Simone Foxman
Dec. 8, 2011
9:14 PM
 Image: YouTube |
Right now, EU leaders are trying to agree on a solution that is legal based on the terms of individual states constitutions and the EU treaties and one that actually fixes the major problems at the heart of the crisis.
But most of all, they're looking for a plan that their voters will go for.As you can imagine, they're not doing so hot right now.
1. The costs of sovereign borrowing could spiral out of control.
Image: Scott Barber via Twitter
Yields on Italian sovereign bonds rocketed to record—
and arguably unsustainable—yields last month.
In the secondary markets, yields on 10-year bonds topped 7.3%,
and sub-par bond auctions have made everyone wonder if Italy has become illiquid.
But this is not just happening in the PIIGS anymore—borrowing costs rose sharply in
France, Belgium, Austria, and even Germany at the end of last month,
suggesting that no country is safe from the effects of the crisis.
2. Contagion from Italy and Spain.
Image: BIS
The Italian and Spanish economies are too big to fail and too big to save. Italy's 120% public debt-to-GDP ratio second in size only to Greece among euro area countries, and Spain's public debt is rapidly expanding to prop up an overly leveraged private sector.
If one country falls it affects bond yields elsewhere in Europe and lending throughout the banking system via contagion. These effects would be particularly strong if the failing country were Italy or Spain. EU leaders must find some way to reassure markets that both countries' debt issuances are truly risk-free in order to stem rising borrowing costs that could render finding funding in the open market impossible.
3. The euro rescue funds.
The European Financial Stability Fund (a temporary fund) and the European Stability Mechanism
(the permanent version) are the rescue funds meant to provide funding for Greece,
Portugal, and Ireland, to construct a firewall around Italy and Spain to prevent contagion from spreading,
and to serve as the ultimate backstop for troubled EU banks.
The problem is that neither of these funds appear to be large enough to truly backstop Italy
and Spain as they stand, let alone if France gets downgraded.
The current incarnation of the EFSF has a 440 billion euro ($590 billion) lending capacity,
some of which has already been devoted to Portugal, Ireland, and Greece.
The ESM has been capped at 550 billion euros.
Now EU leaders are considering allowing both funds to function simultaneously for a year after the
ESM goes into effect in July 2013.
That would nearly double funding available to helping Europe. Germany is objecting to that plan.
4. Private sector involvement in getting the crisis under control.
Since this crisis seems to be exacerbated by a lack of market confidence,
EU leaders need to act in a way that will restore faith in sovereign borrowing.
Doing this is difficult when EU leaders also want creditors to take 50% haircuts on their holdings of Greek debt
(since it turned out to be a poor investment choice).
German Chancellor Angela Merkel and French President Nicolas Sarkozy are struggling
to reassure investors that Greece is the only place where the private sector will have to deal
with debt restructuring—but the fact they will have to stomach losses of 50% on their debt holdings
does not bode well for investment in other struggling sovereigns.
This issue is at the heart of technical debates about the future European Stability Mechanism,
the permanent bailout fund that leaders want to adopt by July 2010.
5. Greece.
Image: AP
Even with the prospect of massive debt restructuring, there is little hope that the country will be able
to return to the markets for funding in the foreseeable future.
What's more, drastic austerity measures have taken an axe to growth and
have caused massive strikes and riots in Athens.
Without heavy currency deflation that would make exports cheap once again,
Greece is unlikely to pull itself out of its hole of debt.
6. The European Central Bank's role in the crisis...and in the monetary union.
Image: Wikimedia Commons
The ECB is not like the Federal Reserve or most normal central banks.
It only has a single mandate—the commitment to ensuring price stability—
and cannot purchase bank debt or sovereign debt on the primary markets.
But now investors are praying that the ECB will step in and stand behind the
sovereign debts of Italy and Spain, not to mention Portugal, Ireland, and Greece.
It could do this through financing the ESM, EFSF,
or IMF in lending directly to sovereigns or by buying up vast quantities of their debt in a bid to cap
or stem rising bond yields.
However, ECB President Mario Draghi told reporters today that
the bank won't step in without the go-ahead from EU leaders,
which would need to be enshrined in treaty change.
It doesn't yet look like EU leaders are willing to step up to the plate and ask the ECB
to step in, and even if they did treaty change will be time-consuming.
7. Eurobonds.
Image: RetroVintageModStyle
Jointly issued eurobonds would allow strong EU sovereigns to back
the debt of struggling sovereigns in part or in whole.
Both the Council of Economic Experts and the European Commission
have been studying options for eurobonds, some of which could avoid
the time-consuming treaty change likely needed for broader changes to
the role of the ECB in general EU governance.
However Germany is adamant that eurobonds are only something that
can be considered very far down the road, and should not be included in the current debate.
8. IMF involvement.
The IMF is already participating in the bailouts of Greece, Ireland, and Portugal.
EU and IMF leaders have talked about expanding the fund's role in the bailout effort.
It even announced a plan that would allow sovereigns to borrow up to 1000%
of the quota of funds they contribute to the fund for one to two years.
However, the IMF's current lending capacity is too small to provide for the funding needs of Spain or Italy.
The U.S. is highly unlikely to agree to any plans to expand the capacity of the IMF,
regardless of the fact that other countries (in particular the BRICs) have said
they would contribute to an IMF-led effort to bail out Europe.
9. Political divide.
Image: YouTube
And you thought the U.S. was bad.
Relations between the fiscally sound Germany, Finland, and the Netherlands and the rest of Europe
led by France are heating up. Germany is objecting to many of the proposals that France
and the periphery are advocating, and Finland is against giving up its right to a veto on any proposals
(it is objecting to most).
These debates underscore a greater problem in the euro area.
Lack of enforcement mechanisms let eurozone countries violate the Stability and Growth Pact in the first place,
resulting in the excessive debts at the root of this crisis.
The lack of adequate taxation and power-sharing mechanisms
impedes passage of joint guarantee mechanisms, too. Finally,
without a more comprehensive central government,
states struggling with excessive debt will have a hard time ever returning to growth.
10. Euro versus non-euro.
Image: UK Prime Minister's Office
The European Union ties 27 countries together, only 17 of which use the euro.
The divide between the euro- and non-euro countries is deepening,
with German Chancellor Angela Merkel and French President Nicolas Sarkozy announcing that
they will try to include all 27 countries in a new EU treaty,
but will go ahead with plans even if they can only get 17 to approve it.
In particular, tensions appear to be escalating between the U.K.
and Germany/France over financial regulations and a financial transaction tax.
Whether or not these issues deepen, it is clear that euro states have less and
less in common with the rest of the EU.
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