"Portugal Insolvent" says Citigroup Chief Economist; Why Ireland Will Default

Citigroup's chief economist, just threw fat in the Euro-fire with his statement ‘Insolvent’ Portugal Needs Loans Soon

Portugal is “insolvent” and will probably need soon to join the emergency-loan program from the European Union and the International Monetary Fund that’s available to Greece and Ireland, according to Willem Buiter, Citigroup Inc.’s chief economist.

“The market’s attention is likely to turn to Portugal’s sovereign, which at current levels of interest rates and growth rates is less dramatically but quietly insolvent,” Buiter wrote in a report dated yesterday. “We consider it likely that it will need to access the European Financial Stability Facility soon.”

“Despite the recent drama, we believe we have only seen the opening act, with the rest of the plot still evolving,” Buiter wrote. “Accessing external sources of funds will not mark the end of Ireland’s troubles. The reason is that, in our view, the consolidated Irish sovereign and Irish domestic financial system is de facto insolvent.” This means “either the unsecured non-guaranteed creditors of the banks, and/or the creditors of the sovereign may eventually have to accept a restructuring.”

Europe Debt Fears Hit More Secure Countries

As long as we are tossing fat in the fire let's discuss the fact that Europe Debt Fears Hit More Secure Countries

Fears among European bondholders spread Tuesday from the weakest members of the euro zone to other countries, including Italy and Belgium, spurring a stepped-up search for a solution to a crisis that is increasingly putting political as well as financial strain on Europe’s decade-old monetary union.

Despite the commitment of 200 billion euros, or $260 billion, in bailout funds to Europe’s two most stricken nations — Greece and Ireland — institutional investors were unimpressed with the rescue effort this weekend of Ireland and continued to sell bond holdings in the weaker euro-zone economies.

But what is worse for the European Union and an increasingly stretched International Monetary Fund is that investors have begun to disgorge some of their positions in Belgium, Italy and even Germany.

The recent bond market attacks on Ireland and other weak European debtors set off as soon as the German chancellor, Angela Merkel, broached the idea of requiring bondholders to take a share of the loss. They gathered speed this week when it became clear that Ireland, as well as Greece, would have to pay a still-steep 5.87 percent interest rate on their loans — a tacit acknowledgement on Europe’s part, analysts say, that even with its bailout package Ireland remains a significant default risk.

“We have created more doubts than existed before,” said Paul De Grauwe, an economist in Brussels who advises the president of the European Commission, José Manuel Barroso. “The interest rate now being charged for Ireland is a vote of no confidence for the package and it has obviously been inspired by a notion that we should punish our sinners. If we don’t succeed in containing this thing it could lead to a disaster in terms of the euro’s survival.”

Another idea that has gained some ground recently is a Brady plan for indebted European economies. The plan was recently put forward by a former Treasury secretary, Nicholas F. Brady, who led an effort in 1989 to help Mexico and other Latin American economies restructure their debt — requiring bondholders to take a loss of 30 percent in exchange for new, longer dated debt instruments that had lower rates and were backed by 30-year United States zero-coupon bonds. Much criticized at the time, the plan is now seen as the first step of Latin America’s recovery.

“The key was getting banks to write down their debt and accept a new security,” Mr. Brady said during an interview. “Why don’t people get to work and get something done?”

Why Don't We Get Something done?

Gee. That's a good question. Let's ask Christian Noyer, governor of the Bank of France, and ECB president Jean-Claude Trichet.

Noyer said "As far as I'm concerned, I exclude that there will be haircuts in the future" (yes, that's a real quote).

Trichet warned German Chancellor Angela Merkel not to "unsettle bondholders".

The ECB wants a free lunch but no haircuts. That's why nothing of merit gets done.

Moreover, the current scheme is guaranteed to blow sky high. Here's why: Ireland has to pay an average interest rate of 5.8% for the loans while shrinking its deficit from 30% of GDP to 3% of GDP.

It is impossible for Ireland to grow enough to pay back interest on the loan. Ireland will default.

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