EU: MF Global Bankruptcy and the EU Reform Papers

As the 1st American casualty of the European crises emerges from the folds of Jon Corzine’s corporations, the public has effectively accomplished a 360 turn of emotions concerning the progress resulting from last week’s European Union Summit.

The European Summit has Resulted in Mixed Sentiments

In an echo of the demise of Bear Stearns and Lehman Brothers in 2008, the bankruptcy notice of MF Global has resulted in escalating skepticism about last week European Summit and an overarching fear from investors concerning Greece.  Despite the supposed success of last week’s EU Summit, the failing firm, formerly known as Man Financial, demonstrates that the plan will not insulate financial institutions from losses on holdings of European sovereign debt.  The fundamental weakness has reversed signs of growth in stock markets, as stock have quickly slid with growing investment fears from their exposure to Greek debt.  So saying, the volatility of stock markets has been one constant during this growing crisis.

“We’ve been on a buying stampede.  The market was due for a pullback.  Europe did get a rescue that buys them more time, but they are not anywhere near a resolution to their crisis.  We’re not out of the woods yet.” – Jeffrey Saut, chief investment strategist at Raymond James & Associates

Moreover, the atmosphere has shifted drastically on the heels of the previous optimism and progression felt internationally following the EU Summit.  The EU’s search for financial support has already run into resistance.  Help from China and cooperation from the IMF were immediately sought but immediately rejected, as G-20 members seek more details on the “cure” that has been proposed by Euro Members.  China’s president, Hu Jintao, expressed confidence in Europe’s capability of solving its crippling debt crisis, but he has made no move of dedicating financial support.  The US, which used a $700 billion Troubled Asset Relief Program to bail out institutions (resembling the purpose of the EFSF), has also avoided the guaranteeing financial support for the beleaguered Euro Members.  So saying, despite the new powers of the $1.4 trillion EFSF, the alternative options open for financial help to the Euro-zone members are the European Central Bank, which did not commit any new resources last week, emerging nation such as China, which is limiting its involvement to trade, and the IMF, which has requested further specifics on last week’s plan before any decisive actions are to be taken.  Such resistance has left its mark on global markets.  The S&P dropped 1.6%, the Dow Jones Industrial lost 1.5%, European banks such as Caterpillar Inc slumped 2.5%, and with the bankruptcy of MF Global, American banks such as Citigroup and Morgan Stanley were not isolated, both falling 5.4%.

“I am confident that Europe has the financial and economic capacity to meet this challenge, and the United States will continue to support our European partners as they work to resolve this crisis.” – Barack Obama, 44th President of the United States

So, with so much resting on last week’s plan, much of media attention has turned its sensationalist eyes on the content of the EU Summit statement.  Last week, the European Union did announce a plan to help prop up the economies of its weak members.  A more in-depth look at the July 21st Summit illustrates the typical complexity of the already too complex regulations, powers and rhetoric of the EU and their treaties.   The 17 Members of the Euro ratified all measures related to the EFSF, significantly strengthening their capacity to react to the crisis and any potential developments.  An agreement by the European Commission, the European Parliament and the European Council on a strong legislative package within the EU to better structure economic governance represents another major achievement.   Moreover, the introduction of the European Semester has fundamentally changed the way the fiscal and economic policies will be coordinated at the European level.  With the coordination of the EU, the intergovernmental element of fiscal governance will be substituted by supranational supervision.

The European Member States did not stop with overarching rhetoric demanding shared sacrifices of sovereignty by all members through calls for deeper integration.  Further action was clearly required and was taken into account by the representatives at the Summit.  The Member States, and therefore the EU as a whole, must reform.  The Summit called for sustainable public finances and structural reforms for growth.  Steps taken by Spain, for instance, illustrate the level to which the European Union is requiring of all Members.  Spain has taken steps to reduce its budget deficit, restructure its baking sector and reform product and labor markets, as well as the adoption of a constitutional balance budget amendment.  Even Italy’s plans for growth enhancing structural reforms and the fiscal consolidation strategy, resulting in a balanced budget by 2013, are also commended efforts that the EU wishes reciprocated across the supranational entity.

Both Spain and Italy have not received adjustments program from the EU or IMF, taking an intergovernmental stance on reform.  So saying, not to forget the countries that have, the EU Summit state the intention to continue providing support to all countries under programs until they have regained market access.  Countries such as Ireland and Portugal have marked great success in the full implementation of their adjustment programs, underpinning fiscal sustainability and improved competitiveness.  Greece, which has received its 6th tranche of EU-IMF support still represents a thorn, but with international progress reaching its fellow indebted nations, Greece can only fall in line at some point.  The ownership of the adjustment program is Greece and its implementation is the responsibility of the Greek authorities and with the nonchalance of Greece, it will take a considerable amount of time for progress to be evident.

