Macro: EU Summit – Hot Air only or circuit breaker ?
I don’t want to transform this blog into a macro blog, as I do not have the competence to really talk about macro events. However I wanted to follow up on the Bull case for Europe post to quickly look at the results of last week’s EU summit
As it is always best to ignore most of the press stuff, let’s look at the original statement:
In my opinion, the 120 bn “growth budget” is less important, as well as the intention to move to a fiscal union. The most important part in my opinion is this one:
Euro area summit statement
Eurozone heads of state or government decided:
to establish a single banking supervisory mechanism run the by the ECB, and, once this mechanism has been created, to provide the European Stability Mechanism (ESM) with the possibility to inject funds into banks directly.
Spain’s bank recapitalisation will begin under current rules, i.e. with assistance provided by the European Financial Stability Facility (EFSF) until the ESM becomes available. The funds will then be transferred to the ESM without gaining seniority status.
It was also agreed that EFSF/ESM funds can be used flexibly to buy bonds for member states that comply with common rules, recommendations and timetables.
The Eurogroup has been asked to implement these decisions by 9 July 2012.
I would call this decision the “Spanish bank circuit breaker”. Up to now, everyone was aware of the potential death spiral, if the ESM gives money to Spanish banks only via the government because this further incrases the debt load.
Interestingly, they did not specifiy what instruments should be used, My assumpton would be someform of “Contingent Convertible” which would provide much needed Tier 1 capital to Spanish banks. The ESM original document speaks of “lending”, but CoCo loans or bond would not violate this.
So in theory, we now have the “full package” for any Eurozone bank:
1) unlimited liquidity from the ECB plus
2) a big pot of potential bank equity from the ESM.
Draghi’s bazooka from last year was only a small bonfire without the possibility to inject capital.
For those who still remember the beginning of the crisis, this was exactly how the US TARP developed. The 700 bn USD fund was initially planned to buy mortgages etc. but was then used to inject money directly into banks. The “vicious circuit” was only broken, when Bazooka Paulson forced his Tarp funds into any large US banks.
So does this end the crisis ? Are banks stocks now good investments ?
I don’t think so, but this feature definitely reduces both, the probability and severity of a tail risk event.
As expected, the usual suspects again come out and say: This is not enough.
Like Nobel laureate Paul krugman, who of course demands a complete solution to any problem being implemented right now.
However, for me it looks like a necessary and logical next step. No solution but risk mitigation. And therefore important and good. I hope it leads to ample supply of loans for PIIGS companies in order to have time to implement necessary other reforms.
At some point in time one might want to start to look into PIIGS bank subordinated securities…….