Fears that deadlock will lengthen Italy’s two-year recession and spill over into rest of the eurozone hit markets across Europe
Three years of German-led austerity and budget cuts aimed at saving the euro and retooling the European economy was left facing one of its biggest challenges as Italian voters’ rejection of spending cuts and tax rises opened up a stark new fissure in European politics.
The governing stalemate in Rome and the vote in the general election – by a factor of three to two – against the austerity policies pursued by Italy’s humiliated caretaker prime minister, Mario Monti, meant that the spending cuts and tax rises dictated by the eurozone would grind to a halt, risking a re-eruption of the euro crisis after six months of relative stability.
Fears that the deadlock will lengthen Italy’s near two-year recession and spill over into the rest of the eurozone hit markets across Europe. The Italian banking sector fell 7% in value, dragging the main MIB stock market index 4% lower.
The market turmoil in Milan spread to Germany, France and the UK, with domestic banks among the biggest fallers. Deutsche Bank saw almost 5% knocked off its value, while Barclays suffered a 4% decline. The FTSE 100 fell 1.4%. The German Dax slumped more than 2% and the Paris Cac was down 2.75%.
The cliffhanger vote saw the maverick comedian Beppe Grillo’s 5 Star movement take almost one in four of the votes and the political revival of the ex-prime minister Silvio Berlusconi. But the narrow victor, Pier Luigi Bersani, on the centre-left, claimed the mantle of the premiership, although it was unclear if he would be able to form a government.
Despite the withering popular verdict on cuts and taxes, Brussels and Berlin insisted the austerity programme had to be continued in Italy. France and others seized on the outcome for their own purposes, arguing for a relaxation of spending cuts and greater emphasis on policies to boost growth and job creation.
Bersani moved to try to cobble a government together by wooing the upstart Grillo with tentative talk of a reformist leftist coalition. Looking weary, Bersani said it was time for the 5 Star movement to do more than just demand a clean sweep of Italy’s established political order.
“Up to now they have been saying ‘All go home’. But now they are here too. So either they go home as well, or they say what they want to do for their country and their children.”
Grillo said earlier his followers in parliament would not join a coalition, but would consider proposals “law by law, reform by reform”.
Bersani said that, since his four-party alliance had won an outright majority in the lower house of the Italian parliament and more seats than any other grouping in the Senate, it had a responsibility to suggest ways in which Italy could be governed, despite the deadlock in the upper house.
Shunning the idea of a grand coalition with Berlusconi and the right, he proposed a government committed to a five-point plan for sweeping reform of Italy’s political parties and institutions.
The north-south split in Europe opened up by the election presaged clashes between eurozone governments, likely to surface at an EU summit next month, amid calls for a shift away from the harsh regime prescribed and driven through by Berlin in recent years as the price of bailing out insolvent eurozone periphery countries.
The Italian stalemate combines with tough negotiations over a bailout for Cyprus, being resisted by Germany, worries about the French economy, an unresolved debt crisis in Spain, and David Cameron’s decision to throw Britain’s future in Europe into question, making EU politics unusually volatile.
“Italy plays a central role in successfully overcoming Europe’s debt crisis,” said the German foreign minister, Guido Westerwelle.
“So we assume that the policy of fiscal consolidation and reform will be consistently followed by a new government.”
Angela Merkel, bidding for a third term as German chancellor in September, has been banking on a period of eurozone calm in the run-up to her election, but Italian voters have wrecked that calculation.
The Dutch finance minister, Jeroen Dijsselbloem, recently made head of the political committee that runs the euro, said Monti’s policies had to be continued. “They are crucial for the entire eurozone.”
The European Commission echoed the calls for sticking with the austerity medicine. Italy has the highest national debt level in the eurozone after Greece, although its budget deficit is in better shape than many others, including France and the Netherlands.
But Paris led the chorus for a policy shift. French government ministers, including Pierre Moscovici, the finance minister, demanded a change of course in remarks directed at Berlin.
Spain waited anxiously to see what impact the Italian leap in the dark would have on its debt crisis. “This is a jump to nowhere that does not bode well either for Italy or for Europe,” said the foreign minister, Jose-Manuel Garcia-Margallo, adding he was “extremely concerned” about the effect on Spain’s borrowing costs.
Both Berlusconi and Grillo have been harshly critical of the Germans, decried Monti’s austerity packages, and have raised questions as to whether Italy, the eurozone’s third biggest economy, should remain in the single currency. Grillo has called for a referendum on the matter.
