Walter Radermacher, head of the European Union’s statistics agency Eurostat, says Greece is the only euro country that lied about using complex swap contracts to conceal debt. Four months after the 110 billion-euro ($140 billion) bailout for Greece, the nation still has not disclosed the full details of secret financial transactions it used to conceal debt. “We have not seen the real documents,” Walter Radermacher, head of the European Union’s statistics agency Eurostat, said in a Sept. 2 interview in his Luxembourg office. Eurostat first requested the contracts in February. Radermacher vows new toughness when officials from his staff head to Greece this month to come up with a “solid estimate” of the total value of debt hidden by the opaque contracts.

 “This is a new era,” he said. Greece is the only euro country that lied about using these complex swap contracts after Eurostat told countries to report them in 2008, Radermacher said. It also likely signed a greater number of individual agreements than any other euro member, based on information it has provided to Eurostat, he said. Greece’s debt was 115.1 percent of its total economic output last year, second among the 16 counties that share the euro, behind Italy’s 115.8 percent.

“What the Greeks did was an absolute cardinal sin,” said Ruairi Quinn, former finance minister of Ireland. “They deserve to be punished for it. I think they have been severely punished for it.”

Confidence in Greece’s statistics and its ability to repay debt was shattered in October, when the country more than doubled its 2009 deficit estimate. The euro plunged, sparking questions whether the single European currency could survive. It has lost 15 percent of its value against the dollar since Oct. 20.

No trust in markets
Investors still don’t trust Greece. They demand yields more than five times that of Germany to hold 10-year Greek debt – a sign that buyers fear the country will have to reorganize its borrowing.

“I think restructuring will be a necessary part of them pulling out of the predicament they are in,” said Andrew Bosomworth, Munich-based head of portfolio management at Pacific Investment Management Co. He cited the projection of the International Monetary Fund, or IMF, which foresees Greece’s debt topping out 149 percent of gross domestic product in 2012.

Banks worldwide increased their total exposure to Greek debt in the first quarter of the year by 7.1 percent, or $20.7 billion, to $297.2 billion, according to a Sept. 6 report by the Bank for International Settlements. Norway’s sovereign wealth fund, the world’s second largest, said in August that it had bought Greek bonds, along with those from Spain and Portugal, because of higher yields and as those governments push to reduce their deficits.

The fiscal crisis turned attention to currency swaps arranged by Goldman Sachs that helped Greece hide the extent of its debt.

“There are more, or even many, of this kind of swap operation, which we have to clarify,” said Radermacher. “The Goldman Sachs case was the beginning.”

Greece has told the agency that the other contracts were each significantly smaller than the ones signed with Goldman Sachs, Radermacher said. Signed in 2000 and 2001, the Goldman swaps reduced the country’s foreign denominated debt in euro terms by 2.367 billion euros and lowered debt as a proportion of GDP to 103.7 percent from 105.3 percent, according to a Feb. 21 statement by Goldman.

In April, Eurostat said it might have to revise Greece’s 2009 debt figure higher by as much as 7 percentage points of GDP, in part because of the use of swap contracts that allowed it to reduce current reported debt in return for greater liabilities in future years.

Swapping away debt
About a third of Greece’s borrowings have swaps attached to them, according to a person with direct knowledge of the operations. Only a portion of those contracts were set up in a way to reduce current reported debt, the person said. Radermacher said he believed Greece stopped using swaps that included up-front payments in 2008, about the same time that Eurostat questioned the country that year.

Eurostat gained new powers effective last month that allow it to audit a country’s financial data if it can show there are clear risks that the statistics aren’t accurate. The visit to Greece this month will include officials from Eurostat, the European Central Bank and the European Commission’s Economic and Financial Affairs directorate, Radermacher said. “Because we have more muscles, so to say, we are free to ask for an inside look to whatever we find important or relevant,” he said.

He said he expects to have sufficient details to present an estimate of the off-market swaps’ impact for its semi-annual report on member states’ debts and deficits on Oct. 22.

In the week following the bankruptcy of Lehman Brothers on Sept. 15, 2008 — global financial markets actually broke down, and by the end of the week, they had to be put on artificial life support. The life support consisted of substituting sovereign credit for the credit of financial institutions, which ceased to be acceptable to counterparties.

As Mervyn King of the Bank of England brilliantly explained, the authorities had to do in the short term the exact opposite of what was needed in the long term: they had to pump in a lot of credit to make up for the credit that disappeared, and thereby reinforce the excess credit and leverage that had caused the crisis in the first place. Only in the longer term, when the crisis had subsided, could they drain the credit and re-establish macroeconomic balance.

This required a delicate two-phase maneuver just as when a car is skidding. First you have to turn the car into the direction of the skid and only when you have regained control can you correct course.

The first phase of the maneuver has been successfully accomplished — a collapse has been averted. In retrospect, the temporary breakdown of the financial system seems like a bad dream. There are people in the financial institutions that survived who would like nothing better than to forget it and carry on with business as usual. This was evident in their massive lobbying effort to protect their interests in the Financial Reform Act that just came out of Congress. But the collapse of the financial system as we know it is real, and the crisis is far from over.

