The CTC Global Corporate Treasurers Forum in Phoenix opened Thursday morning with a panel discussion on key issues facing the European, U.S. and global economies. Not surprisingly, the focus quickly turned to the eurozone crisis and what its fragility could mean for the global financial system.
Panel moderator Gillian Tett, U.S. Managing Editor of the Financial Times, began the discussion, commenting that the current situation in the eurozone, coupled with JPMorgan's recent $2 billion trading loss, underscore these “profoundly uncertain” economic times. “Not only because the world's being tipped into uncharted territory, by virtue of a deleveraging process after a credit bubble that is arguably of a magnitude that has never been seen before—but also because central banks have responded to an extraordinary degree, again, using tools on a scale that have not been seen before in the modern world,” she said.
Tett noted that many of really important questions about economics no longer pertain to the issues experts focused on prior to 2007 (numbers and bubbles) but instead concern political risk, social fabric and cultural systems—things that investors, policymakers and economists are not prepared to evaluate. “Trying to make sense of where those systems are going at the moment, trying to make sense of the politics and the political economy, is very unpredictable and very hard for most investors, and I would guess, most corporate treasurers,” said Tett.
Panelist Robert Sheehy, Deputy Director, Capital Markets at the International Monetary Fund, gave a brief presentation on the eurozone crisis, noting that it is not solely a European problem and can be traced back to the 2007-08 financial crisis. He illustrated the pattern we follow when confronting such crises, and recognized that it is not sustainable. “We go through a period where there's a buildup of stress—if you think back to the Bear Stearns situation or you think back to Lehman—and we get ourselves into a real crisis, we get a policy reaction, and things start to calm down,” he said. ”Then, for a variety of reasons, either because policymakers become complacent, or there's political resistance, you end up with the effort to reform things being relaxed, and we move back into crisis again.”
This back-and-forth cycle of building up and calming down ultimately results in a system that can never go back to pre-crisis mode, Sheehy added.
According to Sheehy, the central debate about the European situation is actually a false debate. While many analysts believe the answer lies with the governments of Greece, Portugal, Spain, etc. enacting policy reforms, Sheehy sees a more fundamental question. “Is the underlying architecture of the euro system completely up to the task of solving this problem?” he asked.
Sheehy turned to the key issue in Europe, which is the need for banks to reduce leverage. European banks’ leverage is much higher than banks in the U.S. and UK, and the loan-to-deposit ratio is much higher. He noted that a lot of the wholesale funding markets have broken down over the past five years. “But it has a particular impact on the European banks because of this underlying structure of their balance sheets,” he said. “When the securitization market was broken and abandoned, that was a major way of recycling funds from banks that had money to banks that needed it. With all of the issues of counterparty risk that came to the floor during the crisis that started in 2007, you had the real retrenchment on interbank lending, and that again puts banks that have high loan-to-deposit ratios under a lot of stress.”
Panelist Francesco Papadia, Adviser to the Executive Board of the European Central Bank, gave his assessment of the current situation, presenting six components that he feels need to be implemented which could correct the problem:
1. Individual countries of the euro area must maintain or reach sound fiscal budgetary conditions and must promote long-term, sustainable growth.
2. The macroeconomic heterogeneity between the North and South must be reduced as soon as possible.
3. The euro area governments must protect the euro area while the first two components are implemented.
4. The 'E' component of EMU (Economic and Monetary Union) needs to strengthen.
5. Adequate recapitalization, capital market funding and in some cases, restructuring of European banks, is needed.
6. No solvent bank in the euro area should fear becoming insolvent due to illiquidity problems.
“Each of them is necessary, but none of these six points are self-sufficient,” he said.
Papadia noted that Greece is a particularly difficult situation. “Other countries had to change policies. Greece, in many ways, has to change its society, which is much more difficult,” he said. “But difficult—even very difficult—does not mean impossible.”
Progress has been made in Europe, Papadia added, even though much still needs to be done. “I particularly stress two points; one is remedying the macroeconomic divide between the North and South, and the other is doing more for the recapitalization and restructuring of banks,” he said. “I personally never had doubts that Europe would manage to do what it needed to be done. We are talking about some of richest countries in the world, and we are talking about countries that have a 60-year successful project of unification that they don’t want to put at stake.”
Tett asked the audience where they stood on several key issues. Judging by a show of hands, few attendees believe that Greece will be in the eurozone in a year’s time. However, most of the attendees do believe that the eurozone will still have a single currency in about five years. Lastly, about a third of the group is concerned about a sudden rise in yields on Treasuries in the U.S. markets over the next couple years.
Tett asked both panelists whether the ECB and the IMF are bracing for Greece exiting the eurozone and formulating “war games” plans. Papadia said that it really depends on whether or not Greece “wants” to take the necessary steps to remain, and noted that there would be “enormous costs” if it does leave. “If rationality prevails, Greece should do what it needs to do in order to be helped,” he said. “Because of course, the rest of Europe is very much willing to help Greece.” Papadia said he could not get into specifics about any type of contingency plan, but did say that the risk has intensified.
Sheehy noted that at the start of the crisis, the gap in the Greek budget was about 20 billion euros, and the current official holding of Greek debt is 400 billion euros, thanks to all of the efforts to contain the crisis. “We’ve somehow not got the balance right between what we're asking the Greeks to do, what they’re capable politically to do and what we're asking everyone else to do,” he said. “We’ve always been in crisis mode when these measures have been taken. I think the world would be better off if we were doing a bit more ‘war gaming’ and starting to think through these issues on a much longer term basis.”