Slowly but surely the news that the “plan for a plan” isn’t going to be anywhere near as impressive as expected. As I warned late last week, the best thing all European leaders could do is talk down expectations because if I have learned anything over the last 18 months of covering the European “crisis” it is that their resolutions are always underwhelming.
The latest plan suffers from exactly the same issues that every other resolution does. Europe has macro-economic imbalances that continue to grow stemming from differentials in competitiveness between nations sharing the same currency and a de-regulated banking system. These imbalances have now reached a point where they are completely unsustainable in many nations. The European “crisis” is an on-going disagreement between the nations of Europe in how to resolve these imbalances, although after 2 years I get the feeling that nearly everyone involved has completely lost sight of the original problem.
As I said early last week in a summation of the issues facing the latest merkozy plan:
Re-capitalise the banks, save Greece, help Italy, Spain and Portugal, stabilise the euro all while keeping France’s AAA rating without extending the use of the ECB. I can’t wait to hear this “credible” plan!
Given the amount of capital now required any credible bailout plan must include the ECB as it is the only institution in the world that is able to create Euro denominated financial assets. The Germans, however, have made it very clear on many occasions that they will not support the use of the ECB in this way unless it comes with an agreement from European nations to hand over their fiscal sovereignty to a centralised European authority, i.e under the control of Germany. Given that it has taken over 4 months to simply ratify an adjustment in the amount of money nations are willing to loan each other if required based on an existing agreement, there is absolutely no evidence that there is the political will across Europe to enact a change of this magnitude.
The middle ground for a “bail-out” plan is some form of leverage of the existing stability mechanism. Again Germany seems to be against this approach, but there have been statements from a number of German representatives suggesting that they are more malleable on this than an ECB route. The latest plan being thrown around seems to be using the EFSF as a “first loss” insurance policy, by using the €310 billion of un-committed capital as a 20% “first-loss”.
The issue for this approach is that, as I have stated previously, France is in no real financial position to support it without threatening its own AAA rating. If statements by the French PM are anything to go by then AAA is to France is what the ECB is to Germany.
France’s triple-A credit rating cannot be taken for granted in the current crisis, which is threatening the future of Europe and of the shared euro currency, French Prime Minister Francois Fillon said on Tuesday.
“Despite its high deficit and debt levels, France is one of the 10 developed nations that is most credible to investors,” Fillon told a conference in Paris.
“That is an extremely precious asset that we must in no way jeopardize and it’s an asset … that is not inviolable.”
Moody’s said on Monday it would scrutinize its stable outlook on France’s triple-A credit rating in the coming three months to assess if the costs of helping to bail out banks and other euro zone members would stretch the budget too far.
A chart from Credit Writedowns showing the blowout the in 10 year bond spread between France and Germany speak volumes:
So you can now see the issue with the parameters of a bailout plan. The Germans will not support the use of the ECB in any form of direct leverage or printing operation, and the French will not allow the loss of their AAA rating. Under these parameters there is little doubt we will get a half-baked plan that is sure to disappoint anyone who expected a permanent resolution to the problems.
The other point of dispute is how to handle the existing write-offs on sovereign debt. Germany has been pushing for bond holders to take 50-60% write-downs on their notes while France only wants to see changes to the structure of those write-downs. I seem to remember that back in June that no one wanted to touch the Greek write-down issue because of the concern about triggers in the opaque CDS market. Those concerns seem to have been thrown aside by the Germans who have become far more vocal about the need for private sector write-downs over the last month, but once again France is reluctant to back bigger losses because their banks are so exposed to Greece and the country has a limited ability to provide a “back stop” because of its own economic position.
So as I said last week, with these two very large issues and seemingly immovable parameters on both sides of the merkozy “plan” the best thing that everyone can be doing is to talk down the expectations. That is exactly what Merkel is now doing:
German Chancellor Angela Merkel said that a European Union summit in five days will mark an “important step,” though not the final one in solving the euro-area sovereign debt crisis.
“These sovereign debts have built up over decades, so they won’t be ended with one summit,” Merkel told reporters in Berlin late today. While European officials recognize their responsibility to stop the crisis, “this will require tough, long-term work.”
The comments marked the second time in two days that Merkel sought to lower expectations that the European crisis-fighting effort would climax at the Oct. 23 meeting in Brussels, as international officials are advocating.
Earlier today, she told a meeting in Berlin of her Christian Democratic caucus that officials from the 17-nation euro area are moving millimeter by millimeter on solving the crisis, an official who attended the talks told reporters.
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Merkel’s spokesmen Steffen Seibert said yesterday that EU leaders won’t provide the complete fix that global policy makers pushed for at a Group of 20 gathering three days ago.
Merkel has made it clear that “dreams that are taking hold again now that with this package everything will be solved and everything will be over on Monday won’t be able to be fulfilled,”