Eurozone Bailout, Not So Fast

(10 am. – promoted by ek hornbeck)

Cross posted from The Stars Hollow Gazette

Last Thursday Mario Draghi, the president of the European Central Bank, won almost unanimous support for an unlimited bond purchase that would relieve the pressure on financial troubled countries by spreading the repayment of debt to Euro Zone countries as a whole:

The central bank’s program will not solve the deep structural problems of the euro, Europe’s common currency. But it will buy time for the political leaders of the 17-nation euro zone to follow through on their past promises to discipline each others’ spending more closely and work harder to relax labor regulations and barriers to business creation that are regarded as impediments to growth.

The central bank will buy bonds on open markets, without setting any limits, in contrast to an earlier bond-buying program that proved too hesitant to be effective. The bank said it would act only after countries agreed on certain conditions with the euro zone rescue fund, the European Stability Mechanism. That fund, known as the E.S.M., would buy bonds directly from governments, taking responsibility for imposing the conditions, while the central bank would intervene in secondary markets. [..]

The one dissenting vote came from Germany’s central bank, the Bundesbank, that was cast by Jens Weidmann despite Chancellor Andrea Merkel’s support for the plan.

But no so fast. The plan relies heavily on Spain and Italy to ask for help from the ECB. Both governments expressed reluctance for fear of political back lash at home and the harsh policy changes that they would have to accept. Spanish  Prime Minister Mariano Rajoy took the stance that Spain would not be forced into asking for assiatance from the ECB until the conditions were made “crystal clear”:

After Mario Draghi, European Central Bank governor, made clear that any assistance from the central bank to reduce Spanish borrowing costs would come with “strict and effective” conditionality, the Rajoy government remained steadfast in its view that a request would only be made if, and when, it is ready. High quality global journalism requires investment.

“There is no urgency,” a Spanish official said following a joint press conference between Mr Rajoy and Angela Merkel, where the German Chancellor deftly avoided a series of questions over possible new conditions for Spain. [..]

The Spanish prime minister is aware of the disastrous political consequences a direct request for a bailout would have on a nine-month-old government that was elected on a pledge to avoid the fate of Greece, Portugal and Ireland.

At the FDL News Desk, David Dayen gives his analysis:

Basically, Rajoy is saying “do your worst.” And he has some leverage. The Eurozone might be able to survive without Greece, but Spain is too big to fail. Draghi is adamant that he will not rescue the bond yields of any state that does not comply, but that has not been confirmed by events. So we have a game of chicken. And Rajoy, who campaigned on avoiding the fate of Ireland and Greece and Portugal, has political reasons to remain steadfast. He wants to keep the troika out of Spain; it’s political suicide if they come in and tell him how to manage the Spanish economy.

The knowledge among bondholders that Rajoy could at any time sign up for aid may be enough to keep them at bay relative to Spanish debt, and the debt of other sovereigns. That’s my hope, anyway. Because forcing Spain into more brutal austerity will turn out just the way it has turned out in Britain and any other country with a fragile economy.

From the annual Ambrosetti Forum at Lake Como on Friday, economist Nouriel Roubini gave his assessment:

“The ECB move is helpful but is not a game-changer. The eurozone is still in crisis,” said Nouriel Roubini, head of Roubini Global Economics.

“Unless Europe stops the recession and offers people in the peripheral countries some light at the end of the tunnel – not in five years but within 12 months – the political backlash will be overwhleming, with strikes, riots and weak governments collapsing.”

Professor Roubini said the German Bundesbank and will insist that “severe” conditions are imposed on Spain once the country requests a rescue from the eurozone EFSF/ESM bail-out funds and signs a memorandum ceding budgetary sovereignty.

“Plenty of accidents can still occur. There is austerity fatigue in the periphery and bail-out fatigue in the core. Eveybody is restless,” he said [..]

This current plan only kicks the can down the road. There are structural problems of the Eurozone system that must be addressed to adequately resolve this crisis:

There is a structural contradiction within the euro system, namely that there is a monetary union (common currency) without a fiscal union (e.g., common taxation, pension, and treasury functions). In the Eurozone system, the countries are required to follow a similar fiscal path, but they do not have common treasury to enforce it. That is, countries with the same monetary system have freedom in fiscal policies in taxation and expenditure. So, even though there are some agreements on monetary policy and through European Central Bank, countries may not be able to or would simply choose not to follow it. This feature brought fiscal free riding of peripheral economies, especially represented by Greece, as it is hard to control and regulate national financial institutions. Furthermore, there is also a problem that the euro zone system has a difficult structure for quick response. Eurozone, having 17 nations as its members, require unanimous agreement for a decision making process. This would lead to failure in complete prevention of contagion of other areas, as it would be hard for the Euro zone to respond quickly to the problem.

In addition, as of June 2012 there was no “banking union” meaning that there was no Europe-wide approach to bank deposit insurance, bank oversight, or a joint means of recapitalization or resolution (wind-down) of failing banks. Bank deposit insurance helps avoid bank runs.

So countries like Greece, Ireland, Italy, Spain and Portugal, who find themselves in a financial crunch, must rely on the not so “goodwill” of countries like Germany who are reluctant to share the pain.


