What Really Happened at the European Summit?
Give Mario Monti credit. The Italian prime minister, almost universally described as “technocratic,” showed the negotiating skills of a master politician in the wee hours of Friday, Brussels time. In a marathon session that lasted until 4:30 a.m., Monti teamed up with the leaders of France and Spain to extract some important concessions from Europe’s biggest creditor nation, Germany. The agreement triggered the biggest rally of 2012 in Spanish bonds and in the value of the euro.
But what exactly does the agreement do, and what doesn’t it accomplish? Here are the main points.
What’s in the deal:
• Italy and Spain will have an easier time qualifying for aid from the European Stability Mechanism, the permanent bailout fund that goes into operation on July 1. Countries that comply with existing economic-policy recommendations will be eligible for aid without having to fulfill any extra conditions. That’s less onerous than the conditions that Greece, Portugal, and Ireland had to meet to get bailouts.
• The European Stability Mechanism will be able to put money into Spanish banks directly, rather than having to filter it through the Spanish government. But that can happen only after the creation of a European-wide banking supervisor—a step toward the ultimate goal of a full-scale banking union.
• Taxpayers won’t get preferred creditor status on emergency loans to Spanish banks. This is a big change. By claiming preferred status, official lenders have effectively subordinated the banks’ private bondholders. Knowing they don’t have first claim on the banks’ assets in the case of default, the private bondholders have demanded even higher interest rates as compensation. That has made it almost impossible for Spanish banks to raise money except through official channels.
What’s not in the deal:
• For now, at least, official lenders like the ESM will still have preferred creditor status on loans to countries other than Spain.
• The European Central Bank hasn’t done anything new on the monetary side to complement the fiscal measures. In the past, the ECB has made money available after the fiscal authorities in Europe have made clear demonstrations of progress. The ECB’s next rate-setting meeting is on July 5. Some traders are betting the bank will lower its benchmark interest rate a quarter-point to a record low 0.75 percent.
• Another way the European Central Bank could ease credit conditions would be to engage in a third round of long-term lending to banks.
• The ECB could resume buying the bonds of ailing countries. It stopped doing so in February under pressure from Germany.
• The ESM is still limited to a maximum of €500 billion ($633 billion) in bailout funds. That’s not a lot, considering Italy and Spain alone owe about €2.4 trillion on bonds, bills, and loans. Allowing the ESM to borrow, presumably from the ECB, would enable it to raise more money, giving it more firepower to stop crises. But that would also increase the exposure of the ECB to losses.
• Outside of Greece, debtor nations haven’t had any reduction in the amount they owe.
• Germany is still resolutely opposed to the issue of euro bonds—debt that would be jointly guaranteed by all European Union nations.