If you see Ireland's latest financial crisis as a sign that Europe's financial system is getting weaker, then you're reading the situation backwards.
This is because latest surge in Irish debt yields wasn't sparked by deteriorating economic fundamentals, or new spending plans.
Rather, it was sparked by Europe beginning to create a system to hold private investors liable for sovereign bond losses.
IT WAS the proverbial butterfly that caused the hurricane. On October 29th, leaders of the European Union agreed that they should re-open the treaties “to establish a permanent crisis mechanism” that would include “the role of the private sector”. The markets took this as a sign that bond-holders would be made to pay for future bailouts of troubled euro-zone members, and duly dumped the debt of the most exposed countries, notably Ireland and Portugal.
The reduction of implied future bailout protection caused the latest Irish yield surge, thus if you hate government bailouts then you should be happy with what's happening, actually. Ireland is experiencing short-term pain, but from a long-term perspective Europe is reducing long-term bailout expectations in the market, even if still providing a short-term source of financial support.
They are on the right track, but the trick is how to manage the transition as painlessly as possible, says the Economist:
The problem, as Mrs Merkel has discovered, is precisely how to manage the transition from blanket protection for bond-holders to a system where they are exposed to greater risk and, in turn, impose greater discipline (and impose it earlier) on sovereign borrowers.
The view among most European leaders is that all this would have been easier to deal with next year, once more stringent rules to monitor countries’ deficits, backed by sanctions, would be in place. By then, the hope was, the markets would have settled down. So should they drop the matter of a restructuring system be dropped as a bad idea?
Probably not. Now that they have been stirred, the markets are unlikely to be assuaged by yet more uncertainty and speculation. The best hope is to settle the matter as soon as possible. Call it what you want - a crisis-resolution mechanism, a stability mechanism, a peace offering to the gods – but a plan is needed sooner rather than later, with clarity about how it will be phased in after 2013. This time, though, leaders should deliberate knowing that, as one source puts it, “the markets are at sitting at the negotiating table”.
Had Europe, specifically Germany, not begun to address the creation of a new, reduced European bailout mechanism, then there would be no Ireland crisis right now. Instead, things would be smooth sailing while a larger, future crisis kept building.
Disclosure: No Positions