Europe stares into the abyss: Kohler

The European crisis is entering a new phase because markets have realised that a Greek bailout is impossible, pointless and essential, all at the same time.

• Impossible because it will be rejected by either the Greeks or the Germans or the German constitutional court, or, more likely, all of the above.
• Pointless because Greece has a primary deficit (before interest) of 8.5 per cent of GDP, so even if it could be out of the bond market for three years and all of its bank debt could be “restructured” so that it paid no interest for three years, its fiscal consolidation task would still be horrendous.
• Essential because ending monetary union by booting out Greece, so it can reintroduce the drachma and then devalue, is not an option because of the impact on banks.

Greeks are pining for the drachma but it is already too late for this to apply only to Greece: contagion is already well established across the rest of the PIIGS – Portugal, Spain, Ireland and Italy – in the form of a blow-out in bond yields and CDS spreads.

Germans are pining for the deutschemark, with many economists calling for its reintroduction, and even the establishment of a new deutschemark bloc among the strong eurozone members – Netherlands, Belgium, Austria and perhaps Scandinavia. That would allow the PIIGS and France to devalue the euro.

But the banks of northern Europe have been feasting on high returns from Mediterranean sovereign debt since the Maastricht Treaty was signed in 1992 and the euro was created in 1995, are now so exposed to them that a currency realignment, either by devaluing the drachma, lira, punt etc or by revaluing the deutschemark upwards, would be catastrophic.

Citigroup analysts estimate the total European bank exposure to the peripheral countries (both sovereign and private credit) at €2.3 trillion, of which German banks have about €615 billion and French banks €700 billion.

Loans to Italian borrowers total €770 billion; to Spain, €700 billion; Ireland about €460 billion; Greece about €200 billion.

But it is difficult to find these amounts in the individual disclosures of the banks.

Deutsche Bank has said it has “limited” exposure to Greece and has made no comment on the other countries. Commerzbank has €3.1 billion in Greece, no comment on the others. Munich Re has disclosed about €10 billion worth of loans to all of the PIIGS. Hypo Real Estate is in for €38.8 billion, most of which is in Italy.

The French banks have not commented much, although AXA has disclosed close to €10 billion of exposure. The Dutch bank ING is in for about €15 billion, Belgian banks are in for plenty, and only the Swiss banks stayed away – because they kept the Swiss franc and had a healthy suspicion of the euro.

Ending monetary union and allowing the PIIGS countries to resume their old ways of devaluing their currencies to maintain competitiveness would destroy the European banking system because the loans would blow out in value and become unserviceable.

After 1995 Europe’s banks went to heaven because they could start lending at high yields to the European basket cases and have their loans guaranteed by the European Central Bank through currency union.

For 18 years that has worked, but now the cracks in monetary union have turned into fissures.

The stronger governments of Europe now have a choice: prop up the weak countries or prop up the banks.

This article first appeared on Business Spectator.