While details are still a bit sketchy, in essence the latest euro rescue effort is pretty straightforward. Italy and Spain had their backs against the wall, so they threatened to completely block any result (like the stimulus efforts or baby steps towards a budgetary union) unless something was done to stem the rising interest rates on their sovereign debt.
It is also pretty straightforward why Angela Merkel finally caved into these demands. The alternative risks a breakup of the eurozone, an outcome which has terrible consequences also for Germany:
Der Spiegel has published an internal ministry report that estimates a breakup would cause German unemployment to double, and GDP to contract by 10 percent. [Yahoo]
And that hasn't covered all costs:
According to the IFO institute, German losses via all European bail-out funds if the GIIPS countries were to default amount to €704bn. [Telegraph euro blog]
Spain and Italy threatened to block "everything":
A crisis summit to save the European Union's single currency broke up in disarray early this morning after Italy and Spain threatened to block "everything" ... unless they got immediate eurozone aid to bring down their borrowing costs. [Telegraph]
That strategy seems to have worked, at least to a considerable degree. There are real concessions from the Germans, and real progress towards stabilizing the eurozone crisis. The main results:
- The permanent rescue fund, the ESM can recapitalize banks directly so any of it won't add to the country's bailed banks sovereign debt.
- This happens only after a single banking supervisory mechanism has been established by the ECB (so it can take a while).
- The rescue funds can also be used for buying bonds on the secondary markets (although details and conditions are pretty hazy at this moment), on "Troika" (ECB, EU, IMF) conditions and checks.
- Most notably, perhaps, the seniority of this bank funding by the rescue funds has been abolished. This eases the funding problem for banks further, as private bond holders have less to fear from being the first victims of bank debt restructurings.
Before you get too enthusiastic, much leaves to be done before we can say with any kind of confidence that the eurozone crisis could be a thing of the past though:
- The ESM isn't even ratified in some countries, like Germany and Italy.
- It's doubtful (to put it mildly) whether the EFSF/ESM is anywhere near big enough for it to recapitalize eurozone banks and buy Italian and Spanish bonds.
- The EFSF cannot fund itself for the required size.
- the ESM might have to be given bank status in order to achieve sufficient size, but that requires Treaty changes and Germany is dead set against this.
- Seniority in ESM bond buying hasn't been removed, so subordinating private holders still makes it less attractive for private investors to buy these bonds.
- ESM bond buying is likely to put a definite end to ECB bond buying. Since the latter has a near infinite balance sheet, this is actually an inferior solution. It would be different if the ESM is granted a banking license though, as it could fund itself cheaply at the ECB with such a license.
- And of course, the competitiveness gap between the center and the periphery, as well as the euro zone economic slump are still reigning.
So all in all, useful steps. We are somewhat encouraged (euro is up, Spanish yields are down), but much remains to be done.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.