Indeed, we have just entered Act II of the drama, when financial markets started losing confidence in the credibility of sovereign debt. Greece and the euro have taken center stage, but the effects are liable to be felt worldwide. Doubts about sovereign credit are forcing reductions in budget deficits at a time when the banks and the economy may not be strong enough to permit the pursuit of fiscal rectitude. We find ourselves in a situation eerily reminiscent of the 1930s. Keynes has taught us that budget deficits are essential for counter cyclical policies, yet many governments have to reduce them under pressure from financial markets. This is liable to push the global economy into a double dip.

It is important to realize that the crisis in which we find ourselves is not just a market failure but also a regulatory failure, and even more importantly, a failure of the prevailing dogma about financial markets. I have in mind the Efficient Market Hypothesis and Rational Expectation Theory. These economic theories guided, or more exactly misguided, both the regulators and the financial engineers who designed the derivatives and other synthetic financial instruments and quantitative risk management systems which have played such an important part in the collapse. To gain a proper understanding of the current situation and how we got to where we are, we need to go back to basics and re-examine the foundation of economic theory.

I have developed an alternative theory about financial markets which asserts that financial markets do not necessarily tend toward equilibrium; they can just as easily produce asset bubbles. Nor are markets capable of correcting their own excesses. Keeping asset bubbles within bounds have to be an objective of public policy. I propounded this theory in my first book, “The Alchemy of Finance,” in 1987. It was generally dismissed at the time, but the current financial crisis has proven, not necessarily its validity, but certainly its superiority to the prevailing dogma.

Let me briefly recapitulate my theory for those who are not familiar with it. It can be summed up in two propositions. First, financial markets, far from accurately reflecting all the available knowledge, always provide a distorted view of reality. This is the principle of fallibility. The degree of distortion may vary from time to time. Sometimes it’s quite insignificant, at other times it is quite pronounced. When there is a significant divergence between market prices and the underlying reality I speak of far from equilibrium conditions. That is where we are now.

Second, financial markets do not play a purely passive role; they can also affect the so-called fundamentals they are supposed to reflect. These two functions that financial markets perform work in opposite directions. In the passive or cognitive function, the fundamentals are supposed to determine market prices. In the active or manipulative function market, prices find ways of influencing the fundamentals. When both functions operate at the same time, they interfere with each other. The supposedly independent variable of one function is the dependent variable of the other, so that neither function has a truly independent variable. As a result, neither market prices nor the underlying reality is fully determined. Both suffer from an element of uncertainty that cannot be quantified. I call the interaction between the two functions reflexivity. Frank Knight recognized and explicated this element of unquantifiable uncertainty in a book published in 1921, but the Efficient Market Hypothesis and Rational Expectation Theory have deliberately ignored it. That is what made them so misleading.

Reflexivity sets up a feedback loop between market valuations and the so-called fundamentals which are being valued. The feedback can be either positive or negative. Negative feedback brings market prices and the underlying reality closer together. In other words, negative feedback is self-correcting. It can go on forever, and if the underlying reality remains unchanged, it may eventually lead to an equilibrium in which market prices accurately reflect the fundamentals. By contrast, a positive feedback is self-reinforcing. It cannot go on forever because eventually, market prices would become so far removed from reality that market participants would have to recognize them as unrealistic. When that tipping point is reached, the process becomes self-reinforcing in the opposite direction. That is how financial markets produce boom-bust phenomena or bubbles. Bubbles are not the only manifestations of reflexivity, but they are the most spectacular.

In my interpretation equilibrium, which is the central case in economic theory, turns out to be a limiting case where negative feedback is carried to its ultimate limit. Positive feedback has been largely assumed away by the prevailing dogma, and it deserves a lot more attention.

I have developed a rudimentary theory of bubbles along these lines. Every bubble has two components: an underlying trend that prevails in reality and a misconception relating to that trend. When a positive feedback develops between the trend and the misconception, a boom-bust process is set in motion. The process is liable to be tested by negative feedback along the way, and if it is strong enough to survive these tests, both the trend and the misconception will be reinforced. Eventually, market expectations become so far removed from reality that people are forced to recognize that a misconception is involved. A twilight period ensues during which doubts grow and more and more people lose faith, but the prevailing trend is sustained by inertia. As Chuck Prince, former head of Citigroup, said, “As long as the music is playing, you’ve got to get up and dance. We are still dancing.” Eventually a tipping point is reached when the trend is reversed; it then becomes self-reinforcing in the opposite direction.

Typically bubbles have an asymmetric shape. The boom is long and slow to start. It accelerates gradually until it flattens out again during the twilight period. The bust is short and steep because it involves the forced liquidation of unsound positions. Disillusionment turns into panic, reaching its climax in a financial crisis.

The simplest case of a purely financial bubble can be found in real estate. The trend that precipitates it is the availability of credit; the misconception that continues to recur in various forms is that the value of the collateral is independent of the availability of credit. As a matter of fact, the relationship is reflexive. When credit becomes cheaper, activity picks up and real estate values rise. There are fewer defaults, credit performance improves, and lending standards are relaxed. So at the height of the boom, the amount of credit outstanding is at its peak, and a reversal precipitates false liquidation, depressing real estate values.

The bubble that led to the current financial crisis is much more complicated. The collapse of the subprime bubble in 2007 set off a chain reaction, much as an ordinary bomb sets off a nuclear explosion. I call it a superbubble. It has developed over a longer period of time, and it is composed of a number of simpler bubbles. What makes the superbubble so interesting is the role that the smaller bubbles have played in its development.

