needs closer to €820-850 billion in funding in the form of both rights placements, assets disposal, and government capital supports.

Now, factor in the second order effects of the above numbers onto the real economy.

Injecting €820 billion in new capital or, equivalently, providing some €1 trillion in fresh capital and bonds guarantees as envisaged under the EFSF proposals being readied by the European officials will increase broad money supply by 10%. This is consistent with long term ECB rates rising to well above their previous historical peak of 4.75% - triple the current rate. European banks trying to raise new capital and deleveraging foreign assets will saturate equity markets across Europe with capital demand. Reduced banking sector competition, pressures on the margins and higher funding costs will push retail rates into double-digit territory.

For European companies – more addicted to debt financing than their US counterparts and now competing for scarce equity investors against their European banks – this will mean a virtual shutting down of credit supply. Starved of domestic credit, European multinationals will aggressively divest out of the Continent and pursue jobs and investment growth in places where capital is more abundant – the US and Asia.

As Paul Krugman recently said, “The bitter truth is that it’s looking more and more as if the euro system is doomed. And the even more bitter truth is that given the way that system has been performing, Europe might be better off if it collapses sooner rather than later.”

Sadly, Krugman is correct. European cure proposals to the crises are worse than the disease itself and the Wednesday’s proposals for dealing with the crisis are case in point.

Firstly, banks recapitalizations – first via private equity raising and bond-to-equity conversions, then via sovereign/EFSF funding – risks extending the recapitalization procedures into the second half of 2012 and simultaneously increase the risk premia on banks funding. In other words, credit crunch is likely to get worse and last longer. Most likely, this will require additional guarantees to ensure the funding market does not collapse in the process. The ECB balance sheet exposure to peripheral banks and sovereign debts – currently at €590 billion, up from €444 billion back in June 2011 – will become impossible to unwind.

Secondly, the insurance option for sovereign bonds issuance is likely to be insufficient in cover and, coupled with greater seniority accorded to EFSF debt can lead to a rise in yields on Government bonds. This, in turn, will amplify pressure on countries, such as Spain and Italy which are facing demand for new bonds issuance and existent debt roll over of some €1.3-1.5 trillion over 2012-2014.

Thirdly, leveraging EFSF to some €1 trillion via creation of an SPIV (Special Purpose Investment Vehicle) will create a nightmarishly complex sovereign debt structure.

Under leverage EFSF option, a country borrowing from the fund €1 billion will receive only a small fraction of the money directly from the fund itself, with the balance being borrowed from international lenders that may include IMF. In order to secure such lending, the EFSF will require seniority for international lenders over and above any other sovereign debt issued by the borrowing state. This will de facto prevent the EFSF borrower from raising new funding in the capital markets in the future.

In all of this, Ireland is but a small- albeit a high risk – player with the power to influence some of the EU decisions, especially those that matter most. Alongside the EFSF reforms and banks recapitalizations, the EU will require stronger fiscal and sovereign debt oversight measures, and ultimately closer integration.

The Irish Government should make it clear from the earliest date possible that Ireland’s participation in this process is conditional on three measures. First, Irish banks debts to the euro system should be written down to the tune of €60-70 billion, allowing for clawing back some of the funds injected into banks as capital and providing a stronger cushion for a households’ debt writeoff. Second, we should demand that the debt-for-equity swaps explicitly encouraged as the means for recapitalization of the euro area banks in Wednesday agreement be applied to Irish banks. These swaps can be used to further reduce previously committed funds and reverse some of the debt accumulated by the Exchequer (on and off its balancesheet). Third, Irish Government should make it unequivocally clear that we will veto any tax harmonization in the future.

On the net, European solutions unveiled this Wednesday are simply not going to work. In Q1 2012 the latest recapitalization of Euro area banks and Greece will run out of steam. Next time around, this will happen in the environment of slower growth and possibly a full-blown recession with Spain, Italy and Portugal all running into deeper fiscal troubles. The real price of Europe’s serial failures to deal with the crisis will be the real economy of the euro zone.

Box-out:

This week’s CSO-compiled Residential Property Price Index (RPPI) had posted another 1.49 percent monthly fall in house prices nationwide. Exactly four years ago, at the peak of residential property valuations, RPPI stood at 130.5. At the end of September this year, the index was just 72.8 or 44 percent below the peak. The misery of falling prices is now impacting not only hundreds of thousands of negative equity mortgage holders, but even the all-mighty Nama. Nama referenced its original valuations of the assets it took over from the banks to November 30, 2009. Since then, residential prices in the nation have fallen 29.5% and apartments prices (the category of property more frequently related to Nama loans) have fallen 33.9%. All in, Nama will now require a 35% uplift on its assets (55% for apartments) to break even, not including the organization’s gargantuan costs of managing its assets.