Berlusconi rounded on the Germans on Tuesday, declaring that the “spread” – the difference between how much Italy and Germany pay to borrow on the bond markets – had been “invented” two years ago. This was code for saying that Berlin and Frankfurt, the German government and the European Central Bank, conspired to push up the cost of Italian borrowing in 2011 in order to topple Berlusconi and bring in Monti, the technocratic darling of the eurozone elite.
The turmoil saw Italian bond yields also jump, indicating that any new government will be forced to pay a higher interest rate on its debts.
The 10-year Italian bond yield edged back into dangerous territory on Tuesday after it passed 4.9%, although this is a far cry from 2011 when the yields shot above 7%.
As the Bank of England’s Andy Haldane points out, the first international Basel rules on finance ran to only 30 pages
Called upon at the start of the credit crunch to explain the collapse in value of a Goldman Sachs investment fund, the bank’s chief financial officer did some high-net-worth head-scratching: “We were seeing things that were 25-standard deviation moves, several days in a row.” Which all sounds plausibly lofty and technical until you are reminded of the observation from the economist Tim Harford that one wouldn’t expect to see three 25-standard deviation days in a row for far longer than the 13bn years the universe has been in existence. Goldman’s David Viniar was effectively saying that his models weren’t at fault; it was reality that was wrong.
Laughable though that sounds, financial regulators – the people paid to protect the rest of us from overconfident financiers – have trusted the bankers and their highly sophisticated models of risk. Indeed, the watchdogs have themselves adopted ever more complex models of risk – thus taking the bankers at their own word. As the Bank of England’s Andy Haldane points out in an important new paper, The Dog and the Frisbee, the first international Basel rules on finance reached in 1988 ran to only 30 pages. The latest incarnation, Basel III, weighs in at 616 pages. In America, the Dodd-Frank act on financial regulation is more than 20 times as long as Glass-Steagall, the 1933 law that split investment banks away from savings banks. All this complexity costs: the number of people employed in the UK’s financial sector has barely increased over the past 20 years (despite the lobbyists’ promises, finance does not create jobs); the number of regulators has leapt almost six-fold.
Yet all this detail and sophistication is a less effective guide to regulation than the old trusty rules of thumb. As Mr Haldane effectively demonstrates, looking at how much banks had borrowed by the end of 2006 – their leverage ratio – would have been a better predictor of which would go bust than all the rest of the armoury. As the Bank’s head of financial stability sums up: “Modern finance is … too complex… As you do not fight fire with fire, you do not fight complexity with complexity.”
Two obvious conclusions flow from this. The first is that financial economics is heading back towards the world as Keynes and Hayek knew it: where economic uncertainty was recognised as such, rather than mathematised and missold as controllable risks. Second, that regulators really ought to deal with bankers using a regime of brutal simplicity that errs of the side of caution. If a bank looks like it’s borrowed too much, it probably has – no matter what the risk models say – and should be stopped. Mr Haldane’s view makes far more sense than that described in the Basel agreements or Vickers commission: and in its simplicity, it is pleasingly radical.
Surprise filip in Athens stocks on ‘pro-Europe’ coalition rumours comes against backdrop of panic and economic devastation
Whatever government emerges from Greece’s make or break ballot on Sunday, it will take over a country on the edge of financial collapse.
The telltale signs are too obvious to ignore: the early morning queues outside banks, the banner headlines predicting economic disaster, the businesses shuttered and boarded up, the deals and projects put on hold.
“Absolutely nothing is moving either in the public or private sector,” said a prominent Athenian lawyer who sits on the committee of a large foreign hedge fund. “No one wants to invest, or make any commitment in such uncertainty,” she said. “They are all waiting to see what will happen after the election.”
If the economy is all about psychology, then Greece is already fighting a lost war – even if the Athens stock exchange soared on Thursdayon secret polling data suggesting that a pro-European coalition, committed to punishing reforms, would win the election.
The country’s main stock index closed a staggering 10.1% higher, with banking shares posting a collective 23.6% increase.
But the surprise development comes against a backdrop of devastation. Heightened talk of Athens’s exit from the eurozone in recent months has not only led to credit lines drying up but has spurred ever greater numbers of panic-stricken citizens to pull their savings from banks.
Up to €5bn (£4bn) is believed to have been withdrawn from local lenders in the past two weeks alone, according to media reports. Following inconclusive elections on 6 May, up to €700m was removed by depositors in a single day.
“Last week was especially bad,” said an official at the Bank of Greece. “People were pouring into our branch on Syntagma Square and literally emptying their accounts,” he said, referring to the capital’s main square.
