When expectations are exceedingly low, as they were for the European Union summit in Brussels, any accomplishment made by 27 perennially squabbling leaders can trigger a pleasing reaction in the markets.
That happened Friday morning, when investors cheered the “breakthrough,” to use a bit of hyperbole, achieved in the wee hours of the morning. In a victory for Spain and Italy, the countries suffering most from soaring sovereign bond yields, the EU agreed to recapitalize banks directly instead of funneling the bank rescue funds to the national governments, which in turn would deploy the money to the banks.
Spain, Italy and France had been lobbying the for the direct-funding method for months, only to see their efforts run into a brick wall in the form of German chancellor Angela Merkel, also known as Frau Nein. Ms. Merkel finally relented Friday morning, after an all-night negotiating session during which Mr. Monti, who has emerged as her ballsiest adversary, refused to budge from his demands.
Perhaps the man was emboldened by Italy’s stunning victory over Germany in the Euro Cup. The Italian media this morning hailed the victory for the “two super Marios” – Mario Monti and Mario Balotelli, whose twin goals humbled Germany.
In London, investors drove up the FTSE-100 index by 1.2 per cent by mid-morning. The Eurofirst 300, which represents Europe’s biggest companies, was up by 1.5 per cent and the euro was up by 1 per cent to $1.256 (U.S.). Commodities surged, with oil gaining about 2 per cent. The Asian markets were also up strongly.
Yields on Spanish and Italian bonds fell sharply, bringing relief to those countries’ finance ministers, especially the Italian one, who faces the formidable task of rolling over some €200-billion ($251.5-billion U.S.) of debt this year.
The measures agreed this morning are on the short-term side of the save-Europe spectrum. Mr. Monti and his Spanish counterpart, Mariano Rajoy, have been arguing for months that their countries need help now, not in several years, when the European fiscal unity and banking oversight project comes to fruition.
Direct recapitalization of the banks has some important advantages, especially for Spain, which has asked for as much as €100-billion to recapitalize its ailing regional savings banks. Under the current rules, the bank bailout loans would land on the Spanish balance sheet, boosting the debt to gross domestic product ratio considerably. That spooked bond investors, who pushed up Spain’s funding costs to punishing levels – about 7 per cent – in recent weeks. That’s the level that triggered the bailouts of Greece, Ireland and Portugal.
Under the new agreement, the bank recapitalization loans will come directly from either or both the EU bailout funds – the European Financial Stability Facility or the European Stability Mechanism. The direct loans would allow Spain to avoid having to record the debt on its own books. Efficiency is the other big advantage. The bailout funds can move more quickly than the national governments, whose rescue efforts (or lack thereof) routinely get mired in national politics.
The summit produced another breakthrough. Under Mr. Monti’s demands, countries will be able to tap into the bailout funds to purchase their bonds. While that was always theoretically the case, the new agreement means that governments can do so without being subject to horrific, Greek-style conditions and monitoring programs as long as their are meeting their debt– and budget-deficit reduction commitments.
Mr. Monti insisted that Italy will not ask for a bailout, though he is expected to tap into the bond purchase program if Italian yields shoot up again.
European Council president Herman Van Rompuy said the summit had made great progress. “We are opening the possibilities for countries that are well-behaving to make use of financial stability instruments, the EFSF and ESM, in order to reassure markets and get again some stability around some of the sovereign bonds of our member states.”
Why Ms. Merkel conceded is not known. Perhaps she realized that the failures of Italy and Spain, the euro zone’s third and fourth largest economies, would prove fatal to all of Europe and ruin a nice summer. Or perhaps the mild-mannered Mr. Monti was a lot tougher than he appears. You can bet that Mr. Monti’s predecessor, Silvio Berlusconi, would not have had the same success in standing down Europe’s most powerful politician. Bravo super Mario!