Europe Scrambles for Solutions, by Tim Duy: Monday morning is fast approaching, and European leaders are scrambling to come up with something credible to float ahead of the market opening. Recall that we ended last week with the S&P downgrade of Belgium, and policymakers would like to have something on the table in response. Most significant is that policymakers now realize that changing the Lisbon Treaty to enshrine fiscal discipline is a far too lengthy process to serve as an effective counterweight to emerging the soveriegn debt crisis. From Reuters:
Germany's original plan was to try to secure agreement among all 27 EU countries for a limited change to the Lisbon Treaty by the end of 2012, making it possible to impose much tighter budget controls over the 17 euro zone countries -- a way of shoring up the region's defenses against the debt crisis.
But in meetings with EU leaders in recent weeks, it has become clear to both German Chancellor Angela Merkel and French President Nicolas Sarkozy that it may not be possible to get all 27 countries on board, EU sources say.
Even if that were possible, it could take a year or more to finally secure the changes while market attacks on Italy, Spain and now France suggest bold measures are needed within weeks.
As a result, senior French and German civil servants have been exploring other ways of achieving the goal, either via an agreement among just the euro zone countries, or a separate agreement outside the EU treaty that could involve a core of around 8-10 euro zone countries, officials say.
The goal is to provide enough of a framework to allow the ECB to step in and shore up debt markets more decisively:
Germany's Welt am Sonntag newspaper reported on Sunday that Merkel and Sarkozy were working on a new Stability Pact, setting out national debt limits, that could be signed up to by a number of euro zone countries and which would allow the ECB to act more decisively in the crisis.
"If the politicians can agree to a comprehensive step, the ECB will jump in and help," the paper quoted a central banker as saying.
Is the plan for real or just a bargaining ploy?
While EU officials are clear about the determination of France and Germany to push for more rapid euro zone integration, some caution that the idea of doing so with fewer than 17 countries via a sideline agreement may be more about applying pressure on the remainder to act.
By threatening that some countries could be left behind if they don't sign up to deeper integration, it may be impossible for a country to say no, fearing that doing so could leave it even more exposed to market pressures.
The risk here is that market paricipants read the bilateral agreements as they emerge as an invitation to attack those nations not yet signed up to the plan. Those nations would be even more vulnerable as they would explicitly lose any ECB backstop. The other choice for some nations would to be to go down the road of Greece and accept crushing austerity in order to stay in the Eurozone. Damned if you do, damned if you don't.
Note also that although these ideas are bandied about in terms of "greater fiscal integration," I don't think we are seeing much mention of fiscal transfers, just mechanisms to enforce budget discipline. This is certainly a framework for a two-speed Europe.
In other news, someone is floating rumors that the IMF is preparing a massive lending program for Italy. From Bloomberg:
The International Monetary Fund is preparing a 600-billion euro ($794 billion) loan for Italy in case the country’s debt crisis worsens, La Stampa said.
The money would give Italy’s Prime Minister Mario Monti 12 to 18 months to implement his reforms without having to refinance the country’s existing debt, the Italian daily reported, without saying where it got the information. Monti could draw on the money if his planned austerity measures fail to stop speculation on Italian debt, La Stampa said.
Details are unclear. Ed Harrison at Credit Writedowns has a translation of a German version of the story that mentions the possibility of ECB funding of the bailout, with an IMF gaurantee.
Speaking of Italy, the austerity parade marches forward, via Bloomberg:
The Italian government, led by Prime Minister Mario Monti, may introduce additional austerity measures totaling as much as 15 billion euros ($20 billion) on Dec. 5, Il Sole 24 Ore reported.
Monti may levy a tax on first homes, increase value-added tax, and introduce anti-evasion measures on transactions of more than 300 euros to 500 euros, the Italian daily reported, without saying where it got the information. The introduction of a wealth tax is still uncertain, Il Sole said.
Italy needs reform, to be sure. But in the near term, austerity only worsens the European crisis. Troubled European nations need compasionate austerity that rewards progress toward long-term goals with near-term stimulus. But without a fiscal transfer mechanism, their is no way to offer such stimulus.
Finally, I emphasize that austerity and ECB intervention may bring short-term relief to financial markets, and at least one element of the crisis under control, but these efforts do not address the banking crisis that is settling over the Continent. Felix Salmon points us to a must-read IFR report:
European banks are being forced to abandon their efforts to sell off trillions of euros worth of loans, mortgages and real estate after a series of talks with potential investors broke down, leaving many already struggling firms with piles of assets they can barely support.
Lenders have instead turned their attention to reducing the burden of carrying such assets over months and years, with many looking at popular pre-crisis “capital alchemy” arrangements to minimise capital requirements and boost their ability to use the assets to tap central banks for cash.
Deadlocked talks with potential buyers – a mix of private equity firms, hedge funds, foreign banks and insurers – show little sign of making breakthroughs, say bankers taking part in those negotiations, with the stalemate threatening to block the industry’s ability to save itself from collapse through a mass deleveraging.
The article concludes with a key insight:
“Natural deleveraging through not renewing loans is one of the few options remaining to banks to shrink their balance sheets, but the timetable for implementing this kind of strategy can be very protracted,” said Ryan O’Grady, head of fixed income syndicate for EMEA at JP Morgan.
One way or another, Europe will experience a massive credit shock. Presumable, the ECB could help offset this by allowing governments to loosen spending to support demand and fund bank recapitalization. But the path we are on appears to provide ECB help only in return for more austerity. And it is that never-ending pursuit of austerity that leaves me bearish on Europe, regardless of the political news of the day.