“We must keep in mind the feelings of our people, who have a justified desire to see that private investors are also on the hook, and not just taxpayers,” said German Chancellor Angela Merkel.
Or in the words of Bundesbank chief Axel Weber: “Next time there is a problem, (bondholders) should be part of the solution rather than part of the problem. So far the only ones who have paid for the solution are the taxpayers.”
These were the terms imposed by Germany at Friday’s EU summit as the Quid Pro Quo for the creation of a permanent rescue fund in 2013. A treaty change will be rammed through under Article 48 of the Lisbon Treaty, a trick that circumvents the need for full ratification. Eurosceptics can feel vindicated in warning that this “escalator” clause would soon be exploited for unchecked treaty-creep.
Mrs Merkel needs a treaty change to prevent the German constitutional court from blocking the bail-out fund as a breach of EU law, and a treaty change is what she will get. “This will strengthen my position with the Karlsruhe court,” she admitted openly.
One might argue that bondholders should have been punished for their errors long ago. The stench of moral hazard has been sickening, on both sides of the Atlantic. An orderly bankruptcy along lines routinely engineered by the International Monetary Fund is exactly what Greece needs. It makes no sense to push Greece further into a debt compound spiral by raising public debt from 115pc of GDP at the outset of the “rescue” to 150pc at the end of the ordeal.
If you strip out the humbug, the Greek package allows banks and funds to shift roughly €150bn of liabilities onto EU governments, or the European Central Bank, or the IMF. Greek citizens are being subjected to the full pain of austerity under false pretences, without being offered the cure of debt relief.
It is in reality a bail-out for investors. There is a touch of cruelty in this. Needless to say, the Greek Left has noticed. A socialist dissident from the “anti-Memorandum” bloc (ie anti EU-IMF) is likely to win the Athens region in coming elections.
Note too that the ruling socialists have fallen to 25pc in the Portuguese polls, while the Communists and hard-left Bloco are together up to 18pc. Ain’t seen nothing, you might say.
Yet opening the door to bondholder haircuts at this delicate juncture – with spreads reaching fresh records in Ireland last week, and Portugal struggling to pass a budget – is to toss a hand-grenade into the eurozone periphery.
We now know that that ECB’s Jean-Claude Trichet warned EU leaders on Thursday night that it was dangerous to stir up this hornets’ nest, and moreover that the politicians did not understand what they were unleashing. He was slammed down acrimoniously by French President Nicolas Sarkozy, who later denied that he lost his temper.
“Mr Trichet expressed a number of reserves. There was a debate, there is always a debate, but the European Council took its decision,” he said.
“It is wrong to say I was irritated. You can reproach heads of state for all kinds of things in a democracy, but I don’t think you can reproach them for not being aware of the seriousness of the situation,” he snorted.
Mr Sarkozy was not going to let his Brussels `triomphe’ slip away after stitching up EU affairs once again in a pre-emptive deal with Germany and imposing his will. The notion that the Franco-German axis still runs Europe is potent politics in France, even if the decisions actually reached are often of little value or – as in this case – ill-advised. Such is the chemistry of EU summits, where mad things happen.
Spain’s premier Jose-Luis Zapatero knew he had been mugged. “We need to listen carefully to what the head of the ECB says about the rescue mechanism. Great care is called for because this message is risky,” he said.
Eurozone sovereign states must issue €915bn in new bonds next year, according the UBS, either to roll over debt or to cover very big deficits – though it is hard to outdo Ireland’s deficit of 32pc of GDP in 2009. Yet investors have just been told in blunt terms to charge a hefty risk premium on any peripheral debt that expires after 2013, with great confusion over what happens even before that date. Can any investor be sure what the terms will be if Ireland or Portugal needs to access the EU’s bail-out fund next week, or next month, or next year? Are haircuts already de rigueur?
A study by Giada Giani at Citigroup entitled Bondholders Moving Back Home said data from the second quarter reveals a sharp drop in foreign ownership of debt from Greece (-14pc), Portugal (-12pc), Spain (-8pc), and Ireland (-5pc).
Local banks have stepped into the breach, borrowing cheaply from the ECB to buy their own state debt at higher yields in a `carry trade’ that concentrates risk. These four countries account for the lion’s share of the €448bn in ECB funding for banks (Spain €98bn, Greece €94bn). Frankfurt is propping up this unstable edifice. Mr Trichet may well fret.
A strong case can be made that Spain has decoupled from other PIGS in pain, though the deficit will still be 6pc next year, and the economy is at serious risk of a double-dip recession as wage cuts and higher taxes bite in earnest. But none are safe yet.
An ominous pattern has emerged across much of the eurozone periphery: tax revenue keeps falling short of what was hoped. Austerity measures are eating deeper into the economy than expected, forcing further fiscal cuts. It goes too far to call this a self-feeding spiral, but such policies test political patience to snapping point.
There is little that these nations can do in the short-run as EMU members. They cannot offset fiscal tightening with full monetary stimulus or a weaker exchange rate – as Britain can. All they do can is soldier on, sell family silver to the Chinese and Gulf Arabs, beg the ECB to join the currency war to bring down the euro, and pray that the fragile global recovery does not sputter out.
Chancellor Merkel is ultimately correct. A mechanism for sovereign defaults is entirely healthy. Had it been in place long ago, EMU would have been stronger. The proper timing for this was at the Maastricht Treaty, or Amsterdam, or at the latest Nice, but in those days the EU elites were still arrogantly dismissive about the implications of a currency union. To wait until now borders on careless.
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The Portugal is under pressure to follow the Ireland and the Greece and accept a rescue. Photo: AP
Saxo Bank said the EU's ?370bn bail-out fund would lose its AAA credit rating if Spain needed serious help Photo: PA