The world financial instability and the Euro zone crisis -

Chapter 3

Jacques SAPIRCEMI-EHESS

3

The December 2011 crisis and its partial

solutions

• 1. A rapid worsening of the Crisis since August 2011 and the quick increase of interest rates.

• The degradation of long-term rates.– An indicator of general solvency market estimates.– The process of de-uniting the Eurozone.

• The degradation of short-term rates.– Short-term worries.– The speculative dimension.

• The “spreads”.– How are they computed.– What the study of historical movement is teaching us.

• The destruction of the only real asset of the Euro zone: lower interest rates for all.

– Were low rates have been a financial bubble?

Italy (10 Y)

Italy 2 Y

Spain 10 Y

Spain 2 Y

Belgium 10 Y

Germany 10 Y

France to Germany spreads (10Y)

• Interest rates have climbed to unseen levels before dropping down following the ECB intervention.

• Could this situation be sustained?• Is the ECB really “monetizing” the debt?• Interest rates on Sovereign and Corporate debts?

• The spread of French rates to German ones is now on par to what has been the situation before the introduction of the Euro zone.

• Even after the dropping down of interest rates, levels are still much too high for countries like Italy and Spain.

• Italy: a problem with the accumulated debt.• Spain: Public finance out of control?• Insolvency or a simple liquidity crisis?

– External solvency.– Internal solvency.

• 2. Bank on the brink: the stress-test issue and the liquidity crisis.

• What a stress-test is.– Theoretical view: a “worst case simulation”.– The critical importance of inserting realistic assumptions.

• The intra-European debt market.– Sovereign debt– Corporate debt.

• The CDS on banks are very high and banking sectors all over Europe have seen their valuation coming down.

– The development of a new market.– CDS at bay: Greece.– What would be a world without CDS?

• The collapse of the intra-European debt market.

• 3. The collapse adverted or only postponed?– Why the risk of a collapse was real by early

December 2011.• The quick rise of interest rates on Italy and Spain.• The collapse of the short term intra-bank liquidity

market.• The evil synergy between the bank crisis and the

sovereign debt crisis.

– The political reaction.• The December 9th summit: no place for

disagreements.• The European Central Bank and its brinkmanship.

• Conclusion: Problems still unsolved.

– The “budget federalism” so far concerns only the expenditure side of State budgets.

• No real transfers.

• Fiscal discipline and Growth.

• Political worries.

– The disciplinarian side of the December 9th agreement is subject to a lot of critics and of adjustments.

– There is still no solution to the recessive effects of “austerity plans” and the EZ could well be on a deflationary path.