Let’s not sugarcoat tonight’s “resolution” – this is merely a temporary measure that will buy them more time to resolve the true cause of the currency crisis. Let’s take a brief look at some of the key points of tonight’s statement (read it in full here):
“All Member States of the euro area are fully determined to continue their policy of fiscal consolidation and structural reforms. A particular effort will be required of those Member States who are experiencing tensions in sovereign debt markets.”
Translation: Austerity will continue. This is more of the same. Trade deficit nations undergoing a balance sheet recession will be forced into further budget consolidation which will continue to put downward pressure on growth and ultimately worsen the fiscal picture.
“We commend Italy’s commitment to achieve a balanced budget by 2013 and a structural budget surplus in 2014, bringing about a reduction in gross government debt to 113% of GDP in 2014, as well as the foreseen introduction of a balanced budget rule in the constitution by mid 2012.”
Translation: they still believe Italy and the other periphery trade deficit nations can undergo austerity, external sector outflows and debt improvements. Greece has already proven this wrong.
“We reiterate our determination to continue providing support to all countries under programmes until they have regained market access, provided they fully implement those programmes.”
Translation: The ECB will temporarily enter markets in order to avoid catastrophe, but will not become the fiscal issuer required to resolve the crisis.
“To this end we invite Greece, private investors and all parties concerned to develop a voluntary bond exchange with a nominal discount of 50% on notional Greek debt held by private investors. The Euro zone Member States would contribute to the PSI package up to 30 bn euro. On that basis, the official sector stands ready to provide additional programme financing of up to 100 bn euro until 2014, including the required recapitalisation of Greek banks.”
Translation: Greece is the offering to the German austerity Gods. Bondholders will take a haircut on the $120B Greek debt they own, but will also be recapitalized. This is really nothing more than a peace offering to those who want to see the banks “take a loss”.
“Being part of a monetary union has far reaching implications and implies a much closer coordination and surveillance to ensure stability and sustainability of the whole area. The current crisis shows the need to address this much more effectively. Therefore, while strengthening our crisis tools within the euro area, we will make further progress in integrating economic and fiscal policies by reinforcing coordination, surveillance and discipline. We will develop the necessary policies to support the functioning of the single currency area.”
Translation: We know we need a fiscal union of some sort, but we can’t get everyone on board. This is a work in progress.
“The EFSF will have the flexibility to use these two options simultaneously, deploying them depending on the specific objective pursued and on market circumstances. The leverage effect of each option will vary, depending on their specific features and market conditions, but could be up to four or five.”
Translation: A larger EFSF will help to stem the bleeding and reduces the odds of a worst case scenario where we experience a Lehman type event. The leveraging of the EFSF ensures that Europe’s banks will not be allowed to fail and cause massive private sector contagion.
“Financing of capital increase: Banks should first use private sources of capital, including through restructuring and conversion of debt to equity instruments. Banks should be subject to constraints regarding the distribution of dividends and bonus payments until the target has been attained. If necessary, national governments should provide support , and if this support is not available, recapitalisation should be funded via a loan from the EFSF in the case of Eurozone countries.”
Translation: Substantial capital has been set aside in the case of widespread bank failures or recapitalization needs. Again, this fends off the worst case scenario where a massive banking crisis spreads into the private sector.
Conclusion: This is a step in the right direction. By recapitalizing banks and enlarging the EFSF they have set a nice sized rifle on the table. Unfortunately, this is just more of the same in greater size. Ultimately, none of these measures will resolve the true cause of the crisis which is rooted in the currency and the incomplete currency union. Until Europe resolves the imbalance caused by the single currency there is no reason to believe this crisis has ended. I still believe the ultimate resolution here will involve fiscal transfers of some sort directly to the sovereigns that resolves the lack of sovereignty issue. That likely means e-bonds or a central Treasury at some point. We are clearly not there though this statement buys them time.
For now, we can breathe a sigh of relief knowing that we aren’t on the verge of Lehman 2.0. Unfortunately, we can’t expect this to resolve the sovereign debt crisis as austerity will continue and the current measures do not attack the lack of sovereignty issue. All in all, this removes the worst case scenario, but virtually guarantees a muddle through scenario. If budgets worsen on the periphery we should expect to revisit this issue in the coming quarters and the crisis will once again ripple through the market forcing Euro leaders into greater action. Perhaps a true resolution is not far in the future. Unfortunately, it likely means more market volatility before leaders realize the true gravity of this situation.
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