As Europe begins its latest swirl around the debt bowl toilet , the schemers are looking at how to further put the taxpayer on the hook for further and perpetual bailouts...

http://www.telegraph.co.uk/finance/comment/jeremy-warner/9229765/Europeans-will-never-accept-a-federal-banking-system.html

The latest crackpot idea for shoring up Europe's monetary union, much discussed at last week's spring meeting of the International Monetary Fund and now widely promoted by eurocrats, is the establishment of a federal banking system, with a single framework for regulation, bailouts, deposit insurance, supervision and resolution.

There is, of course, nothing particularly new in the proposal; for many economists, it's long been seen as an essential precondition for successful monetary union, at least as important as the federalisation of fiscal and political systems. The one cannot work without the others.

The dollar, for instance, couldn't function effectively without a federal banking system, if only for this rather obvious reason; many US banks are of a size that would overwhelm the ability of the individual states in which they are based to underwrite them. Take the example of Citigroup, with assets at the last count of nearly $2 trillion. If it had been solely Citi's home state of New York that had been responsible, Citi would have taken New York down with it when it went bust in the sub-prime banking crisis three years ago as surely as the Irish banks have sunk Ireland, and Spanish banks are now bankrupting Spain.

The fact that Citi was regarded as a federal responsibility, not a state one, saved New York from a ruin as otherwise certain as that of Iceland. Citi was the collective responsibility of the US as a whole. Yet in the eurozone, banks are deemed to be a sovereign liability, not a federal one.

If Irish, or indeed Spanish banks, had been regarded as a mutual ward of all eurozone nations, neither economy would today be in quite the same mess as it is, where the sovereign has effectively been overwhelmed by the hubristic expansionism of its banks.

So why do I say that the formation of a federal banking system in euroland is another crackpot idea? It's because as things stand, there is virtually no chance of it happening. To the contrary, all the pressures right now seem to be the other way around, towards disintegration of the eurozone banking system rather than further integration. It is as if in progressively retreating behind national borders, finance is subconsciously preparing for the eventual break-up of the euro back into its constituent sovereign currencies.

From the start of the financial crisis, Europe has been in denial about the state of banks. To begin with, Euroland didn't think it had a banking problem at all. The banking crisis was regarded as a wholly Anglo-Saxon affair which, but for the stupidity of a few wayward Landesbanken in over-exposing themselves to American sub-prime assets, was not really applicable to the euro area.

Even today, policymakers are reluctant to admit that the eurozone has its own, homegrown banking crisis, preferring instead to blame their travails on the fiscal irresponsibility of periphery governments. Markets were never convinced by this diagnosis. Grudgingly, euroland eventually agreed to conduct stress tests. These only made matters worse. Nobody believed them, and small wonder.

The first stress test judged two of Ireland's most obviously busted banks to be perfectly sound. By the time the stress tests were published, the "worst case scenarios" the European Banking Authority tested against had already been exceeded.

So what were the roots of Europe's banking crisis? Like the wider travails of the single currency, the underlying problem is that of lost competitiveness in the eurozone periphery. This showed up in a number of widening current account deficits, which were in turn financed through the banking system. The surplus nations were in effect lending the deficit nations the money to buy their goods.

Eventually it was realised that the deficit nations would never be in any position to pay, so the lending stopped, crystalising a massive bad debt overhang. Since then, the problem nations have been financed by injections of European Central Bank liquidity and joint eurozone/IMF bailouts.

These have succeeded in putting the crisis on hold, but they haven't solved the underlying problem. Full mutualisation of banking assets and liabilities under a federal banking system would plainly take us some way further towards a lasting solution, but nowhere in the eurozone is such a framework thought remotely acceptable.

This is because national banking systems are still seen as an important conduit for the economic and industrial policies of individual sovereign governments. No one is going to surrender these levers to the "greater good" intentions of some unaccountable eurocrat. In France, the major banks are so much a creature of government that they might as well be regarded as one and the same thing. In Germany, too, the banking system is unashamedly used for the pursuit of perceived industrial advantage.

Despite the fact that monetary policy is supposed to be pursued collectively through the European Central Bank, eurozone members also still use their banking systems for sovereign, monetary purposes. For instance, unhappy with the supposedly loose monetary policies of the ECB, the German Bundesbank is considering the use of credit controls to choke off a perceived house price bubble.

Further evidence of the way the eurozone financial system is rebooting itself back along national lines is found in recent calls from Jens Weidmann, Bundesbank president, for direct access to the collateral lodged with the ECB by eurozone periphery banks in return for cheap liquidity.

Once upon a time, it was the German banking system that provided for the external financing needs of the deficit nations. With the advent of the banking crisis, this stopped, forcing the ECB to do the job itself. But that doesn't get Germany off the hook, for the ECB liquidity comes in essence from the central banks of the surplus nations, including the Bundesbank. This is obviously causing German concern about the build-up of contingent liabilities, now running to hundreds of billions of euros.

In any case, the eurozone is finding it bad enough dealing with new, internationally-imposed capital requirements, which are widely thought unnecessary and economically damaging in Germany, France and Italy. A federal banking system would be beyond the pale for a Continent where, despite the rhetoric, sovereign self-interest is still routinely prioritised over wider European solidarity. The political barriers to a banking union are too big to be surmountable.

and....

http://www.telegraph.co.uk/finance/debt-crisis-live/9227632/Debt-crisis-as-it-happened-April-26-2012.html

18.25 There's been a conference on financial integration in the EU going on today, and this has brought up the subject of eurozone-wide bailouts for banks in the different nations.

