Behind the Euro problem is doubt about the financial stability of European governments that support the currency. Financial markets behave more like a frightened herd when faced with uncertainty of this nature. Enter the Horse Whisperer. Horse whispering, or natural horsemanship, is an old practice dating from the 19th century that rehabilitates horses that have become intractable due to abuse or accident trauma. The practice gained public awareness in the movie, “The Horse Whisperer,” starring Robert Redford as a trainer with a gift for understanding horses. He is hired to help an injured teenager and her horse back to health following a tragic accident involving collision with a truck.

Meet the Eurozone's own Robert Redford—Mario Draghi—president of the European Central Bank since November 2011. He was hired to help an injured Eurozone and its banks back to health following a tragic accident involving collision with debt repayment. And to date, he has been successful.

Draghi, the counterpart of Federal Reserve chairman Ben Bernanke, heads the European Central Bank. The ECB oversees monetary policy for Eurozone's 17 members which make Draghi the most important central banker in the full 28-member European Union bloc and the person most able to influence market direction. In July 2012, Draghi gave a speech to an investment conference in London in which he implied the ECB will overtly intervene in the bond market:

"To the extent that the size of these sovereign premia hampers the functioning of the monetary policy transmission channel, they come within our mandate. Within our mandate, the ECB is ready to do whatever it takes to preserve the Euro. And believe me, it will be enough."

PAGE 2: Eurozone's Financial Ketamine

Frightened horses are sometimes calmed by tranquilizing them with the drug ketamine. In Europe's case, the ketamine has come in the form of Outright Monetary Transaction, a policy announced by Draghi in August 2012. This is the purest expression of his pledge to save the Euro: OMT is the promise by the ECB to buy government bonds if needed. It is difficult to overstate the calming effect OMT has had on the Eurozone, although the irony is that the policy has not resulted in the purchase of a single bond—anywhere—in Europe.

OMT's mere existence is having a placebo effect on European financial markets by stopping fears of sovereign default, allaying fears about governments being unable to underwrite their banks' debt. Bond auctions in Spain and Italy prior to OMT were akin to an endurance steeplechase with worries that each issue would fall at the fence. Bond yield spreads narrowed substantially since whispering began last year:

[IMGCAP(1)]

Since August, investors have less fear about bond quality because the ECB is ultimately there to honor the bonds. There has also been government bond yield stabilization across Europe, reducing funding pressure on governments and expectations of Eurozone disintegration.

Drug agencies describe ketamine as “a powerful general anaesthetic used for operations on humans and animals. The effects do not last long, but until they wear off, ketamine can cause a loss of feeling and lead to users experiencing a distortion of reality.”¹

That fairly accurately describes financial market reaction to events in Cyprus earlier in 2013. In March, Cyprus became the latest country in the Eurozone requiring a bail out. Cyprus' economy, at $22.8 billion in 2012, is smaller than that of Vermont. It is a tiny contributor to the overall European economy so, in theory, not a problem for the European Union.

Cyprus needed $20 billion in a bank bailout to prevent sovereign default. European partners only offered $13 billion, requiring Cyprus to fund the remainder. The political reason why the EU is not funding the full lot is that 2013 is an election year in Germany and the incumbent German government does not want to be seen bailing out non-EU investors (the big depositors in Cypriot offshore banks).

If this occurred prior to OMT, it may have triggered another major stampede of investors galloping to exit Europe. This time the stable door was sufficiently bolted shut. The prevalent thinking resulting from OMT is the ECB will not let any crisis develop into a catastrophe.

So the sedative effect of OMT is widespread but not without critics. Using ketamine to sedate animals is often regarded as unethical. Likewise ECB actions are regarded with suspicion, particularly by the Bundesbank, the German central bank. The legality of OMT and the European Stability Mechanism (the fund used in bail outs) are currently being tested in the German Constitutional Court (the equivalent of the U.S. Supreme Court). It reflects concerns about the moral hazard of letting the country have an open-ended commitment to underwriting debts. At some point, the bond markets may test the viability of OMT for real.

Europe's bank problems mean lending for real estate is anaemic for all but the most secure projects. Europe's banks grappling with Basel III requirements and the need to recapitalize have retreated from cross-border lending. Reduced bank activity is leading to growth in alternative lending. European insurers are getting involved, but interestingly, American companies like Wells Fargo, Tishman Speyer, Cornerstone and Pricoa are plugging the funding gap. American debt funds are expanding into Europe for the first time because there is little competition.

European bank deleverage programs and CMBS issues requiring refinancing are creating plenty of buying opportunities. Risk-free rates have reduced because of ECB action so hurdle rates are becoming more achievable. Properties still have risk, but bargains abound. In addition, the underlying occupier fundamentals are starting to look better. Prime rents have stopped falling in most cities. Many companies have already cut costs through strategic consolidation, and given many European lease lengths can be short, contractions may be nearing an end. A lack of development over the last four years means that key cities are experiencing moderate Grade A space shortages, creating opportunities with buildings that remain. Many opportunistic funds, especially American, are looking to buy these investment dark horses as the market hits bottom.

Down The Stretch?

OMT is not a cure for the problems with the Euro, but the currency seems likely to survive for the mid-term. Eurozone membership is even set to expand next year when Latvia joins the bloc as its 18^th member. Europe now needs to build on stability with growth. Draghi cannot whisper growth back into European economies alone. Like the child in the Horse Whisperer who eventually has to get back on her injured horse, countries have to be willing to do more themselves.

Greg Cooke is chairman of BNP. The views expressed in this column are the author's own.