The prevailing trend in the superbubble was the ever-increasing use of credit and leverage. The prevailing misconception was the belief that financial markets are self-correcting and should be left to their own devices. President Reagan called it the “magic of the marketplace,” and I call it market fundamentalism. It became the dominant creed in the 1980s. Since market fundamentalism was based on false premises, its adoption led to a series of financial crises. Each time, the authorities intervened, merged away, or otherwise took care of the failing financial institutions, and applied monetary and fiscal stimuli to protect the economy. These measures reinforced the prevailing trend of ever-increasing credit and leverage, and as long as they worked, they also reinforced the prevailing misconception that markets can be safely left to their own devices. The intervention of the authorities is generally recognized as creating amoral hazard; more accurately it served as a successful test of a false belief, thereby inflating the superbubble even further.

It should be emphasized that my theories of bubbles cannot predict whether a test will be successful or not. This holds for ordinary bubbles as well as the superbubble. For instance, I thought the emerging market crisis of 1997-98 would constitute the tipping point for the superbubble, but I was wrong. The authorities managed to save the system and the superbubble continued growing. That made the bust that eventually came in 2007-8 all the more devastating.

What are the implications of my theory for the regulation of the financial system?

First and foremost, since markets are bubble-prone, the financial authorities have to accept responsibility for preventing bubbles from growing too big. Alan Greenspan and other regulators have expressly refused to accept that responsibility. If markets can’t recognize bubbles, Greenspan argued, neither can regulators — and he was right. Nevertheless, the financial authorities have to accept the assignment, knowing full well that they will not be able to meet it without making mistakes. They will, however, have the benefit of receiving feedback from the markets, which will tell them whether they have done too much or too little. They can then correct their mistakes.

Second, in order to control asset bubbles it is not enough to control the money supply; you must also control the availability of credit. This cannot be done by using only monetary tools; you must also use credit controls. The best-known tools are margin requirements and minimum capital requirements. Currently, they are fixed irrespective of the market’s mood, because markets are not supposed to have moods. Yet they do, and the financial authorities need to vary margin and minimum capital requirements in order to control asset bubbles.

Regulators may also have to invent new tools or revive others that have fallen into disuse. For instance, in my early days in finance, many years ago, central banks used to instruct commercial banks to limit their lending to a particular sector of the economy, such as real estate or consumer loans, because they felt that the sector was overheating. Market fundamentalists consider that kind of intervention unacceptable, but they are wrong. When our central banks used to do it, we had no financial crises to speak of. The Chinese authorities do it today, and they have much better control over their banking system. The deposits that Chinese commercial banks have to maintain at the People’s Bank of China were increased 17 times during the boom, and when the authorities reversed course, the banks obeyed them with alacrity.

Third, since markets are potentially unstable, there are systemic risks in addition to the risks affecting individual market participants. Participants may ignore these systemic risks in the belief that they can always dispose of their positions, but regulators cannot ignore them because if too many participants are on the same side, positions cannot be liquidated without causing a discontinuity or a collapse. They have to monitor the positions of participants in order to detect potential imbalances. That means that the positions of all major market participants, including hedge funds and sovereign wealth funds, need to be monitored. The drafters of the Basel Accords made a mistake when they gave securities held by banks substantially lower risk ratings than regular loans: they ignored the systemic risks attached to concentrated positions in securities. This was an important factor aggravating the crisis. It has to be corrected by raising the risk ratings of securities held by banks. That will probably discourage loans, which is not such a bad thing.

Fourth, derivatives and synthetic financial instruments perform many useful functions, but they also carry hidden dangers. For instance, the securitization of mortgages was supposed to reduce risk through geographical diversification. In fact, it introduced a new risk by separating the interest of the agents from the interest of the owners. Regulators need to fully understand how these instruments work before they allow them to be used, and they ought to impose restrictions guard against those hidden dangers. For instance, agents packaging mortgages into securities ought to be obliged to retain sufficient ownership to guard against the agency problem.

Credit-default swaps (C.D.S.) are particularly dangerous. They allow people to buy insurance on the survival of a company or a country while handing them a license to kill. C.D.S. ought to be available to buyers only to the extent that they have a legitimate insurable interest. Generally speaking, derivatives ought to be registered with a regulatory agency just as regular securities have to be registered with the S.E.C. or its equivalent. Derivatives traded on exchanges would be registered as a class; those traded over-the-counter would have to be registered individually. This would provide a powerful inducement to use exchange traded derivatives whenever possible.

Finally, we must recognize that financial markets evolve in a one-directional, nonreversible manner. The financial authorities, in carrying out their duty of preventing the system from collapsing, have extended an implicit guarantee to all institutions that are “too big to fail.” Now they cannot credibly withdraw that guarantee. Therefore, they must impose regulations that will ensure that the guarantee will not be invoked. Too-big-to-fail banks must use less leverage and accept various restrictions on how they invest the depositors’ money. Deposits should not be used to finance proprietary trading. But regulators have to go even further. They must regulate the compensation packages of proprietary traders to ensure that risks and rewards are properly aligned. This may push proprietary traders out of banks, into hedge funds where they properly belong. Just as oil tankers are compartmentalized in order to keep them stable, there ought to be firewalls between different markets. It is probably impractical to separate investment banking from commercial banking as the Glass-Steagall Act of 1933 did. But there have to be internal compartments keeping proprietary trading in various markets separate from each other. Some banks that have come to occupy quasi-monopolistic positions may have to be broken up.

