Italy casts doubt on the timely start of the ESM and its ability to bail out Spain
The latest, with Spanish ten-year debt over 7% and 12-month loans just secured for over 5%, is that the ESM will buy Spanish bonds directly. According to the Guardian, Germany is prepared to use the ESM bailout fund to buy Spanish (and Italian sovereign debt if need be). Ironically, it is the Italian government’s ability to come up with legislative approval for the bailout fund that is the biggest sticking point at this point.
Angela Merkel, it appears, has agreed that Europe’s bailout fund should be used to buy up Spanish bonds. This is precisely the show of "shock and awe" that the markets have been demanding, and the immediate response will undoubtedly be positive. All the financial firepower that Europe can muster will be used in an attempt to drive down Spain’s borrowing costs from the 7%-plus level they have reached this week.
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The rules say that the bailout funds should not take on the risks associated with buying up the debt of a member country unless it is part of an official European Union-International Monetary Fund programme. Although details are sketchy, this appears to be the sort of no-strings attached deal that Merkel has always steadfastly opposed.
So why is this happening? Not because Germany has come under fire at the G20 summit, although it has. Not because Merkel has changed her mind about the potential costs of such an arrangement for her own taxpayers. Rather, it is because the events of the past few weeks have left Germany with a binary choice: support emergency action to prop up the eurozone’s fourth biggest economy or watch monetary union slide into the abyss. Berlin does not want to be blamed for destroying the euro"project", and recognises that a crisis involving Spain (with Italy waiting in the wings) is of a whole different order or magnitude to one affecting Greece, Portugal and Ireland.
What this means is that European policymakers have decided to take on the bond vigilantes. The hope is that they can drive 10-year Spanish bond yields out of the danger zone, take the pressure off the creaking Spanish banking system, and thus avoid the need for Madrid to seek formal help from the EU and the IMF.
Reports are coming in that the Italian Minister of European Affairs Enzo Moavero has said:
"Can we get the approval before the summer recess? In the Senate, probably. Where the House is concerned, we must wait, "he said. "If the political will is there, we can still do it this summer.
As the political holiday season in Italy starts in early August, this is very urgent. The intention is to have the ESM activated by 9 July for use in Spain. According to Belgian daily De Standaard, failing that, Spain will have to use the temporary EFSF bailout fund. The Germans are known to prefer using the ESM fund for any Spanish bailout activities because the ESM has seniority over other creditors while the EFSF does not.
In any event, it won’t work unless they can use the ECB’s firepower. If the ECB were involved it would be better but I am not impressed yet.
What would be impressive is if the ECB said, for instance:
"Look, we will absolutely not support sovereigns. But we are willing to buy their debt at penalty rates over the German benchmark level. It just so happens that this penalty rate is below current market rates. But what we are saying is that we will always be prepared to buy at these spreads or even at lower spreads to facilitate an orderly market for securities that the banks in the euro system buy. This is what Bagehot suggested years ago and what we are going to do."
I will have a non-premium post out fleshing this out in greater detail soon.
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