Last week’s newsletter focused on Monti and Rajoy forcing Europe into true EuroTARP as the chief headline coming out of the latest European summit. A lot of other commentary focused on the agreement to let the ESM/EFSF buy up sovereign bonds. But I don’t think this is significant because the EU bailout funds are still too small to deal with either Spain or Italy. On the other hand, for Spain and Ireland, the potential of getting away from contingent domestic banking sector liabilities is meaningful. And Ireland’s ability to tap bond markets this week is testament to that fact.
I wrote:
The Europeans put the decoupling of bank distress and sovereign risk at the center of their post-meeting Memorandum of Understanding. Along those lines Rajoy and Monti were able to get Merkel to agree to have the EU bailout funds EFSF and ESM inject money directly into banks without seniority. This is a significant concession because, as you recall, when this deal was announced the market turned away in revulsion as the Spanish sovereign was on the hook. That created a Spanish sovereign death spiral. Significantly, Ireland will benefit from this sovereign debt relief as well and that could mean they avoid a second bailout.
In my view, the EuroTARP-style agreement, while still provisional is key to stopping the crisis in both Ireland and Spain where it is the banking sector and not the sovereign that has the most significant problems. On the back of the market’s belief that Ireland will soon have its banking woes behind it, Ireland was able to go to market for 500 million euros of three-month paper. This was the first public market splash by Ireland since September 2010 and the issue was 2.8 times oversubscribed, a healthy number regarding demand for Irish paper.
At 1.8%, Ireland paid lower for its placement than Spain did in its most recent similar auction. At 6.2%, Ireland’s 10-year bond yields are at their lowest since before Ireland was forced into a bailout. To me, this demonstrates that Ireland is seen as a better bet than Spain, largely because the bank writedown and housing crash solutions are far more advanced in Ireland than in Spain.
Going forward, we will need to see both the talk of an EU-wide banking union and the Euro-TARP agreement solidify for these gains to hold. At present, Hans Werner-Sinn and a group of German economists are planning to make a broadside public attack on German Chancellor Angela Merkel for allowing these concessions to go through at the European summit. Europe still has a long way to go.