People celebrating in Spain. Could it be that we figured out how to repay the $125 billions we owe to Europe? Ah no… it’s football, again. Congrats Spain for winning the Euro 2012!
Reverting back to he EU submits in the words of Satyajit Das ” The Pavlovian response of financial markets to the European leaders’ summit of 28 and 29 June 2012 was remarkable. The frugal communiqué of 322 words fired the “animal spirits” of financial markets, which now believe that the European debt crisis has been “solved”. As comedian Robin Williams joked: “reality is just a crutch for people who can’t handle drugs. “
Have tried to figure out some of the remarkable work and some real impossibilities :
Summiting Once More…
The summit supported a single regulatory body for all European banks.
The previously agreed Euro 100 billion capital injection for Spanish banks was ratified. Payments will now be made directly by the European Financial Stability Fund (“EFSF”) and its successor the European Stability Mechanism (“ESM”) to the banks rather than as loans to the relevant country. Loans will also not have priority of repayment over commercial lenders.
The EFSF/ ESM will take whatever actions are “necessary to ensure the financial stability of the euro area… in a flexible and efficient manner”. This was taken to mean that they will purchase bonds of beleaguered countries like Spain and Italy to reduce the cost.
The European Union (“EU”) will provide Euro 120-130 billion of financing for investment to boost growth.
The language was vague and the details sketchy. After the meeting German Chancellor Angela Merkel told the Bundestag that differing communications” from various Euro-Zone leaders about the exact agreement had “led to a whole number of misunderstandings”.
The initiatives may require complex and time-consuming changes in European treaties.
The German Constitutional Court must rule on some aspects of the current proposal.
In essence, implementation risks remain.
Bank recapitalisation will require the establishment of the EU central bank supervisory body, which should only be “considered” by the Council before the end of 2012. Given issues of national control and sovereignty, the risk of delays and failure of agreement are not insignificant.
Capital injections are subject to unspecified “economy wide” conditions. One potential condition could be that the national government compensate the EFSF or ESM for any losses. This is what Germany sought pre-summit, arguing that the EU could only lend to sovereigns, not foreign banks over which it had little or no control.
Where’s the Money…
There was no commitment of new money of any kind. Since mid 2011, Germany has succeeded in ensuring that existing bailout facilities are not increased.
The ability of the EU to support the peripheral nations on an ongoing basis is questionable.
The Euro 440 billion of the EFSF is largely committed to the Greek, Irish and Portuguese bailouts as well as the Euro 100 billion required for Spanish banks. After the new ESM is fully implemented, there will be at most Euro 500 billion available.
Potential requirements include a third bailout for Greece and further assistance for Ireland and Portugal. Additional money for recapitalising European banks may be needed. Spain and Italy have financing requirements of around Euro 600 billion in the period to 2014, mainly to pay maturing debt.
The cost of support for the peripheral nations is rising. The ECB has provided over Euro 2 trillion in the form of bond purchases and funding for European banks. Euro-Zone members are directly and indirectly supporting the two European bailout funds -the EFSF and ESM- for around Euro 1 trillion. National central banks in Germany, Netherlands, Finland and Luxembourg have provided more than Euro 700 billion in financing for weaker nations.
In the short run, the ECB will probably lower rates and continue to provide liquidity to manage the risk of financial collapse. But the deep-seated problems remain.
The real economy –growth, employment, investment, capital flight out of weak nation will continue to be problematic. The economic performance of stronger countries like Germany will deteriorate. The problems of the financial system –loan losses, funding difficulties will continue. Weaker sovereigns will continue to face challenges in raising funds at acceptable costs.
Despite progress, European leaders refuse to acknowledge that a portion of the debt of the peripheral nations is unrecoverable. None of steps announced improves the sustainability of the debt levels of the affected countries, their access to markets or cost of borrowing in the medium to long-term. Ultimately, it is not possible to solve the problem of excessive indebtedness with more debt or by simply changing the lender.
Austerity dooms Europe to a prolonged contained depression as the debt burden is worked off. The alternative, a debt write-off, would result in significant loss of wealth for the mainly European lenders and investors triggering an economic contraction and prolonged period of economic stagnation. There are now limited policy options available.