Looking to stop a worsening crisis, the EU, backed by world central banks, launches bailout plan.
Catching the egg before it hit the ground the European Union today announced a bailout package to halt a worsening sovereign debt crisis. The plan calls for the governments of the 16 euro nations, along with the IMF, to lend up 750bn euros, or more than $950bn, to the zone’s most troubled countries. World governments hope the action will squelch further sovereign debt contagion affects, what appeared to be the beginnings of a double dip in the global economy that so many have feared, and speculation that the eurozone might break up.
Following the announcement the European Central Bank said it would purchase euro zone bonds. The US Federal Reserve, along with several other central banks also pledged support, with the Fed re-starting its emergency swap facility. Such a coordinated response is reminiscent of actions taken during the height of the financial crisis in 2008. With the market events of last Thursday, including a 1,000 point fall in the Dow partially triggered by errant trading signals, fear of the unthinkable could not be allowed to grow and overwhelm a still-shaky global economic recovery and the return of risk-appetite in financial markets.
While the immediate market reactions have been positive, the longer-term implications for MNC treasury departments call for caution:
1) Hedge the euro carefully. The probability of recovery in the euro-dollar relationship has heightened tremendously, but so too has the risk to the downside if the massive bailout program does not succeed; if this fails, all bets on the euro (including its survival) should be off.
2) Beware of crowding out. Another trillion in public sector debt adds to already growing concerns that government refinancing will crowd out private sector refis from 2012 on. While treasurers have so far been able to ignore the liability tower slides of debt capital market bankers, as corporate bond markets have shown that they will not be satiated, the stakes of getting crowded out of the next round for refinancing just keep getting higher. Plus, while spreads have come in, base rates reflecting increasingly less “risk-free” sovereign debt offerings will be rising and will more than offset any further spread compression—even if it goes negative. Since reference rates will not all respond in lockstep, look for questions surrounding the appropriateness of Libor and related rates to reemerge.
3) The taxman commeth. These massive calls on public treasuries will only further exacerbate pressures for new and higher taxes, along with stricter scrutiny of transfer pricing and tax planning schemes. If there is cash that’s trapped, or faces a haircut in order to be repatriated, it may be better to free it now than pay for the consequences at tomorrow’s tax rates.