Monday, May 10, 2010

Eurozone buys some time

European finance ministers came out of their late-night, closed-door meeting Sunday with all guns blazing. The question is, how long will their ammunition last?

In essence, the European Central Bank will buy up the bad debt of Greece (which Moody’s said it is about to drop to junk status) and any other EU countries needing help and issue its own bonds to pay for them. In this way, the whole of the EU (along with help from the IMF) is stepping in to back up its floundering members, to the tune of nearly $1 trillion. That sounds impressive until you realize that Greece’s debt alone is over $400 billion. Greece is in the worst shape but it is also one of the smallest of the EU member economies. Throw in the rest of the PIIGS (or PIGIS as I recently saw it spelled)—Portugal, Ireland, Italy and Spain—and that trillion bucks disappears in a hurry. Oh, and then there’s Hungary, and Austria’s not looking so good, and ….

The stock markets loved it, of course, but that could change in a hurry. This mess has now cost German Chancellor Angela Merkel her majority in the Upper House and a legal challenge to the bailout in German courts is entirely possible. The UK is trying to form a new government which is almost certain to be weak and short-lived. French President Sarkozy may also soon be facing an opposition controlled National Assembly due to public anger over the bailout.

EU leaders are pedaling as fast as they can and this weekend’s plan is straining the union’s legal structure (much of it was enacted through “emergency” provisions). There is growing concern that this weekend was a dramatic push towards a United States of Europe and there is certainly no consensus for that.

Many commentators have described the EU plan as a TARP for Europe. Its goal is largely the same. TARP took bad bank and other corporate debt and put in on the Federal Reserve’s books. The EU is now taking bad sovereign debt and putting in on the books of the ECB. In short, debt is being paid with more debt but now with taxpayers' help. In both cases the hope is that over time somehow the mess will clear itself up. It is not at all clear that is the case and, even it were true, that the credit markets will give it that time. This is high stakes poker unlike anything we’ve ever seen.

Note: Good analysis and discussion of the EU bailout can be found at many of the financial and economics blogs I have refered to in the past, including: Bill McBride's Calculated Risk (always my first stop), Paul Krugman's Conscience of a Liberal, Yves Smith's Naked Capitalism, and The Baseline Scenario of Simon Johnson and James Kwak.

Note 2: Here's a succinct evaluation of the bailout's problems from Bloomberg's Businessweek:

The leaders of the euro-area countries have thrown 750 billion euros ($963 billion) at shoring up confidence in the single currency. But it doesn’t matter how many zeros you put on the end of a bad idea. It’s still a bad idea.

In reality, you can’t stabilize a sinking ship.

The new stability package suffers from the same problem as all the other ones the European Union has come up with in the months since the Greek crisis started rattling the markets last year: It tries to fix the symptoms, not the causes.

Greece has exposed deep structural problems within the euro. There is no mechanism to stop governments breaking the rules. There is no popular support for massive fiscal transfers between countries. The rules for the euro area have turned out to be unreliable. And there is no way to start stimulating economic growth again in the heavily indebted nations.

Those are the hard questions. Even 750 billion euros won’t get close to answering any of them.

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