For more than a year now people have been calling for the collapse of the euro zone. Either one of the bailed-out nations would leave, or the more fiscally sound northern European states would form their own version of a union.
Regardless of what the outcome would be, the harsh reality was that the Eurozone’s massive floor – allowing countries like Greece to borrow for nearly a decade at German-style interest rates without some limit on spending or enforcement of fiscal rules – meant that it could not survive.
But after 18 months of stop-gap solutions, emergency weekend summits and hastily constructed bailout plans, it feels more and more like September may be the swan song for the currency bloc.
Event risk is piling up: Greece is scheduled to receive its sixth tranche of bailout funds from the EU and IMF at the end of this month, Germany is scheduled to vote on the legality of the extension of the European Financial Stability Facility (EFSF), and now the region’s banks look like they are being sucked into the crisis.
Added to this, various governments are trying to pass austerity budgets and Italy has more than 60 billion euros of debt to finance during the month.
The EU’s response to the crisis so far has been littered with errors, but we are rapidly reaching a point where there is no more margin for error. Already there have been gaffes, and we are only at the start of the month.
Firstly, Greece was forced to deny reports that it had hired a US law firm to manage its exit from the Eurozone. Who knows if there is any truth to the story, but it caught my attention, as it suggested what a process for exit might look like, something I hadn’t really considered before.
If as a member of the currency bloc you decide to leave, then you hire a law firm and they sort out the nitty-gritty for you: how to change back to your original currency, what would happen to any outstanding euro debts, etc
And that wasn’t all from Athens. The finance minister was forced to claim that a report circulating in the Greek Parliament that said Greek debt dynamics were out of control was based on inaccurate information. This is hardly the stuff that engenders confidence in the currency bloc.
But the most worrying thing to me is the banking sector. The sovereign crisis is turning into a full-blown banking crisis. The banks are the glue that holds an economy together, but Europe’s banks are sinking under their sovereign debt holdings. Not only are they being asked to take a haircut on the Greek debt they hold, but they also need to boost capital ratios in case haircuts are applied to other members’ debt.
We have already seen heavy losses on banking stocks: the KBW large-cap banking index has fallen nearly 30 per cent since July. And at the start of this month Societe Generale and Unicredit were removed from the blue-chip pan-European Eurostoxx 50 equity index.
But rather than boost confidence in the sector, politicians are making things worse. On the one hand you have IMF chief and former French Finance Minister Christine Lagarde saying that Europe’s banks need to be urgently re-capitalised.
This was repudiated by the ECB and other EU officials, who said there was no need to re-capitalise the banks more than the 5 per cent bare minimum threshold set out in the European bank stress tests that were conducted earlier this year. Only eight banks in the region actually failed this test, a test that did not include some of the banks that are suffering right now.
There are many unanswered questions regarding the sovereign debt crisis. The share price of Europe’s banks tells us that the EU is running out of time to come up with solutions.
(Kathleen Brooks is research director at forex.com)