Before the debt crisis erupted in December 2009, the country’s total household and corporate deposits stood at €238bn. Since then €72bn has made its way out of the system, with the Bank of Greece announcing that deposits stood at €165.9bn in April.
Much of the money is believed to be hidden in private homes, the result of Greeks fearing they will lose savings if Athens is forced to leave the single currency. But a great deal has also been whisked abroad, with stories of depositors travelling with suitcases stuffed with cash now legendary.
This week, it emerged that leading foreign lenders, including Deutsche Bank and Merrill Lynch, had dispatched delegations to Athens to lure private Greek depositors and companies.
The staff of European and US banks were reportedly working from suites in central hotels in an attempt to convince high earners to move deposits abroad. “Foreign banks are ‘fishing’ for Greeks and their savings,” declared a headline in the mass-selling daily Ethnos.
With the ballot widely seen as a referendum on the crisis-hit country’s future in Europe, bank officials say they expect outflows to increase dramatically if the leftist party, Syriza, emerges as the winner.
The party’s leader, Alexis Tsipras, reiterated that while Syriza was not aiming to leave the euro, it would rescind the unpopular austerity and structural reforms that Greece has undertaken in return for rescue loans from the EU and IMF if it came to power.
“The memorandum will be repudiated by the people’s vote, not us,” he told Antenna TV.
Tsipras has blamed Greece’s “violent internal devaluation” for deepening poverty in a country struggling with a fifth straight year of recession. By the end of the year, officials project that GDP will have shrunk by around 27% – an unprecedented contraction for an advanced western economy.
On Thursday, the nation’s statistics service revealed that the jobless rate, already at a record high, had jumped to 22.6% in the first quarter of this year because of the slump in economic activity.
With Athens being asked to enact more austerity measures – including reducing the minimum wage by a further 22% – the process of aggressive internal devaluation will only get worse, experts say.
“With wage reductions of up to 50%, what has remained of the middle class is trying to stay calm,” said Theodore Pelagidis, professor of economics analysis at the University of Piraeus.
“Tell me one country in the world that with so much austerity would be in a better situation? This is not creative destruction. It is destruction, period.”
From Greek industries, fast running out of raw materials, to supermarkets where stocks have been depleted, shortages are growing.
In recent weeks the healthcare system has been hit by a “critical lack” of medicines and other essentials including syringes and gauze, according to doctors. Shortages have been blamed on suppliers refusing to provide goods without down-payments in cash.
Highlighting the parlous state of the country’s public finances, Giorgos Zanias, the economy minister in the interim government, announced this week that reserves were drying up at a dramatic rate. The political paralysis spawned by the country’s indecisive vote last month had delivered a devastating blow to tax collection, with revenues falling precipitously. Greece, Zanias said, had “enough money to survive until 15 July”. After that, it would be unable to pay public sector wages and pensions.
“Whatever government emerges from the elections will be called to confront a tragic situation in Greece,” proclaimed the satirical weekly To Pontiki in an extensive report that was anything but funny.
Move sees value of shares jump by 6% to 212p as bank’s chairman Sir Philip Hampton says tactic will reduce volatility
Royal Bank of Scotland has swapped every 10 shares owned by investors for one new share – meaning they started trading at 200p, compared with 20p on Friday afternoon.
The “consolidation” is an attempt by the board to make the shares more attractive, and RBS closed up 6% at 212p.
Before the state bailout, which left the taxpayer with an 84% stake in the bank, shares were trading at around 600p on the old value.
Shares would now need to hit £60 to be at the same level. The RBS chairman, Sir Philip Hampton, said the tactic would reduce volatility in the bank’s share price.
At last, leaders of the eurozone are talking about the issue that really matters – the existential threat to the single currency
This week, Spain’s government did something extraordinary and dangerous – yet factually correct. Ministers admitted that their banks are in such severe trouble they’ll require a bigger cash injection than Madrid can stump up. This is the point that many observers of the euro crisis have been waiting for: the call for some kind of cross-border bank aid that could mean Germany and others handing over tens, if not hundreds, of billions in euros to Spain and others – largely to prop up their banks.
On the one hand, this is an extraordinary cry of desperation by a government that now freely admits it is all but locked out of financial markets, with lenders only willing to give it a loan at punitive interest rates. On the other, it is an admission of the truth – one that Spain, like so many other countries, has tried over the past couple of years to play down. But in finally admitting that its banking problem is too big for it to handle alone, Mariano Rajoy’s government has thrown open the door to a whole bunch of concerns and questions: whether Spain will have to ask for what is commonly called a bailout (but is more accurately a giant loan) from the rest of the eurozone; whether the other governments in the single-currency club have the financial or political capital to extend that lifeline; and, crucially, whether all this can be done before the bank jog visible across the southern eurozone turns into a full-on bank run with Northern Rock-style queues outside the cajas of Andalucía.
