As pointed out by Markit yesterday, the EU leaders has come up with another financial agreement, and once again the bond markets panic. The agreement is a proposal to replace the European Financial Stability Facility (EFSF) with a new mechanism that allows the EU authorities to “bail-in” the holders of sovereign bonds. This means in practice that investors may be facing interest free periods on their bonds, as well as other forms of “haircuts” on their investments. The proposal will also dramatically increase the probability of sovereign default in the euro zone.
“This whole chain of events shows clearly that EU leaders continue to underestimate the complexities of a monetary union.”
Last Friday’ summit only agreed on some minimum parameters for president of the EU Council Herman van Rompuy’s next task force, but the difference in views between the EU members on how the crisis resolution mechanism should be is still remain extreme. Germany wants the “bail-in” mechanism to replace the EFSF. As a result European bond spreads is on the rise again, with borrowing costs increasing for the most troubled EU nations.
Germany is favoring a mechanism that allows an “orderly default” of the EU nations with the largest debt burden and the most severe economic problems.
Investors understand that the German proposal will dramatically increase the probability of future sovereign default in the euro zone.
In addition, they could be forced to accept interest pauses on their bond holdings, as well as other forms of so-called “haircuts”.
However, most of the other EU leaders have taken a stand against any sovereign default within the euro zone.
Here’s Herman Van Rompuy, President of the European Council, outlining the recommendations of the Task Force presented to the EU Heads of State or government on Friday.
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The Show Will Go On
The EFSF is not a solution to a crisis resolution, it is merely a temporary arrangement set to expire in 2013.
The European Financial Stability Facility (EFSF) is a special purpose vehicle (SPV) agreed on by the 27 member states of the European Union on 9 May this year, with the intent to preserve financial stability in Europe by providing financial assistance to euro zone states in financial trouble.
The proposal that now is on the table is supposed to replace the EFSF, maybe before the EFSF expires.
That will be decided by voting in the EU Parliament, next year at the earliest.
There’s a long and winding road ahead…
Turkeys Voting For Christmas
Italian ECB board member Lorenzo Bini Smaghi says, according to Reuters, that it was easy to talk about an orderly crisis resolution mechanism, but much more difficult to implement it:
“In advanced economies the restructuring of the public debt would have to involve a much larger number of financial assets and liabilities, including those of the domestic banking system, vis-a-vis residents and non residents… It can be easily seen that there can hardly be anything ‘orderly’ in such a process.”
And it’s hard to imagine Greece, Ireland, Spain, or Portugal agreeing to a crisis resolution mechanism, whose main effect would be to drive up their bond rates.
It would be like “turkeys voting for Christmas.”
“This whole chain of events shows clearly that EU leaders continue to underestimate the complexities of a monetary union,” eurointelligence.com comments.
The structure is simply not capable of handling default, and at the same time ruling out bailout and exit.
This could easily go on until the EFSF expires in 2013.
Meanwhile, all we can do is watch the credit market falling apart – piece by piece.
– Irish Bailout
“Will all the lawyers please the room,” Le Monde writes Tuesday.
(As understandable as this wish may be, it is perhaps a bit unrealistic.)
Le Monde argues that it is crazy trying to renegotiate the financial stability treaty, and that leaders should focus on what they need, rather than engaging in long detours.
Ireland is perhaps the EU state with the most acute problems right now, after the nations CDS spreads closed above the 500bp level yesterday, near a new all-time-high.
The Irish government has postponed their borrowing in September and October, due to the high borrowing. But the borrowing is only postponed, McCarthy points out.
And the Irish borrowing costs keep rising.
“What happens if the re-entry into the bond does not work?,” McCarthy asks.
Answer: A bailout by the EFSF – of course!
10-year sovereign yields
Euro bilateral exchange rates:
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