George Kerevan: Brussels ‘fix’ not solid enough to make euro safe

DAZED and confused? Here’s a handy beginner’s guide to the very latest “euro fix”:

Why don’t they go back to deutschemarks?

Forget finance, this is about politics. Berlin may rant over bailing out profligate southern Europeans but the truth is that Germany has been the biggest beneficiary of the euro. If it had been using the dependable deutschemark over the past two years, the value would have gone through the roof, as investors parked surplus funds in German banks as a safe haven. Instead, the cheap euro has driven Germany’s export boom.

So Angela Merkel has agreed to go on funding Greece?

Er… no. Everybody else does. The deal agreed on Wednesday in Brussels comes in four parts. First, European banks have been told to write off 50 per cent of what they are owed by the Greek government. That’s supposed to take the pressure off the Greeks. Second, these banks have to raise extra capital reserves from their shareholders to cover any future losses. That’s to maintain confidence in Europe’s rickety financial system.

Third, everybody – not just eurozone countries – is supposed to underwrite a giant insurance policy called the European Financial Stability Facility (EFSF). Worth €1 trillion, the EFSF is supposed to guarantee repayment of any future loans to eurozone members, should they default. The hope is never to activate this insurance policy, but to rely on its existence to persuade Europe’s banks that it is safe to lend to eurozone governments again.

Finally, every country in the eurozone crosses their hearts and promises not to be naughty ever again. If they do, changes to the EU treaties will allow Brussels (meaning Berlin) to veto their budgets. This is the modern version of a Blizkreig.

Surely that sounds common sense?

It is far from common sense and far from being a done deal. Start with the banks. They are being pressured to write off €100 billion in what they are owed. Because this is “voluntary” it means they can’t claim on their existing credit default insurance. They also have to find a similar sum for recapitalisation. Result: a sharp reduction in what European banks can lend. This could tip Europe into recession.

But at least Greece will be off the hook?

Even writing off 50 per cent of Greek debt to the banks still leaves that country owing the equivalent of 120 per cent of its GDP, and still with nothing to pay it back. Besides, there is no legal obligation on Greece’s creditors to accept the deal done in Brussels. Watch as “vulture” private hedge funds such as NML Capital buy outstanding Greek sovereign debt at a steep discount, then engage in years of international litigation (as they did with Argentina) to extract the full value.

This week’s deal may give Athens a tiny breathing space from its creditors. But unless Greece revives the drachma, devalues the currency and kick-starts its economy, it is a piece of financial Semtex waiting to explode. Once the Greek domino goes, the markets will turn on Italy, Spain, Portugal and Ireland.

What about the EFSF insurance policy?

Don’t uncross your fingers on this one. If you look in the small print of Wednesday’s deal, they have not actually agreed how to finance the new €1 trillion fund. An earlier version of the EFSF, set up last year, put €440 bn in the kitty. After handouts to Greece, Portugal and Ireland, there is only €290bn left. No EU country is putting up any extra cash. Instead, that €290bn will be “leveraged” four or five times to get the o€1 trillion required to make newspaper headlines.

Leveraging means the existing money will be used to repay only the first 20 per cent of any default claim on new euro bonds – so stretching the pot by a factor of five. That’s equivalent to insuring a fifth of your car. The theory is that this is sufficient to underwrite the highest risks involved in sovereign lending, so persuading the markets to buy government bonds. I wonder if Angela Merkel has tried this with her car insurance.

Aren’t the Chinese going to chip in?

Wednesday’s deal suggests the creation of a “special purpose investment vehicle” (SPIV), designed to lure hard cash from China and the Middle East, into the EFSF’s coffers. SPIVs are the fiendishly complicated financial instruments that caused the credit crunch in 2008. To cut a long story short, the EFSF uses its good name to sell triple-A rated bonds to China, then uses the cash to buy risky eurozone sovereign debt. Don’t ask what happens if the SPIV bonds turn out as worthless as sub-prime mortgages. Worse, China has already hinted it will only play ball if it gets concessions for its exports. It might be cheaper to sell them Italy direct.

What about the UK?

There’s a throwaway line in the deal that suggests the IMF might also be persuaded to ante up more bailout cash. This would involve the UK government, as an IMF member, putting its hand in your pocket. The good news is that if the UK slips back into recession, there’s limited chance of that happening.

Surely the markets were up on news of the deal?

They did the same after an earlier (abortive) fix in July. Desperation makes even professional investors light headed. But if this new deal comes unstuck there is not enough money even in an enlarged EFSF to bailout Spain and Italy. Curtains for the euro.

Unless, of course, Europe succumbs to Berlin’s diktat, and takes a massive leap towards wholesale political unification. That would leave the UK on the periphery of a new superpower. However, expect popular resistance to such an outcome.

Consider yesterday morning’s headlines in the Greek press: “Haircut of national dignity – Greece under supervision”, “Demolition of the Greek people’s lives”, “Merkel’s guardianship”, “Government accepted permanent ‘occupation’ by the troika”, and (evocatively) “German tank brings new Memorandum”.