Eurozone Bailout Agreement Not All It Seems

Markets widely interpreted Germany’s recent agreement permitting the European Financial Stability Fund (EFSF) and the European Stability Mechanism (ESM) to purchase Eurozone sovereign debt as a major step on the road to Eurozone economic recovery. That belief may have been misplaced.

A report from Reuters today, citing an unnamed “senior euro zone official,” casts doubt on exactly what the Eurozone has agreed to do and what they have the authority to do regarding sovereign debt. The official is quoted as saying:

There is some degree of mystification going on here … in the broader public who think that under current rules the ESM could all of a sudden end up owning Bankia with the full risk of Bankia on the balance sheet of the ESM. This is very much not the case.

And this is exactly what people were expecting. The official also said that if the proposed supervisory authority is actually created, the Eurozone may someday reach that point:

In the very distant future … if we have a single euro zone supervisor supervising all banks … if there were to be direct bank recapitalisation would this still require a counter guarantee of the sovereign, my understanding is that it would not.

That “very distant future” does not sound like the end of this year, which is what many people were expecting. A banking supervisory committee with real authority would assume sovereign control of a country’s banks and would lead ultimately to full fiscal and political union among Eurozone members. That is not something that can be accomplished in six months — it may take six years or more.

In the meantime, sovereigns will be forced to continue to back bailouts to their banks, piling on more debt that the countries cannot afford to pay. Until that circle is broken, there really is no permanent solution to Europe’s financial crisis.

Paul Ausick