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  1. TMC
  2. banger

    Like everything else in the Empire we will see a highly stratified but more stable system. Debtor countries will be structurally required to remain poor with low investment, low growth and increasing poverty. Populations will be forced to emigrate to rich countries putting a strong downward pressure on wages and increase the talent pool for big corporations in the more successful countries making labor costs cheaper and productivity higher. This will also have the virtue of entrenching the current aristocracy into a fully-hereditary system.

    There will be, as  we see, a nominal allegiance to multi-culturalism, egalitarianism while practicing the opposite until hypocrisy need not pay homage to virtue any more since the whole notion of virtue and morality will be lost in the vague idea of “good guys” v. “bad guys. “We” will be good and “they” will be bad–and that will be the extent of our moral reality in practical terms.

    It still remains to be seen whether Europeans will actually go along with all this over the long-term. The Spanish young people who are rebelling may hold the key. If youth-culture, which is still strong in Europe, can manage to cohere things could change particularly as the create underground and unofficial economies based on barter etc.  

  3. TMC

    at this plan. They don’t like the idea of their tax dollars going to a bailout plan they have control over. Spain and Ital y have rejected asking for assistance without knowing the terms first. They don’t want to find themselves in the same austerity boat with Greece and Portugal.

    Draghi’s plan is hardly a done deal and the threat of a collapse of the Eurozone and euro is still very much a possibility.

    Yves Smith noted this article from the Financial Times by Gideon Rachman.

    The European Central Bank has fired its magic bullet. By promising “unlimited” purchases of sovereign bonds, Mario Draghi, the ECB’s president, may have kept his pledge to do “whatever it takes” to save the euro. But in rescuing the currency, Mr Draghi’s magic bullet has badly wounded something even more important – democracy in Europe.

    As a result of the ECB’s actions, voters from Germany to Spain will increasingly find that crucial decisions about national economic policy can no longer be changed at the ballot box. In Germany, in particular, there is a growing realisation that the ECB, an unelected body that prides itself on its independence from government, has just taken a decision that has profound implications for German taxpayers – but one that they cannot challenge or change.[..]

    So why has Mr Draghi done it? The answer is that he faced a truly hideous dilemma. It was clear that the hundreds of billions of euros committed to European bailout funds have not been enough to ward off the threat of collapsing banks and sovereign defaults across the eurozone. A financial calamity could lead to another Depression, followed by political radicalisation – and a threat to democracy that is much more direct and unsubtle than the menace posed by the ECB.

    By contrast, if Spanish and Italian borrowing costs come back under control – and their governments are prodded into making important structural economic reforms – then the ECB’s actions last week could yet be vindicated. Mr Draghi would not only have saved the euro – he would have bought Europe the time it needs to return to growth.

    However, a great many things now have to go right simultaneously for Mr Draghi’s plan to work. It is rather more likely that political and economic unhappiness will grow in Europe over the next year – as Germany slips into recession and Italy and Spain (not to speak of Greece) struggle with ever deeper austerity. If the euro were ever to break up, the direct financial cost to Germany and other creditor nations – and the resulting backlash – could also be much higher, because of the ECB’s bond-buying programme. Certainly, for anyone with a sense of history, the sight of the German representative on the ECB being isolated and outvoted should be chilling. Since 1945, the central idea of the European project was never again to leave a powerful and aggrieved Germany isolated at the centre of Europe. We are now dangerously close to that point.

  4. banger

    But I still think, at the end of the day, you will have this two or three tier-system of permanently well-off states and another class of states under severe austerity.

  5. TMC

    They still have a semblance of democracy there. Voters count and they can be very vocal. The press is not as “owned” as it is here and now, with the social networking, the game has completely changed. The European will not tolerate what we here in the US have. There is only a limited amount of time left for the Eurozone to walk the fence. It is an very flawed system that cannot function without a fiscal unity. Individual EU nations will never tolerate the “fix”

    Put me on Roubini’s corner, I believe it is doomed to collapse.

  6. banger

    The Germans are blaming, for example, the southern tier of countries. Should the Eurozone just collapse and let the currencies fall where they may? Some people think that it will cause major short-term pain but the southern countries should rebound by being able to adjust their currencies–but it will seriously hurt global trade and, in my view, cause a world recession as countries and people will be focused more on subsistence. Maybe that’s a good thing!

  7. TMC

    That’s what will happen eventually, if it doesn’t fix its structural flaws. The Eurozone member countries are not of a mind to do that. It would be giving up more of their individual rights than they are willing to surrender to the ECB.

    At this point, a second recession is almost inevitable. Even the US faces a second recession mostly because of the failure to adequately address the housing crisis and regulate the banking industry gambling with investor money.

    The sooner the collapse happens, the sooner the government will start acting like a parent again and stop shirking its fiscal responsibility to regulate the banking industry and Wall St. At least that is the hope.

    Look at Iceland, it isn’t out of the woods entirely but they didn’t fare so badly. And they let the banks fail and prosecuted the bankers for their fraud.

    No matter what, its going to be painful. Why shouldn’t it be just as painful for those who caused it.

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