Merkel Threads a Needle
The recent marathon session in Brussels was the EU Council’s 18th meeting on the European debt crisis. As it is comprised of the heads of government from European Union members, the Council was largely thought of as a grand debating society.
Not this morning.
In what may well be the first glimmer of light at the end of the tunnel, the EU will agree to coordinate bailouts across the continent. The details are still incomplete, and there is always devil in the details. In addition, EU members must approve the substantive plan, meaning more coming politics in parliaments from London to Warsaw.
So this is not a done deal.
Actually, until there is some flesh on the bones, we are still uncertain what the “deal” really is.
But this much we do know.
A new EU supervisory body will emerge, allowing the European Central Bank (ECB) to oversee commercial banks across the member states. The European Financial Stabilization Facility (EFSF) – the current bailout fund from which dispersals have already been made to Greece, Ireland, and Portugal and from which Spain is scheduled to receive 100 billion euros – will be replaced by a new European Stability Mechanism (ESM).
The Council members vowed to have the ESM in place by July 9, but that will depend on the political scheduling to pass the plan in 27 member countries, not a very easy task.
Still, the new approach will have two elements of particular importance.
- First, the ESM will take positions in ailing banks, not simply lend out money.
- Two, what paper it cuts to cover assumed debt will be issued pari passu. That means it will not have any preferred status over private debt. Ultimately, the banking problem in Europe must be dealt with by the market itself, not by the central bank.
Without putting the debt paper on an equal footing, the attempt would certainly fail since the borrowing costs experienced by the likes of Spain and Italy would discourage the buying of the instruments needed to bring those costs down.
Now these factors are also crucial for Merkel. Germany has been opposed to continuing the use of German taxpayer funds to bail out troubled (and mismanaged) neighbors, as had been the only remedy using EFSF. This is a position also strong in other EU members, for examples, the Netherland, Austria, and Finland.
But given Germany’s central position as the economic driver of the integrated European market, its failure to agree would doom any suggested solution. Merkel had little leverage here. Another push from the EU for bailout money alone would have certainly crashed in Berlin.
To avoid this impediment, the new system must establish a framework that allows the market to solve the cross-banking credit crunch, and now allow sovereign funds to mettle in the process.
This may provide Merkel a way out, an ability to thread the needle, when she has to convince the Bundestag back home to support the new platform. What is essential if the stabilization program has any chance of succeeding is a provision of “political cover” for heads of government in selling the program.
The reaction to the move was immediate.
Markets opened today sharply higher. More important from our standpoint, both Brent crude trading in London and West Texas Intermediate (WTI) trading on the NYMEX in New York opened up 5%.
This is the single biggest pop since October 5 of last year.
The euro was sharply higher against the dollar and the energy sector (along with financials, the other main beneficiary from the apparent breakthrough in Brussels) was rising well in advance of the market as a whole.
Given that the markets have (for two months) overacted to the read of latest headlines, these came in particularly welcome. However, unless there is an immediate follow up with specifics, matters may soon again turn south.
Another primary reason there will be a major across-the-board rally today lies in what must be done by those who have been betting the market would continue to falter.
They now need to cover their short sales and fast.
Seems there is occasionally justice after all.