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Thursday, May 26, 2011 4:02 PM


Former ECB Chief Economist Says "Greece is Insolvent"; Junker Says IMF May Not Pay Next Greek Loan Tranche; Axel Weber Was Right, Trichet Wrong


In the battle of words and wills between ECB president Jean-Claude-Trichet and Euro Finance Minister Jean-Claude Junker, the latter says IMF May Not Pay Next Greek Loan Tranche

Greece might be denied the next tranche of financial aid if an audit of its budget accounting shows that the country cannot guarantee financing for the next 12 months, Eurogroup President Jean-Claude Juncker said Thursday.

"I'm not the spokesman of the International Monetary Fund, but the rules say they can only disburse if there is a financing guarantee for the 12-month period," Juncker told reporters at a conference in Luxembourg.

"I don't think that the troika will come to the conclusion that this is given. If the Europeans have to realize that the disbursement of the IMF before June 29 can't operatively happen, the expectation of the IMF is then that the Europeans will take the place of the IMF," he added.

He said some countries, including Germany and Finland, would likely not accept this. "Everything depends on the troika report which is due next week," he added.
"Greece Not Just Illiquid, It’s Insolvent"

Bloomberg has additional details in German 10-Year Yield Drops Below 3%; IMF May Withhold Greece’s Bailout Aid
German government bonds rallied a Luxembourg Prime Minister Jean-Claude Juncker said the International Monetary Fund may not release its portion of aid for Greece next month, boosting demand for the safest assets.

German government bonds have handed investors a return of 2.1 percent since the end of March, trimming this year’s loss to 0.3 percent, according to indexes compiled by the European Federation of Financial Analysts Societies and Bloomberg. Greek debt has lost 14 percent this year, Irish debt 9.1 percent and Portuguese bonds 15 percent. Treasuries returned 2.2 percent.

China may account for a “strong proportion” of demand for Portuguese bailout bonds when the European Financial Stabilization Mechanism rescue fund begins selling them in June, Klaus Regling, chief executive officer of the European Financial Stability Facility, was quoted by the Financial Times as saying yesterday.

Former ECB Chief Economist Otmar Issing said Greece will probably be unable to meet its obligations as the euro region’s most indebted nation is “insolvent.” While it is “not physically impossible” for Greece to honor its obligations, repayment is unlikely, he said today at a press conference hosted by Nykredit A/S in Copenhagen.

“I’m skeptical about Greece,” said Issing, who joined the ECB a year before the euro’s inception in 1999 and stayed there until 2006. “Greece is not just illiquid, it’s insolvent.”
Axel Weber Was Right, Trichet Wrong

We all know that Greece is insolvent. I suspect even Trichet now realizes as much. However, Trichet does not want a default on his watch. Trichet will be gone in October and Trichet's mission is to hang on until then.

However, Trichet cannot duck the problem he arrogantly contributed to.

Former German central bank Axel Weber pleaded with Trichet to not buy Greek government bonds. Following an open feud, Weber, who was not too long ago the heavy favorite to replace Trichet, backed out of the race and resigned as head of the Bundesebank as well.

Feud Details

Flashback February 12, 2011: Ex-Goldman Sachs Managing Director is Leading Candidate to Replace Trichet as ECB President
Philosophical Reasons For Weber Leaving

Weber is not leaving for "personal reasons" per se. He is leaving because of huge feuds with current President Jean-Claude Trichet, and the likelihood he would be in disagreement with the the rest of the ECB as well.

ECB’s Trichet Rejects Weber’s Call to End Bond Purchase Program
Trichet said that as ECB president he is the only one who speaks on behalf of the Governing Council. Weber, who opposed the bond purchases since their inception in May, is regarded by economists as a frontrunner to succeed Trichet when his non-renewable eight-year term expires in just over a year.

European Central Bank President Jean-Claude Trichet rejected Bundesbank President Axel Weber’s call to end the bond purchase program that has provided a lifeline for European governments and banks trying to shore up their finances.

There is only one single currency; there is one Governing Council, only one monetary policy decision, and one president, who is also the porte-parole of the Governing Council", Trichet told La Stampa.
Weber was never in favor of the ECB's bond program to begin with, and that caused a feud at the outset.

Weber felt the ECB was not only violating the Maastricht Treaty, but making unsound decisions on monetary policy as well. Given Weber was in a distinct minority on many decisions he decided to say to hell with it.
Debt Restructuring Could Trigger Contagion

Jens Weidmann, the New Bundesbank head pleads Debt Restructuring Could Trigger Contagion
Weidmann, who took over from Axel Weber as head of the Bundesbank at the start of this month, said in an interview with German newspaper Frankfurter Allgemeine Zeitung that the German central bank was not opposed to the idea of a debt restructuring in principle, but that such a move could have consequences.

"Lengthening debt maturities helps only to a limited degree. There is also the risk that an after-the-fact forced maturity extension would amount to default and have contagion effects on other countries," Weidmann said.

"A soft restructuring could lead to troubles in other euro zone countries' banking systems, when the credibility of other aid programmes would be questioned."

Weidmann is currently being squeezed between his former employer the German government, which argues bond holders should swallow losses if a borrowing country does not pay, and the ECB where he is now a policymaker, which remains vehemently opposed to a restructuring.

One of the possible reasons for the ECB's fierce opposition is that it is estimated to have bought around 40-45 billion euros of Greek debt last year under its Securities Markets Programme which was openly criticised by Weidmann's predecessor, Weber.

Weidmann warned a Greek restructuring would hit the ECB and trample over the rules of monetary union.

"In principle, the consequences of fiscal policy mistakes may not be pushed to central banks. In the end, this would lead to a monetisation of debt."

Despite the intensifying debt restructuring debate, the ECB is currently expected to raise euro zone interest rates to 1.5 percent in July, having ended almost two years of record low rates by hiking them to 1.25 percent in April.

Weidmann bolstered that view. "I will not prejudge the policy decisions of the ECB Governing Council. I'll just note that the monetary policy stance currently continues to be expansionary," he said.
Monetization of Debt

The threat of monetizeation of debt by the ECB is very real. For now, the market is ignoring that threat in favor of the view the ECB will hike.

The irony is, the more hikes the ECB makes, the more pressure it puts on Greece, Portugal, Spain, and Ireland.

The risks pile up as noted in Bailing Out the ECB; Hidden Cost of Saving the Euro; ECB Time Bombs Continue to Tick

Here is a chart from the article courtesy of Der Speigel

ECB's Balance Sheet Contains Massive Risks



Trichet's Arrogance Puts ECB, German Taxpayers at Risk

Monetization of debt is against ECB rules. However, so were the bailouts and so were Trichet's purchases of Greek and Irish sovereign debt.

Trichet blew it with his arrogance and the ECB (and/or German taxpayers) are on the hook for it.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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