James Saft, Reuters Columnist
The most telling thing the ECB did on Wednesday’s leap day wasn’t the €530bn in party favours they handed out to banks, but rather the paltry sum they were forced to commit to shoring up Portugal’s government bond market.
Around 800 euro area banks availed themselves of the three-year loans offered by the European Central Bank, money many analysts expected to be recycled into euro area government bonds. It was a clever plan: keep the banks alive with easy money and they in turn will support the ailing governments on Europe’s periphery, pocketing the spread.
It doesn’t seem to be working out that way, at least in Portugal’s case. Portuguese borrowing rates have remained stubbornly high and on Wednesday spiked higher, with 10-year borrowing rates above 13%. That brought the ECB into the market to make its first purchases of government bonds in two weeks.
It may be that Portuguese banks are simply too weak to indulge in the government bond carry trade – after all they themselves have been unable to sell debt for two years. That being the case, there are simply no natural buyers of Portuguese risk left, save the ECB, and it may well be that the more the ECB buys the less anyone else will want to.
The hilarious thing – or tragic, depending on your world view – is that all of this happened just a day after the so-called Troika – the European Commission, ECB and the IMF – gave their blessing to Portugal’s progress in starving itself back into growth.
If we take it as a given that Portugal is going to need additional bailout funds – and a government bond trading at about half its face value is sending that signal strongly – then we have to wonder how that will happen and who will bear the costs.
So let’s see: Portugal will need additional funds and has a ready-made template to follow in the most recent rescue of Greece, which included a loss, or so-called private sector participation, of about 75% for private investors holding its debt. Even worse, the ECB established the principle in the Greek bailout that it, and by extension other official creditors, would bear no losses. Investors just love being subordinated, as we can plainly see.
How on earth then the ECB coming in and buying up Portuguese bonds will help market sentiment I do not understand. Every euro the ECB buys simply puts private creditors a euro farther back in line for dividing up the pie when the eventual default happens.
Default logic
That is not to say that the LTRO will not have an impact. It clearly is supporting asset prices in Europe and globally. It also makes an uncontrolled bank failure, or chain of failures, less likely, which in and of itself is a major support to asset prices.
Good and well, but Portugal still has to figure out how to slim its debt profile without its own currency and central bank, something few, outside of the Troika, seem to think likely. The IMF is asking Portugal to cut spending and raise taxes in 2012 by about 6% of GDP, and it is doing that at a time when there is a domestic credit crunch and an unemployment crisis. This starvation diet is working its magic, and Portugal’s central bank has downgraded its forecast for the economy in 2012, saying it will now shrink by 3.3% rather than 3%.
That may well prove optimistic, and while Portugal is a more reliable negotiating partner than Greece, where there is a huge gap between promise and implementation, a shrinking economy has a nasty way of making a debt burden worse.
The Troika also expects Portugal to begin refinancing itself on the open market beginning in 2013, and while anything is possible in this world, this seems one of the less likely outcomes predicted by a responsible entity in recent memory.
So that leaves a long, slow slide to the next bailout, punctured by intermittent forays by the ECB into bond markets in Portugal’s support, each and every one of which will give private money less reason to play along.
It would be far better, for the Portuguese not least, if everyone involved acknowledged the fix Portugal is in and we moved along directly to an orderly and sustainable debt restructuring with losses all round. The longer you wait in these circumstances the bigger the butcher’s bill is in the end.
That’s probably not possible, because of a failure of politics in Germany and of imagination at the ECB.
The eurozone, come the next leap year, is looking smaller and smaller.
(James Saft is a Reuters columnist. The opinions expressed are his own)