What exactly do investors want from Europe?
The question is far from trivial. Without private investors buying up the bonds of troubled European countries, the economic crisis overseas is likely to limp along. And though Europe has faded from the minds of many Americans as election season heats up, worries of the crisis spreading to the U.S. persist. With that in mind, The Huffington Post called several prominent investors to get their read on the debacle that has been slowly unwinding in Europe.
After a flare-up at the end of the year, and again last week, the crisis in Europe has cooled down temporarily. On Friday, ratings agency Standard & Poor's downgraded nine eurozone countries, including France, Italy and Spain. But Thursday, France and Spain had successful government bond sales with lower interest rates. European stocks rallied on Thursday as well, with Italy's FTSE Italia All-Share closing 2.67 percent higher and France's CAC 40 closing 1.96 percent higher. After months of uncertainty, Greece drew closer to a settlement with private bondholders that would force them to take a significant loss on their Greek government debt holdings and help prevent a Greek government default.
Investors are watching the crisis warily and wearily. "It keeps getting worse," said Jonathan Lemco, principal and senior analyst at the investment company Vanguard. "What incentive is there for investors to get involved?"
Unanimously, investors reached by The Huffington Post agreed that Europe needs to make them feel confident again by eliminating the possibility of a so-called "haircut" on debt, which would allow some governments to reduce the principal on their loans. Investors also want to be reassured that no European government would default. They all point to the European Central Bank and say that it needs to fully step into a role as the lender of last resort -- serving as a backstop against these doomsday scenarios. Some suggested growing the European Stability Mechanism, a European bailout fund, in order to prevent a major eurozone government from defaulting.
"The fear of a short-term collapse of the euro -- of a self-fulfilling speculative attack on these governments -- needs to be taken out of the equation," said Valentijn van Nieuwenhuijzen, head of macroeconomic strategy at ING Investment Management. "We have a central bank which is the lender of last resort for the banks, but the ECB is very aggressively not wanting to play that support function for the governments."
Investors also took issue with European leaders' focus on slashing government spending; they said that there hasn't been enough focus on growing economies. (A message that could easily translate to the United States as the presidential candidates debate how to shrink the growing deficit while also creating more jobs.)
"Just cutting spending and raising taxes is not sufficient," said Stefan Hofrichter, chief economist at Allianz Global Investors in Frankfurt. "You have to generate growth down the road, and in order to do that, you need to implement structural reforms. You have to free up the labor market and the product market."
Germany -- the undisputed leader in Europe's debt talks -- also needs to give more if it wants to keep benefiting from the eurozone, investors said. Germany needs to either give more money to a European bailout fund or allow the European Central Bank to buy troubled eurozone government bonds en masse in order to prevent government borrowing costs from becoming unsustainable. Despite Germany's claims to the contrary, austerity measures are not the only answer, and economic growth would significantly help fiscal sustainability since it would increase tax revenues, according to investors.
"It's a political decision. Does Germany want to retain this grand experiment or not?" Vanguard's Lemco said. "My guess is they do, but the crisis is not perceived as strong enough yet that it'll force them to make this very hard decision."
Nick Eisinger, a London-based sovereign debt analyst at Fidelity Investments, said it's largely unlikely that investors will return to buying troubled eurozone government debt on a large scale anytime soon, since many institutional investors have "a mandate to invest in very low-volatility government bonds." He added that a large enough eurozone bailout fund also appears unlikely, though it is "a big thing that markets would like to see."
There is a contradiction at the heart of the European economic crisis, Eisinger said: Investors want "a combination of fiscal sustainability and stronger growth prospects," but "obviously at the moment, both of those are working against each other."
"It's a no-win situation," Einsiger said. He said that if governments spend more to try to resuscitate economic growth, investors probably would demand higher interest rates on their debt, but if spending is slashed, the economic contraction and government deficits would deepen.
Even investors who said that eurozone governments have been living beyond their means said that ECB purchases of government bonds would help with long-term reforms, rather than disincentivize them, as European leaders have warned.
Jeffrey Rosenberg, managing director and chief investment strategist for fixed income at BlackRock, said that ECB purchases would buy time for European leaders to enact long-term, fiscally sustainable policies, rather than slash spending right away and cause economic growth to plunge. Rosenberg added that if the ECB provides more liquidity to financial markets, banks would stop feeling forced to sell government debt to raise cash.
"First you've got to stop the selling before you're going to get people to start buying," Rosenberg said.
Eric Brard, global head of fixed income at Amundi, the third largest asset management fund in Europe, said that European leaders need to strike the right balance between balancing their budgets and providing the groundwork for economic growth, which he admitted "may not be compatible" since too much budget-cutting can hurt growth and reduce tax revenue. But "a balance" of the two likely would work, he said.
ING's Van Nieuwenhuijzen said he believes that Germany should implement a two-year stimulus to boost economic growth in the eurozone. He added that if the ECB was willing to act as lender of last resort for troubled eurozone governments, and if economic growth and structural economic reforms appeared likely, "I think that Spanish and Italian bonds would be a very attractive proposition" for many institutional investors, since the bonds would be both lucrative and safe. But for now, institutional investors are avoiding troubled eurozone debt because of the risk to their reputations, he said.
"If the crisis escalates by April 2012, then a money manager still investing in Italy will probably lose his job," van Nieuwenhuijzen said. "But if they generate two percent lower returns than they otherwise would have done over the next two years, that will probably not cost them their job."
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