“Over the last 3 years, we have taken unprecedented steps to combat the effects of the world-wide financial crisis, both in the European Union and within the Euro area.  The strategy we have put into place encompasses determined efforts to ensure fiscal consolidation, support to countries in difficulty, and a strengthening of Euro are governance leading to deeper economic integration among us and an ambitious agenda for growth.” – Euro Summit Statement, Brussels, 26 October 2011

A large portion of the plans falls onto the shoulders of the recapitalization of the European banks.  Europe’s largest banks were ordered to increase the ratio of highest quality capital they hold by the end of June, creating a shortfall of 106 billion Euros. Rather than tapping investors or governments, firms are trying to hit the 9% core capital target by adjusting risk-weightings, limiting dividends, retaining earnings, reducing loans and selling assets.  Nevertheless, the issue remains on how much fresh capital will be brought in.  A 50% writedown on Greek debt held by private investors, coupled with a pledge to support the short-term funding markets and a 106 billion Euro recapitalization plan had boosted confidence in banks’ share prices, but the recent development of MF Global and international resistance to supply Europe with financial support has decayed such sentiment.

Without the security of stable banks, the success of the plan will be laid upon the strength of the EFSF, which controls much of the future of the Euro, the indebted nations, the banks, and the regulatory power of the budget.  The ratification process of the EFSF, for new  funding and supranational powers, has now been completed in all Euro Member States.  The Commission will carry out enhanced surveillance of the indebted Member States, and most fiscal actions in the future, and report regularly to the Eurogroup. The objective is to support market access for the Euro area Member States faced with market pressures and to ensure the proper functioning of the Euro area sovereign debt market, while fully preserving the high credit standing of the FSF.  The resources of the EFSF are to be leveraged by providing credit enhancement to new debt issues by Member States, thus reducing the funding cost, which is already extensive enough to culminate in asks for foreign compensation.  Maximizing the funding arrangement of the EFSF with a combination of resources from private and public financial institutions and investors, which can be arranged through Special Purposes Vehicles, is also intended to help reduce the funding cost.  This will all enlarge the amount of resources available to extent loans, for bank recapitalization and for buying bonds in the primary and secondary markets.

In the end, the key milestone for the EFSF’s overhaul, to be finalized by the end of November, is the G-20 Summit.  Much of the funding for the EFSF rests on foreign financial support.  Countries such as Japan have expressed plans to support the increase of the facility and the BRICS (Brazil, Russia, India, China and South Africa, are also discussing joint assistance through the IMF for the EFSF.  Such moves will go a long way in reassuring the security of the EU and the future outlook of  a more supranational and interconnected entity with an effective surveillance and bailout facility.

“We have reached an agreement which I believe lets us give credible and ambitious and overall response to the Greek crisis.  Because of the complexity of the issues at stake it took us a full night.  But the results will be a source of huge relief worldwide.” – Nicolas Sarkozy, President of France

So saying, a new level of deeper integration can be a major key in the success of a stronger supranational entity, a recognized power by both the domestic population of the EU and internationally.  Expressed in the Summit could be this very sentiment, being embodied by the Euro Summit institution.  The entity, meeting twice a year, includes the heads of state/government (HoSG), the President of the Commission and a new position, the President of the Euro Summit.  The President will be appointed by the HoSGs and elected every 2 1/2 years, mimicking the date of the election for the President of the European Council.   These summits will define the strategic orientations for the conduct of economic policies and for improved competitiveness and increase convergence in the Euro area.  Calling for deeper integration among the Euro Members will be affirmed by the mutual dependence on the EFSF, a facility which embodied the shared commitment of all Member States to stability.

In retrospect, such interdependence resulted in the current crises plaguing the Euro Members.  The key to change is supervision, strict regulatory rules and strict supranational discipline.  It is the creation and existence of the Euro Summits, the EFSF, the Eurogroup and the Eurogroup Working Group that will hold together the Euro.  These institutions have been created and/or strengthened to create order among the EU but so were past regulations and institutions, such as the Growth and Stability Pact of 1997.  The necessity to adhere to past commitments and regulations failed and so it is fundamental that closer monitoring will ensure in the future.  The European Summit Statement has called for closer monitoring by the European Commission, which is also the supranational entity responsible for regulatory supervision under the EFSF, of both the Council and the EP under Article 136 of the Treaty of the Functioning of the European Union, formerly known as the Rome Treaty.

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