While I have a high degree of conviction on these five points, there are many questions to which my theory does not provide an unequivocal answer. For instance, is a high degree of liquidity always desirable? To what extent should securities be marked to market? Many answers that followed automatically from the Efficient Market Hypothesis need to be re-examined.

It is clear that the reforms currently under consideration do not fully satisfy the five points I have made, but I want to emphasize that these five points apply only in the long run. As Mervyn King explained, the authorities had to do in the short run the exact opposite of what was required in the long run. And as I said earlier, the financial crisis is far from over. We have just ended Act II. The euro has taken center stage, and Germany has become the lead actor. The European authorities face a daunting task: they must help the countries that have fallen far behind the Maastricht criteria to regain their equilibrium while they must also correct the deficiencies of the Maastricht Treaty which have allowed the imbalances to develop. The euro is in what I call a far-from-equilibrium situation. But I prefer to discuss this subject in Germany, which is the lead actor, and I plan to do so at the Humboldt University in Berlin on June 23. I hope you will forgive me if I avoid the subject until then.

The years of steady enrichment in Europe seem to be at an end. Gone is the confident talk of prosperity through unity, instead the focus is on the great financial crisis welling up on the union's southern fringe, as a rising sea of debt threatens to drown the dreams of millions across the continent.

When it gets dark the drug dealers come out in Exarchia Square. The students walk past them in little groups, deep in argument and abstract thought. Posters shout at you in vivid colours: against capitalism - against police brutality. The riot cops rest, exhausted, against the street corners. This is a typical scene from a place called Europe. If you had to re-enact it, 1,000 years from now, you could reconstruct the whole thing from the costumes - the square sunglasses bourgeois women use to hold their hair back - the jeans and stubble of the manual working men who flood the streets of central Athens when there's a general strike. Layered, tribal, intensely urban, sporadically violent, intellectual, tolerant and until now resilient - this is the civilisation the European Union was set up in after 1945. The euro currency was supposed to harmonise it all, but it now faces its biggest challenge for decades because Europe has become the weak link in the world economy. While China and America have recovered, Europe has been pushed through a door marked austerity.

American disease?

The eurozone has a currency and a central bank but no central government. In place of that, the 1992 Maastricht Treaty imposed common rules: low budget deficits, national debts below 60% of GDP, no bailouts and no central bank intervention in the market for government debt. At the time, all this seemed like a good idea. It was the prevailing economic doctrine. But if you live long enough, you do tend to see today's economic doctrine become wrapping paper for tomorrow's souvlaki. Fast forward to 2010. Europe has survived the credit crunch. The banks infected by that horrible American disease have been saved by medicine dispensed by the European Central Bank. So mild is Europe's recession that President Sarkozy and Chancellor Merkel have the moral high ground at G20 summits. The problem is that, just as with Wall Street, the rules were a fiction. The Greek government, with the help of Goldman Sachs, had moved some of its debts "off balance sheet", just like Enron and Lehman Brothers. As the truth emerged with the election of a new government, Greece's deficit doubled. Twice, Greece drew up plans to slash that deficit. Twice they were approved by Europe and twice the expected bailout failed to emerge. Then, those who lend money to southern Europe realised they might not get it all back. The markets had assumed the Greek people would bear all the pain of deficit reduction and now they realised they, the investors, would lose money. They looked at Ireland with its deserted villages of new-built homes, at Spain with its deflation and mass unemployment and made this calculation - if Greece is allowed to renege on part of its debts, then the rest will follow. So a crisis that could have cost 30bn euros to stop will now cost 750bn - a third of it from the IMF. The no bailout rule is dead. The "no IMF involvement rule" is dead and the European Central Bank, which once insisted on the highest quality collateral, is now swapping good, clean euro notes for, effectively, junk IOUs.

Risk transfer

Why did the EU turn a blind eye for so long to what was happening in Greece? Because all those Prada outlets in central Athens and all those shiny new tractors now lined up at roadblocks along all those brand new motorways in Greece were signs of "harmonisation". This was a phenomenon across south Europe. You could say the whole liberalisation process in politics - from Galway to Lisbon to Barcelona to Athens - was based on a middle class getting quietly rich on property speculation and tax evasion. The whole social truce constructed between the labour movements and employers was based on rapid growth in wages and pension rights, above all in the public sector. As the price of the bailout, the industrial giants of northern Europe want rigid rules on tax, spending and borrowing enforced. Northern Europe has seized control of southern Europe - and for me, this completes a process of risk-transfer that's been under way since Lehman collapsed.

In the autumn of 2008 all the risk was in the banking system. Then, states all over the world took on that risk and for a year they contained it. Now the risk is passing from small states to big states. And it's passing to somewhere else - to the streets. Those narrow streets around Exarchia Square are world-notorious for radicalism and bohemianism. But you will find the same social mix in the 1,000-year-old streets of Oviedo to Perugia to Bratislava. A generation of adult workers who will now see their wages and pensions slashed. A young generation of college leavers who can see no future. For them austerity, even if it saves the euro, may never bring back the lifestyle they were promised. And the risk is they might reject austerity.

by Paul Mason, BBC News

Foreign holders of Greek and Portuguese debt have seized on emergency intervention by the European Central Bank to exit their positions, leaving eurozone taxpayers exposed to the credit risk.

