From Mark Grant, author of Out of the Box
Hardball in Brussels
In the last hour yesterday the equity markets rallied significantly on the basis of a 120 billion growth package for Europe that had been announced. The EU put out the headline like it was all new money but further investigation revealed that it was not. The growth package was mostly the amalgamation of schemes already in existence with the addition of some new money but not a significant amount. As the news behind the headlines was assessed the markets traded back down some in the after hour’s session. Then Europe’s leaders met and the evening got more interesting. The following is the basis of their decisions.
"We affirm that it is imperative to break the vicious circle between banks and sovereigns. The Commission will present Proposals on the basis of Article 127(6) for a single supervisory mechanism shortly. We ask the Council to consider these Proposals as a matter of urgency by the end of 2012. When an effective single supervisory mechanism is established, involving the ECB, for banks in the euro area the ESM could, following a regular decision, have the possibility to recapitalize banks directly. This would rely on appropriate conditionality, including compliance with state aid rules, which should be institution-specific, sector-specific or economy-wide and would be formalized in a Memorandum of Understanding. The Eurogroup will examine the situation of the Irish financial sector with the view of further improving the sustainability of the well-performing adjustment program. Similar cases will be treated equally.
We urge the rapid conclusion of the Memorandum of Understanding attached to the financial support to Spain for recapitalization of its banking sector. We reaffirm that the financial assistance will be provided by the EFSF until the ESM becomes available, and that it will then be transferred to the ESM, without gaining seniority status.
We affirm our strong commitment to do what is necessary to ensure the financial stability of the euro area, in particular by using the existing EFSF/ESM instruments in a flexible and efficient manner in order to stabilize markets for Member States respecting their Country Specific Recommendations and their other commitments including their respective timelines, under the European Semester, the Stability and Growth Pact and the Macroeconomic Imbalances Procedure. These conditions should be reflected in a Memorandum of Understanding. We welcome that the ECB has agreed to serve as an agent to EFSF/ESM in conducting market operations in an effective and efficient manner.”
Behind the Headlines
Apparently Mr. Rompuy had jumped the gun in making the announcement about the growth package late yesterday afternoon as Italy and Spain had not yet agreed to it. No matter, the markets took Mr. Rompuy at his word and rallied away and it was not until after the close that the truth came out. In fact, in the evening negotiations, Italy and Spain threatened to veto the growth measures if certain other measures were not agreed to which were to their benefit. From all indications it was here that Ms. Merkel blinked and was willing to make certain adjustments that are significant. For us the most important change is that the loans from the new ESM fund will not be senior to private debt holders. That is definitely good news for bond investors and a decision that I can applaud.
The other news on that front was that the funds for the EFSF and the ESM were not increased and that while some firewall is a deception of sorts as it does nothing for the troubled nations at all it is indicative, though a contingent and unfunded commitment, of the size of the capital available should further needs arrive for the troubled nations, including Spain and perhaps Italy. If there was one eyes wide open part of the negotiations and discussion it was that Italy may also need some assistance soon because this was hinted at time and again. The ECB will be handling the distribution of bond buying in the secondary and perhaps primary markets for sovereign debt but, unlike the Fed, the printing presses are NOT available as the money allocated to the EFSF and the potential ESM is all of the money that can be used for any bond buying programs. This, then, is a significant negative for the program as there is not enough money to really help out Spain, much less Italy, if it is needed.
Another change is that money can be lent directly to the banks and does not have to go through the sovereign but this change will not take place until the end of 2012 when some sort of European banking supervisory authority is established and there are no details on what that will mean except that it will be located in Brussels. The statements seem to indicate that the money for the Spanish banks will now go the nation of Spain and then its banks and then the money will be transferred off of the Spanish books at a later date when the new banking authority is established.
Now all of this has to go back to various Parliaments, including Germanys, which may cause some consternation as the “seniority” of the ESM has been relinquished which may cause some problems in Finland, Austria, the Netherlands and perhaps even in Germany. It is interesting to note that all of the dictums that have been announced deal with funding and that none addressed the structural or solvency problems of a Europe that is mired in recession.
There is also some good news in today’s release for Ireland which indicates that troubled banks in various nations may now be funded by the EFSF/ESM and not just the nation in which the banks are domiciled. Europe is going to consider EU wide funding which is good for nations such as Ireland and Spain of course but it is bad then for the nations that must provide the bulk of the funding indicating more debt that has to be taken on by Germany, Austria, the Netherlands, Finland et al. It is not exactly Eurobonds because it is limited in scope but it is a definite blink by Germany as hardball was played by both Spain and Italy and Ms. Merkel was outflanked in the end.
The final point that I would make today is that nothing is yet in place and is not even envisioned to be in place until the end of this year. In some sense it is a lot like discussing the ESM which is not yet in place either. All of the talk concerning removing the aid to the Spanish banks from the sovereign obligations of Spain will not happen unless this new banking authority is approved by the nations in Europe and there may well be some that don’t wish to turn over their sovereign banking powers to Brussels. What has been announced then is a plan, a scheme, that is some six months away from actualization if actualized at all. I would point out that there is a lot of risk between now and then and that Europe is quite good with coming up with all sorts of grand plans that somehow do not work out. In the meantime Ireland will still pay for her banks, Spain is going to get money but money lent to the country and not her banks, Greece now awaits the Troika and their report and then the decisions of the IMF and the EU on what if any changes might be made in their agreements and if any new money will be handed to Greece or if the funding will stop.
The EU has done a something I would say, made some progress, but what this something means is yet to be determined and it is one-half year away from implementation under the best case scenario and there will be plenty of challenges ahead in Europe during this timeline. The markets are rallying but the realization that nothing really was accomplished, meaning implemented, will drive the markets the other way soon I fear.
In Existence Now
In the final analysis Europe is quite exposed at this moment and may be for quite some time. The ESM, after the change in seniority status, must be re-affirmed in at least two countries that are the Netherlands and Finland and Germany has not yet approved it yet either. The EFSF has already spent $450 of its capacity on Greece, Ireland, Portugal and now $125 billion for Spain. The balance left in the fund is tissue paper thin and that is all that is in existence presently for any more problems in Europe. Plans and schemes aside, the amount of money that could actually be used today is a drop in the proverbial bucket.