EU Leaders Trigger Another Market Panic

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.”

http://www.eurointelligence.com


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.

The gap between the German position on future crisis resolution in the euro zone and of other EU member states is a fundamental conflict that remain unresolved.

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.

French Fury – 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.

In an article in the Irish Independent today,  Colm  McCarthy does the math on the Irish goverment’s refinance operations.

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

Previous day Today
Greece 7.095 8.640
Ireland 4.054 4.744
Portugal 3.259 3.794
Spain 1.618 1.804
Belgium 0.786 0.826

Euro bilateral exchange rates:

Previous day Today
Dollar 1.3818 1.3935
Yen 112.88 112.29
Pound 0.8731 0.8678
Swiss Franc 1.3636 1.3814
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