The Bank of New Mellon said its custodial data showed a "sharp acceleration" of net sales of debt from the two countries after the ECB began purchasing €16.5bn of bonds from southern Europe and Ireland in bid to halt market panic. "It rather suggests that investors leapt at the opportunity to clear their balance sheets of intolerable risk," said Neil Mellor, the bank’s currency strategist. "This leaves the ECB itself in an unpleasant situation since it now faces a deterioration in its own balance sheet."

While ECB action has greatly reduced bond spreads on peripheral eurozone debt, it has not yet stabilized the broader markets. The euro fell to a four-year low of $1.2260 against the dollar in early trading. Jean-Claude Juncker, the head of the Eurogroup, said on Monday that this risks becoming disorderly. "I'm not worried as far as the current exchange rate is concerned: I'm worried as far as the rapidity of the fall is concerned."

Crucially, there are still serious strains in the interbank lending market. Hans Redeker, currency chief at BNP Paribas, said the LIBOR-OIS spread in Europe used to gauge credit stress is flashing danger signals, hovering near levels seen during the Lehman crisis.

The ECB’s strategy of draining liquidity to offset the stimulus from the bond purchases risks making matters worse. "They are using one-week deposits for sterilisation and the effects of this to make short-term funding more expensive. This will force banks to sell assets to shrink their balance sheet and risks causing a credit crunch," he said.

Mr Redeker said the ECB is pursuing a contractionary policy to assuage concerns in Germany that Club Med bond purchases will stoke inflation. "They have read the German press and it made their hair stand up on their necks. The reality is that a deflationary cycle is developing in Euroland and the ECB will eventually have to start quantitative easing," he said.

Dominic Wison, market chief at Goldman Sachs, said talk of an EMU break-up were overblown but echoed concerned about strains in the short-term money markets. "The LIBOR-OIS spreads widened consistently through the week. Ongoing pressures on funding have not yet been quieted. As we saw in 2008 and 2009, those stresses – if they do not subside – are generally toxic for markets," he wrote in a client note.

A report by RCB Capital Markets said German banks have yet to come clean on 75pc of their combined exposure to €45bn of Greek debt. The state-owned Hypo Re has revealed holdings of €7.8bn, equal to 243pc of its tangible equity. Commerzbanks’s subsidiary Eurohypo holds €3bn, or 77pc, of its tangible equity.

RBS said that some German banks may face risks if there is a voluntary debt restructuring by Greece, since this would not trigger debt insurance contracts on credit default swaps. This would leave them facing much larger debt write-downs than they bargained for.

Analysts say austerity measures across southern Europe are causing the euro to weaken further because they will dampen growth and may lead to protracted slumps, forcing the ECB to delay rate rises.

Italy is next in line for a fiscal squeeze, preparing €25bn of belt-tightening over the next two years. Leaks in the Italian media say Rome plans to freeze public sector wages, limit recruitment, and delay retirement.

The goal is to build a "primary" budget surplus (before interest costs) of 1pc of GDP in 2011 and 2.5pc in 2012 in order to demonstrate discipline to the bond markets. Finance minister Giulio Tremonti, who has been praised for his iron control of spending, aims to establish an ample margin of safety to secure Italy’s place in monetary union.

Italy’s impressive efforts – following austerity packages in Ireland, Greece, Portugal, and Spain – show much Britain has to do to avoid being left behind by other countries in what amounts to a beauty contest over deficits and sovereign debt in global markets.

Greece, Goldman Sachs, Dow drop, weapons of mass financial destruction & computerized front running high-frequency programs

http://www.asymptotix.eu/content/greece-goldman-sachs-dow-drop-weapons-mass-financial-destruction-computerized-front-running

There is no safe haven anymore, the European bond markets and thus equity markets have no floor under them anymore, so it looks like the ECB is going to have to do another liquidity injection exercise through the secondary markets for sovereign debt. This is just a massive sticking plaster. The bottom line is that Europe lacks the institutional configuration to respond to modern financial markets (let alone supervise them). The power game is who will OWN those new institutions necessary to allow Europe's political executive to manage financial crises. In my view this is going to lead to questions inevitably about the political legitimacy of the European Commission and the institutional configuration which bulwarks it. Since the commission is rapaciously sucking all power to its centre at Schuman and in a control freak manner setting out degrees of freedom for the European Central Bank. I fear an argument in Brussels now of an infinite regress nature which no European (and yes I include the Brits) has time for.

http://www.asymptotix.eu/content/portugal-debt-crisis-closer-look-whether-portugal-next-line

Merkel defends Greece rescue package in parliament

German Chancellor Angela Merkel defended her government's Greece rescue package on Wednesday, saying it was for "the future of Europe and Germany.". "We're at a cross in the road," Merkel said in parliament. "This is about nothing less than the future of Europe and the future of Germany in Europe.". "Europe is looking at us today. Without us, against us, there won't be any decision," she said. "With us, with Germany, there can and will be a decision which lives up to the political, historical situation.". Aiding Greece is the only way to avoid a chain reaction that may affect other eurozone members and the stability of the euro, she warned. Merkel said the EU's Stability and Growth Pact must be reformed in order to give more sanctions options, as a lesson learned from the current crisis in Greece.