Before getting to those questions, though, it is worth saying this: at last, the leaders of the eurozone are talking about the issue that really matters – the existential threat to the single currency. Forget austerity, fiscal unions, and inflation regimes at the European Central Bank: with the large exception of Greece, the euro meltdown is primarily about how governments handle the wreckage in their financial sectors. Sure, other factors played a part – such as the vicious wage deflation in Germany that effectively priced southern Europe out of world markets – but the fundamental euro issue can best be summed up by twisting the old Clintonism: it’s the banks, stupid. Not just insolvent banks in Spain or Ireland, either, but the bigger institutions that lent to them and throughout the go-go markets of peripheral euroland. Admit that, and you see how the mild austerity imposed in Spain is the wrong solution, especially when combined with the relaxed approach to restructuring its bust banking sector, encouraging them to admit to bad loans (with numbers that always looked suspect), to merge and to bring in old politicians as bosses. Just as in Ireland, the web of connections between the elite financiers and good-ol’-boy politicos helped fuel the boom and inevitably made sorting out the bust more complex, expensive and ultimately ineffective.
Admitting the root cause of the euro’s problems does not guarantee a decent solution. There are two major issues here: one financial, the other political. At over 10% of the entire eurozone, Spain’s economy is almost twice as big as Greece, Portugal and Ireland put together. Estimates of how much it would cost to recapitalise the country’s banking sector easily reach €100bn – or about 10% of the country’s GDP. Madrid cannot raise such amounts, and so far there is little sign of the ECB accepting any workarounds. Nor is the rest of Europe ready with the cash. The Irish, who have ruined themselves to bail out their banks, would not take kindly to a country in an analogous situation being given a card to get out of debtors’ jail for free.
All this matters to Britain too. If it doesn’t do so today, the Bank of England will soon cut its key interest rate further and pump some more quantitative-easing billions into the economy. But visible on the horizon is a much more alarming prospect: that soon David Cameron will have to funnel more cash into the UK’s banks. This is a prospect that few talk about – except in code. But the longer the euro crisis drags on, and the bigger it grows, the closer that prospect looms.
• FTSE 100 index falls to lowest level since November
• Claim that contingency plan is in place for Greek euro exit
Stock markets across Europe and Asia suffered further losses on Friday as Spain fought to avoid being sucked deeper into the escalating crisis that threatens to push Greece out of the eurozone.
The FTSE 100 index of leading UK companies fell to its lowest level since last November, after a rout in Asia knocked 3% off both the Japanese Nikkei and the main Australian index. The FTSE 100 has now shed 11% since mid-March, as fears over Greece leaving the euro have intensified.
Greece remained centre-stage, after EU trade commissioner Karel De Gucht told a Dutch newspaper that European authorities had drawn up contingency plans to protect the euro in the event of Greece leaving the single currency. A European commission spokesman later denied that an emergency plan was under way, insisting: “We are concentrating all our efforts on supporting Greece and keeping it in the eurozone.”
The selloff was prompted by the news late on Thursday that rating agency Moody’s had slashed its rating on 16 Spanish banks. Santander was hit with a three-notch downgrade, with its British arm downgraded one notch. Moody’s blamed the sweeping downgrade on the weakening Spanish economy, and the Madrid government’s own deteriorating credit-worthiness.
Santander UK insisted that the move would not affect its growth plans, adding that customers should remain confident that it was well capitalised despite the problems in Spain. In another blow to the Spanish economy, the percentage of impaired bank debts rose to its highest level since 1994.
The Spanish government announced that it will name two independent auditors on Monday to conduct stress tests to see whether its banks are strong enough. City analyst Nicholas Spiro, of Spiro Sovereign Strategy, warned that Spain was “treading on very thin ice”.
“The increasing risk of a Greek exit from the eurozone is putting even more pressure on Spanish bond yields as ‘break-up contagion’ starts to take hold. The downgrades are part of a drip-feed of dire economic and financial news out of Spain,” Spiro said.
Angela Merkel, the German chancellor, took time ahead of the G8 summit in the US to telephone Greek president Karolos Papoulias to express “the German government’s wish for a functioning government in Greece”. On Thursday night, Fitch downgraded its credit rating on Greece, saying there was a higher risk that it leaves the single currency after June’s general election.