Vitor Constancio, vice-president of the ECB said:

For the biggest systemically relevant banks, there are around 36 big banks, we really need a resolution fund, because that is the only way of overcoming the very thorny question of burden sharing in a crisis.

And who would contribute to this regional bank rescue fund?

Eurozone taxpayers and taxes on the region's banks, was Mr Constancio's answer.

He said the eurozone should have a body like the FDIC (Federal Deposit Insurance Corporation) in the US, which was created to guarantee deposits and wind down failed banks. Mr Constancio went on:

The FDIC resolved, liquidated and restructured more than 400 banks since the crisis began, some of them sizable in European terms.

Given the eurozone nations don't want to pay to bail each other out, is it believable they would ever agree to be liable for each others' bank debts?

http://ftalphaville.ft.com/blog/2012/04/26/974461/when-psi-is-futile-but-then-again-cyprus/

When PSI is futile (but then again, Cyprus)

Posted by Joseph Cotterill on Apr 26 21:26.

Here’s a nice, Portugal-themed chart from Gabriel Sterne of Exotix.

Only 15 per cent of a eurozone sovereign’s debt not held by senior creditors or by banks whose public recapitalisation would cancel out their write-downs — in two years’ time. (We’re looking at the dark blue bar under 2014.) *Whistles*

This is a theme we’ve hit on a few times here on FT Alphaville – the “officialisation” of Portugal’s debt, and what it might say about the eurozone crisis endgame as a whole.

In this chart, Sterne has already baked in the (by now pretty ubiquitous) view that Portugal will get a second bailout in the not-too-distant future. This would push the official debt stock higher while private debts mature and roll off over time.

But!

It then stands to reason that, if Portugal needs it in the future, it will only get worthwhile debt relief from a restructuring (or even write-down) of official sector loans. You could force write-downs on private bondholders, but: “It appears to us plausible that the window for an effective restructuring is likely to be missed (perhaps it has already),” Sterne says.

That’s very interesting, firstly because we can’t think of a previous sovereign debt restructuring where bondholders became so subordinated that they were actually safe. Then again, as Sterne warns, though PSI has moved further out as a tail risk, it will make a larger impact on bondholders (not to put too fine a point on it, they will get zeroed at this point) if eurozone officials decide they cannot sell OSI to taxpayers without accompanying PSI.

Well, if you like that kind of risk, buy the Portuguese 2037 bond.

Secondly, it’s interesting because – so big would the OSI be – it moves into this idea of effective fiscal transfers from northern governments as the eurozone’s default (ha) future. As we’ve written, this already appears part of the Greek post-PSI endgame. Sterne calls it “liabilities collectivisation”.

So we end with a test case to find out which liabilities are whose, at the other end of the eurozone. Exotix also looked at the investment case for Cypriot sovereign bonds (which are also distressed, even more illiquid to trade, and have so far avoided a eurozone bailout while benefiting from a Russian government loan).

This means looking at Cypriot banks and their exposure to Greece’s depression:

Debt composition is currently amenable to PSI because the “PSI-able” share is over 95% of the total… The composition of Cypriot debt could be transformed extremely quickly were the official sector to provide financing for recapitalisation costs.

The multi-billion euro question for Cyprus is who will pick up the bill for any losses on Cypriot banks operations in Greece; will it be the Greek or Cypriot government. The politics, economics and legal arguments make this a terribly delicate case. The main factors are as follows:• The Greek branches are funded largely through Greek deposits. The implications are illustrated by taking an extreme example. If (in the unlikely event) a Cypriot bank declared insolvency with no government intervention, Greek depositors would probably need to be bailed out by the Greek government. In this case Cyprus saves itself a huge increase in debt. So there is a strong incentive for Greece to show some willingness to contribute to the rescue to forestall such a scenario, though we are not clear from where the money would come from, and if programmed Greek recapitalisation funds are available.

• We think the Icelandic precedent, however, shows, however, that it could be difficult, if not illegal, for Cypriot parent banks to cut loose their Greek branches and responsibility for their depositors, unless they also impose similar losses on Cypriot depositors. Having nationalised the insolvent Icelandic banks, the state-owned banks imposed much harsher treatment towards British and Dutch depositors in Icelandic foreign operations than they did domestic depositors, leading to legal challenges by the UK and Netherlands. In the case of Cyprus and Greece, any attempt by the Cypriot government to bailout its own depositors while imposing losses on Greek depositors would create an ugly legal quagmire.

• The political ties between Greece and Cyprus are so close that we think the incentives to reach some burden-sharing agreement are huge. Cypriot newspaper Politis reported that Finance Minister Vassos Shiarly and Central Bank Governor Athanasios Orphanides met with ECB President Mario Draghi on 17 April to promote a plan to help the Cypriot branches of Greek banks.

Indeed, Shiarly then said the government might recapitalise one bank to the tune of €1.5bn. What makes it curious is that Shiarly neither named the bank nor where funds would be found, except that Cypriot bank access to Greek bank bailout funds was being examined.

Portugal and Cyprus: very curious cases.