The German government on Monday approved a rescue package of 22.4 billion euros (29.1 billion U.S. dollars) for the debt-laden Greece over three years as part of the 110-billion-euro (149-billion-U.S.-dollar) loan from the EU and IMF. German Parliament will vote on this package on Friday, which is expected to meet tough opposition.

Greek Crisis Hydra Engulfs the Euro Zone

Investors and European lawmakers were given a stark reminder that this weekend’s 110 billion euros ($143 billion) rescue package for Greece has yet to draw a line under the sand of the euro zone debt crisis. Tuesday's selloff in stocks continued Wednesday morning in Europe, while the euro's losses deepened on contagion worries. The shorts went after the single currency and bought the dollar. Share prices across the world fell heavily and yields on Portuguese, Spanish and Greek debt all rose sharply as protestors took to the streets of Athens to demonstrate against austerity measures imposed as part of the IMF/EU rescue deal.

As German lawmakers prepare to discuss the Greek rescue package in Berlin ahead of a vote on Friday, the market is already beginning to ask if the German public and the European Union have the stomach for a rescue package for Portugal, for Spain, for Ireland and even for Italy. The German parliament is expected to vote in favor of the Greek rescue plan, with other euro zone members expected to follow suit. Greece now has at least two years breathing space to get its house in order and strip costs out of its bloated public sector. Chancellor Angela Merkel told lawmakers in Berlin this morning that Germany will "live up to its responsibility to the euro."

The cost of that responsibility remains unclear and bankers, investors and analysts give opposing views on how contagious the Greek situation is. Frédéric Oudéae, the CEO of French banking giant Societe Generale which has 3 billion euros exposure to Greek government debt, told CNBC in an exclusive interview that the market was overreacting to the Greek story. Oudéae dismissed fears of contagion saying other euro zone countries where not in a similar situation.

How Much to Stop Contagion?

But Jan Lambregts, global head of financial markets research at Rabobank, disagrees with this view over the long-term. The market, which is often accused of a short-term view, is now taking a very long-term look at the Greek situation and asking if 110 billion euros is just a fraction of what will ultimately be needed to stop contagion. The International Monetary Fund's chief Dominique Strauss-Kahn said there was a risk that the Greek crisis would spread to the rest of Europe, according to a French newspaper report. Lambregts believes investors should be watching for two factors. Firstly, can Greece deliver on its promised austerity program? "Governments need to be elected and it remains to be seen if Greek voters will accept the tough measures imposed by the IMF and EU," he said. The second factor is the impact of austerity measures on economic growth. There is a major risk in the austerity measures pushing Greece into a deep recession, said Lambregts, who questions how higher taxes and lower government spending can lead to growth.

Under the terms of the austerity package, Greece is expected to return to growth within three years but he believes even these lowered targets are ambitious. Amid Tuesday's market selloff, a rumor was doing the rounds that Spain would require 280 billion euros to shore up its finances. Spanish Prime Minister Jose Luis Rodriguez Zapatero dismissed this as "complete madness" but the Spanish stock market fell by 7 percent.

Speculation on what it would cost to bail out Portugal or Spain is now rife, with analysts across the world crunching the numbers on the basis of the Greek package and there is a real risk that this speculation could become self fulfilling.

Credibility Is the Key

If Spain and others are real about averting an attack by the shorts, they need to clearly signal to the market they are credible now, said Lambregts. "Proactive action is needed to get ahead of the market on this story. There is no reason for the market to help them out of a crisis and further action is needed. The current crisis is like Hydra; every time you cut off a head another one grows back and takes a different line of attack," he said.

Governments like Spain and Portugal have no place to hide now, Anthony Gibbs, a senior gilts broker at Vantage Capital Markets said. "Urgent action is needed and it is not just in the euro zone. The UK and US also need to get their acts together," Gibbs told CNBC. The man who oversaw market stability for the Bank of England during the banking crisis believes dithering at the EU level raised the eventual costs of the Greek rescue package.

Sir John Gieve, the former deputy governor of the BoE, told a meeting in London on Tuesday that "there has been sort of a Lehman's moment in the EU.". "They have sort of dithered over this. Will they, won't they, should they shouldn't they, as a result, the price of saving the day has gone up," he said. The big question now is whether governments in Greece and other euro zone members can gain credibility on austerity measures and borrowing without losing power.

If not, the big question will be how much it will cost to rescue the euro zone or find a way out of the 10-year experiment.

Greece announced on Sunday it had agreed with the European Union and International Monetary Fund on the terms of a multi-billion euro rescue package aimed at averting a sovereign default. A sombre George Papandreou, prime minister, told an emergency cabinet meeting,”Our priority is to avoid bankruptcy… That is a red line that cannot be crossed.”

Mr Papandreou’s address to the cabinet, broadcast live on state television, highlighted the challenges Greece faces to implement the €24bn package of fiscal and structural reforms. “We will have make sacrifices that will be difficult but necessary…but at the end of my term in office Greece will be reborn,” he said.

George Papaconstantinou, the finance minster was due to announce details of the measures before flying to Brussels for a an emergency of meeting of eurozone finance ministers. Greece is expected to reduce the budget deficit from 13.6 per cent of gross domestic product to below 3 per cent of GDP by 2014, and stabilise the public debt at around 140 per cent of GDP.

