06.30.12

EU Summit Notes

Posted in Economics, Financial Markets, Politics and Policy at 8:52 am

US stock markets rallied 2-3% and crude oil jumped over 9% yesterday in reaction to the latest “plan to have a plan” and “agreement to agree on what has already been agreed” coming out of the EU.

I’m not convinced that this will amount to much more than another short term attempt to boost market confidence that rapidly deteriorates.

Everyone ought to just read the official statement (which is just slightly longer than one page in length) and ignore the speculation from the financial press.

Here are my key concerns:

  1. Debt subordination. The financial press keeps saying that the EU agreed that the Spanish bailout would be an exception that would not subordinate existing debt.  That seems to be true, but if you read the actual statement, it’s an artifact of the EU simply re-affirming that any assistance provided by the EFSF and then transferred to the ESM will not involve subordination.  This is an important point, for reasons that will become clear in a moment.
  2. ESM.  I have a number of concerns here.  First and foremost, the ESM was supposed to go into effect July 1.  That’s tomorrow.  It appears the new target date is July 9.  Is that realistic?  They need to get to a point where the countries providing 90% of capital contributions ratify it in order for it to become operational.  Progress has been quite slow.  Another concern is the size of the ESM – with approximately €500 billion in credit to be available it will not be nearly large enough.
  3. Direct injection of ESM funds into banks. This is the big one.  The question, again, is timing.  It can’t happen until the new single bank regulator is in place, currently targeted for January 1, 2013 (and we know how target dates slip in the EU).  Furthermore, each individual ESM bank bailout will require UNANIMOUS approval.  Is the thinking that no banks will get in trouble over the next 6 months, and that when they do get in trouble there will be ample time to get unanimous approval on terms?

Given the timing of the ESM itself as well as the timing of its power to provide direct assistance to banks along with the subordination issue, I think there is going to be enormous pressure over the next few months to expand both the duration and size of the EFSF while backburnering the ESM.  Alternatively, some new “medium term solution” may emerge to fill the gap between the EFSF and ESM.  It’s unlikely that matters will proceed along the lines currently proposed, with a smooth and seamless transition between the EFSF and ESM.

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