Portuguese Judiciary Deals a Blow to Austerity

Portugal is in the news because its constitutional court tossed out part of its austerity package. This from a story today by Raphael Minder, "Portuguese Debt Crisis Brings New Trouble for Euro":

In an address to his beleaguered nation on Sunday, Prime Minister Pedro Passos Coelho warned that his government would be forced to cut spending more and that lives “will become more difficult” after a court on Friday struck down some of the austerity measures put in place after a bailout package two years ago. 

The renewed tension in Portugal raised the threat of further trouble elsewhere in the euro zone, where ailing members have struggled to rebuild economic growth after enduring wrenching spending cuts. 

“The risks in the euro zone have increased markedly over the past six weeks or so,” wrote Nicholas Spiro, managing director of Spiro Sovereign Strategy, a London-based consultancy that assesses risk on sovereign debt. 

A critical moment for the latest trouble took place on Friday, when Portugal’s Constitutional Court struck down four of nine contested austerity measures that the government introduced as part of a 2013 budget that included about 5 billion euros, or $6.5 billion, of tax increases and spending cuts. The ruling left the government short about 1.4 billion euros of expected revenue, or more than one-fifth of the 2013 austerity package. 

Specifically, the court, which began reviewing the legality of the government’s austerity measures in January, ruled as unconstitutional and discriminatory the government’s plans to cut holiday bonuses for civil servants and pensioners, as well as to reduce sick leave and unemployment benefits.

Minder also quotes Jens Weidmann, the head of Bundesbank, saying Cyprus may need an additional bailout:

Cyprus received a bailout of 10 billion euros from international creditors last month. It may need even more to save its banks, a top German policy maker said on Sunday. 

“The situation in Cyprus has stabilized in the last few days,” Jens Weidmann, president of the Bundesbank, the German central bank, told Deutschlandfunk radio. “However, I wouldn’t rule out that the need for liquidity in Cyprus could increase.” 

The crisis in Cyprus reflects how urgent it is for the euro zone to establish a means to shut down failed banks without burdening taxpayers or endangering the financial system, Mr. Weidmann said. 

“There continues to be a problem with banks that may be too connected and too big to wind down without creating a danger for the financial system,” he said.

Last Friday Landon Thomas Jr. had a story, "Ex-Bank Officials Named in Cyprus Inquiry," about the findings of an investigative report commissioned by the central bank of Cyprus. Known as the Alvarez report after the financial consulting firm Alvarez & Marsal that the central bank hired to look into why the Bank of Cyprus doubled down on risky Greek bonds, it establishes what has already been widely reported. According to Thomas,

The Bank of Cyprus, long considered the better run of the two large banks that have been at the center of the Cypriot bailout debacle, decided to speculate in high-yielding Greek bonds by accumulating a 2.4 billion euro position from late December 2009 until June 2010, just as the Greece government was running out of money. 

That decision resulted in a loss of 1.9 billion euros, or about $2.4 billion, when bond investors were eventually forced to take a 75 percent haircut under the final terms of the Greek bailout, worked out last year. 

That loss and a larger one at the other big Cypriot bank, Laiki Bank, on a similarly misguided investment foray, totaled 4.5 billion euros. That was more than Cyprus, with a gross domestic product of 18 billion euros, was able to sustain. And the losses resulted in a near-collapse of the Cypriot banking sector, leading the country’s government to seek a 10 billion euro bailout from the troika of international lenders: the International Monetary Fund, the European Commission and the European Central Bank.

The Alvarez report provides new details on the extent to which Bank of Cyprus officials were hoping that the high yields generated by the Greek bonds would cover the bank’s imploding loan book. 

Alvarez investigators said that, according to the records they were able to secure from the bank, the decision to buy the bonds was based on a last gasp effort by the bank to generate profits as their loan book began to sour in late 2009 and through the spring of 2010. 

Investigators also said that the bank, like others in Europe at the time, made use of cheap financing from the European Central Bank to make these bets. As a result, executives in the bank’s treasury department bought the riskiest high-yielding bonds available and found willing sellers in banks eager to reduce their exposure to Greece. 

When it became clear not long after the Greek bailout in May 2010 that some form of debt restructuring would have to take place, the Bank of Cyprus found itself stuck with a 2.4 billion euro portfolio of Greek bonds.

Annie Lowrey has a story today, "Lew to Press for Growth in Europe," about Treasury secretary Jacob Lew's trip this week to Europe to ostensibly jawbone leaders there to dial back on austerity. What's interesting about the story is that the normally excellent Lowrey undercuts her lead halfway through the article:

But countries like Germany have shown little willingness to ease the constraints of austerity for peripheral European countries, or to engage in stimulus spending themselves. And for years, European officials have bridled at being lectured by officials from Washington — particularly because many feel that their financial crisis was largely caused by American financial products exported around the world by American banks. 

Though Mr. Lew will travel to Europe with a familiar message from Washington, it may not be delivered as urgently as in the past. The European crisis continues to weigh on American growth, cutting into exports, but many economists believe that the United States has entered a cycle of self-sustaining economic growth driven by a turnaround in housing and improving household budgets. 

Moreover, American companies have over the last few years steeled themselves against Europe’s financial woes, and the risk of contagion is perceived to be relatively low. 

Europe was the primary international concern for Timothy F. Geithner, Mr. Lew’s predecessor as Treasury secretary and a familiar face on the Continent. But perhaps as a sign of Europe’s diminishing threat to United States economic stability, Mr. Lew’s first overseas trip as Treasury secretary, last month, was not to Paris or Berlin or Brussels, but to Beijing.

Apparently what Lew is really in Europe to do is continue negotiations on a free trade agreement between the United States and the European Union. In other words, it is neoliberalism full speed ahead. Talk up stimulus, continue with austerity, and finalize the free trade agreement.