The programme also calls for tough measures to shrink the size of the country’s bloated public sector, including a salary freeze, the abolition of bonuses and job cuts at state corporations and other entities. It will be approved by parliament – where the governing socialists have a comfortable majority – later this week. The size of the rescue package, which will include bilateral loans from other eurozone countries and a loan from the International Monetary Fund, would be announced after the eurogroup meeting, Greek officials said.

Stocks extended a global slide and commodities dropped, while yields on Greek two-year notes jumped to a record 25 percent and the euro traded near a one-year low against the dollar as sovereign-debt concern spread.

The yield on the Greek two-year note rose 492 basis points to 23.9 percent today, more than 20 times the comparable German bond and 10 percentage points more than similar-maturity notes from Pakistan.

Greece, which faces 8.5 billion euros in bonds coming due on May 19, must still agree on terms for its rescue package, which will be co-financed by the euro region and the IMF. Greek Prime Minister George Papandreou last week activated the aid package and is facing fire from investors who say his budget steps need to go further and from voters who are staging strikes to protest further austerity measures.

As the turbulence exposes the weakness of having a currency area without a single fiscal authority, some economists said policy makers need to create a lending mechanism that will help other euro areas members through fiscal crises.

Greece bowed to overwhelming pressure from financial markets on Friday and appealed for emergency eurozone loans in what will be the first rescue of a euro area country.

Greece’s socialist government said the prospect of financial collapse had forced it to ask for the activation of a €30bn ($40bn) lifeline that could ultimately be worth €45bn once a contribution from the International Monetary Fund is included.

The request marked a defining moment for the European Union, whose ambitions to play a more prominent role in world affairs rest partly on a claim of successful economic integration that the Greek debt crisis has thrown into doubt.

“We believe our European partners will act decisively and provide Greece with a safe haven to rebuild our ship of state with strong and reliable materials,” George Papandreou, prime minister, told the Greek nation in a live televised address from the Aegean island of Kastellorizo.

Athens is expected to spell out how much it wants from its 15 eurozone partners in a letter to the European Commission and the European Central Bank, which will assess if the request is valid. Eurozone finance ministers will then study the request and, if satisfied, approve the aid.

Greece must refinance €8.5bn in bonds that mature on May 19, and interest rates on Greek debt reached cripplingly high levels on Thursday. They remained high in spite of some market relief that Greece had requested the bail-out.

Negotiations with a team from the Commission, ECB and IMF are due to be completed on May 6 but much uncertainty surrounds the disbursement of the loans. Germany’s centre-right coalition government faces a difficult state election in North Rhine-Westphalia on May 9 and is sensitive to the risk of a backlash from voters angry that German taxpayers should bail out profligate Greeks.

Some German politicians said that it was therefore possible that the first tranche of aid might come from the IMF rather than Germany, whose final contribution could go as high as €8.4bn.

Angela Merkel, the chancellor, said any aid would be tied to “very strict conditions”, which would force Athens to present “an absolutely credible savings programme”, and allow the IMF, EU Commission and ECB to determine that a rescue was “needed for the euro’s stability”.

“Only when these two conditions are met, can we talk about specific aid, including the kind of aid and the amount,” Ms Merkel said.

The IMF is likely to demand tougher austerity measures than Mr Papandreou adopted in his 2010 budget.

Greek trade union leaders warned that they would strike in early May to protest against any new measures that threatened salaries, pensions and employment rights. “This mechanism adds to the threat that workers’ rights are about to be overturned. We will take the road of social resistance and increased mobilisation,” said Spyros Papaspyros, head of Adedy, the public sector union.

The euro dived to a fresh 10-month dollar low with concerns over its future stoked further after a senior Chinese central bank official warned the Greek debt crisis was just the "tip of the iceberg."

The European single currency sank to 1.3283 dollars -- the lowest point since May 7, 2009.

The euro later stood at 1.3349 dollars, up from 1.3315 dollars in New York late on Wednesday.

Against the Japanese currency, the dollar dropped to 91.90 yen from 92.24 yen late on Wednesday.

Analysts said the Chinese comments, and a debt downgrade for Portugal on Wednesday, suggested the crisis was widening to take in the entire eurozone project.

"The fact that Zhu Min, the deputy governor of the People's Bank of China, felt compelled ... to call the Greek debt crisis 'the tip of the iceberg,' is as good an indication as any of how rapidly fundamental concerns are growing about the eurozone," said analyst Neil Mellor at Bank of New York Mellon.

"Indeed, this comment might well signal the point that we stop talking about a 'Greek debt crisis' and start talking about a 'Eurozone structural crisis' instead," Mellor added in a research note to clients.

The Spanish EU presidency is seeking a "European solution" to help debt-laden Greece, a spokesman for Spanish Prime Minister Luis Rodriguez Zapatero said ahead of a European Union summit later Thursday.

Germany has set out three fundamental preconditions for any rescue package for Greece, including involvement of the International Monetary Fund, and a commitment by its European Union partners to tough new rules to control public debt and deficits in the eurozone – including necessary EU treaty changes.