Traders in the City were in gloomy mood, despite the excitement of the impending Facebook flotation.
“The ugly prospect of bank runs appears to be spreading over Europe, rumours having hit Spanish banks yesterday to complement those heard about Greece earlier in the week,” said David Jones of IG Index.
At lunchtime in London the FTSE 100 was down 45 points, or 0.8%, at 5295, with Lloyds Banking Group losing 4% to 26.5p, and Royal Bank of Scotland down 3% at 20.4p. Other European markets had clawed back losses. The Nikkei closed 2.99% at 8611.31.
Greece’s euro membership was as much the German elite’s fault as anyone’s. Can it find the leadership to resolve the crisis?
Sometimes, just sometimes, economics and politics are like physics – one can recognize immutable forces. One of those times is now, as Greece is inexorably pushed out of the euro. It took no particular talent to have seen this coming, just the recognition that it has always been a fantasy to believe that the Greeks would democratically choose to destroy their economy for the better part of a decade in order to pay foreign creditors.
The fact is that Greece never was a suitable member of the eurozone. That the Greek economy was extremely inefficient, that corruption was rife, that the government budgets were perpetually out of control, and that the official statistics were not to be believed were widely known. But, as in many marriages, Greece’s entry into the euro was a triumph of sentimentality and wilful blindness over realism.
The pity – in addition to the actual damage already inflicted on millions of Greeks – of this debacle is that it was never clear, and still isn’t clear, that other countries, like Spain, will also be inexorably forced out. For the adjustment that Spain needs to make in order to stay in the euro was never as drastic as it was for Greece. While undoubtedly painful, it is probably still do-able.
But what has become unavoidably clear is that Germany, the linchpin of the eurozone, has been hopelessly stuck in an attitude that makes the break-up of the eurozone almost unavoidable. If Germany cannot pull itself together to keep Spain in the euro, then the markets can no longer ignore the fact that the lack of leadership and governance is a fatal flaw in the system.
What accounts for this? I would argue that the heart of the problem lies in the political culture of Germany and the mindset of its political and economic elites, which have never been willing to admit to their own voters the sacrifices that must be undertaken in order to be the leader of Europe. Instead, they have led Germans to believe that they can have it both ways: enjoying the fruits of the eurozone while times were good, and lobbing the burden of adjustment onto others when times got bad.
By doing this, the German elites set a trap for themselves with their own voters from which they cannot easily escape. Greece has been the perfect storm for the flaws of the eurozone and the vacuum of German leadership. Early in the crisis, the best course of action – the one I believe most likely to have preserved the core of the eurozone – would have been to admit the mistake of admitting Greece into the euro. From that recognition, Greece should have been eased out of the euro, while the German and French banks that were on the hook for losses could have been recapitalized. Finally, a massive firewall of monetary and fiscal support for Spain would have been announced.
But to achieve all this would have required a huge loss of face to the German voters – and a willingness to assume the burdens of leadership.
Instead, in the German mindset, Greece became a convenient but bogus template for assigning blame to other periphery countries – particularly, Ireland and Spain. Rather than acknowledging that these countries suffered from the bursting of a property bubble, greatly inflated by German and French lending, German elites pilloried them alike for having out-of-control budgets and inefficient workers. In the end, it was easier to blame and to moralize than to admit the truth.
Now that the elections in Greece, France and the Netherlands have smashed any illusion that all of the adjustment necessary to make the eurozone work can be foisted on other countries, will Germany step up to the plate? Will it advocate for a higher inflation rate, for a common fund for bank recapitalization, and a policy of direct government bond-purchases by the ECB? In other words, will it finally be truthful with its voters about what must be done in order to save the euro?
Sunday’s regional German elections offer a small ray of hope. Merkel’s party received a thrashing in North Rhine-Westphalia, home to nearly one in five Germans. Rejecting the conservatives’ hard-line platform of more austerity and finger-pointing, German voters instead voted for the Social Democrats, for a platform of more spending and, shockingly, for more debt. This caps a series of defeats in state elections for Merkel and makes it increasingly clear that her government is in serious jeopardy.
Perhaps, just perhaps, German voters are waking up. And therein lies the possibility that the euro can be saved.
But it’s a race against time at this point. Precious time, credibility and resources have been lost. Lives have been up-ended and shattered, voters are angry and restive, markets are in a hostile and unforgiving mood. It is said that leaders are born of great crises. It is now or never for Germany.