A senior government official in Berlin said there would be no agreement at this week’s EU summit on a specific rescue package for the debt-strapped Greek government. If there were to be agreement on a “mechanism” to provide such assistance, he said, it could only be triggered once Greece had exhausted its capacity to raise money on the international capital markets; the IMF had agreed to make a “substantial contribution” to a rescue package; and the EU members has agreed to negotiate new rules to prevent any reoccurrence of such a debt crisis.

The German position was revealed in response to growing pressure from the European Commission, and other EU member states, to reach agreement on the mechanics of a rescue package for Greece at the European Council meeting on Thursday and Friday.

In an interview with the FT on Monday, José Manuel Barroso, Commission president, said rapid agreement was needed to reassure financial markets, and ensure the stability of the euro. He expressed confidence that Angela Merkel, the German chancellor, would back a deal as a “committed European”.

The German response is that the government in Berlin is “negotiating in the European interest, and demonstrating our commitment to Europe in defending the stability of the euro”, the official said.

A negotiation (on help for Greece) should only come as a “last resort”, he said, and only happen subject to the three conditions.

The German demand that could meet the most resistance from its EU partners is the insistence that new rules to enforce budget discipline should be negotiated, even if that requires treaty changes. Both France and the UK are passionately opposed to any such suggestion of reopening treaty negotiations.

“We must draw the consequences for the future, with the goal of agreeing more effective sanctions and prevention measures against excessive indebtedness, [even if] that should include a treaty change,” the senior official said, speaking on condition of anonymity.

Involvement of the IMF in a Greek rescue package is a much more open debate inside the union, with Mr Barroso himself expressing no objection, provided that any Greek rescue is led by Europe. There have been clear divisions within Germany on the question, but advisers to Ms Merkel seem to have won the day in a fierce debate with Wolfgang Schäuble, finance minister, and his staff, who opposed bringing in the fund.

Although Germany has appeared increasingly isolated in the EU in holding out against any formal rescue package for Greece, there seems no prospect of any deal being agreed without Berlin’s agreement.

It might still be possible to agree a first step of a deal this week – setting out the conditions under which an emergency rescue would be launched – but without any direct connection to the Greek crisis, and only if it does not imply that any rescue would be automatic, according to the German view.

The European Commission should thoroughly investigate the case of debt swaps involving Greece and Goldman Sachs, as these types of operations are Destabilizing financial markets, Simon Johnson, Professor of Entrepreneurship at MIT Sloan School of Management, told CNBC.com.

Goldman Sachs was widely reported to have arranged a debt currency swap transaction for Greece at the beginning of the past decade, providing it with money up front in exchange for higher payments later.

The reports sparked the European Union's wrath and the group requested Greece to explain the debt swaps arrangements by Feb. 19

"That's clearly a huge affront to the EU," Johnson, who propposed 10 questions for the EU's investigation on his web site Baselinescenario.com, Told CNBC.com.

"It's more than an insult, it's fundamentally Destabilizing," he said, adding that the debt swaps were "undermining what the EU's Maastricht want to achieve."

Goldman Sachs officials declined to comment.

Under the Maastricht rules, EU member states' budget deficits must not exceed 3 percent percent of gross domestic product (GDP), while public debt must remain under 60th Press reports suggested that the swap arranged by Goldman allowed Greece to push its debt problems into the future.

Read more at CNBC.

Q: Why is Greece's debt load - estimated at 123.3 percent of gross domestic product for this year - such a problem?

A: Greece's debt load has stoked concerns in the markets that it will end up having a full-blown debt crisis. The risk is that it will not be able to get the money it needs to roll over expiring debt and pay off the interest on its rising debt burden, thereby triggering a default.

The principal losers of a default would be those who have exposure to Greece, which includes other countries as well as banks in Greece and Europe holding Greek bonds. In the current globalized world, markets would zero in on the next weakest link - and it's this threat of contagion that has prompted EU leaders to consider ways of helping Greece.

If a much bigger economy, such as Spain, gets into similar difficulties, the global impact would be much greater.

Q: Other countries have large debt loads but no crisis, why?

A: Japan has debt worth nearly 200 percent of its economy but no one is talking about a potential default. The main reason is that Japan has access to an abundant lending market - its own, the Japanese bond market.

Italy also has a bigger total debt burden but its current annual borrowing of just above 5 percent of its gross domestic product is way lower than Greece's 13 percent, meaning that it does not need to tap international investors as urgently.

However, if the EU does not douse the Greek fire, then it might not be long before Italy is in the market's crosshairs.

Q: Don't some countries have low debt but a bad economy?

A: Low debt levels do not necessarily mean that a country has a good economy. After all, one of the reasons why the Great Depression of the 1930s happened was a government obsession to balance budgets. Borrowing can be used to fund capital investments, which should reap returns in the future, and also support economies when times turn sour. When economies recover, these associated social payments for, say, unemployment benefits disappear - helping the budget return to balance.

Q: The U.S. and UK have sharply rising debt levels. Is this a problem for them?

A: It is a problem because borrowing costs money - especially if interest rates start to rise. Borrowing costs will not stay near zero percent in the U.S. forever nor at a record low of 0.5 percent in Britain. Since borrowing levels have to be brought down, there would clearly be an impact on spending programs. The next British government, whoever it is, will have to bring down borrowing levels and government spending will have to be reined in. Do hospitals get less money, or the schools? The choices are not palatable.

Source: The Associated Press