Saturday, June 30, 2012

Despite the summit agreement, it will be a while before the ESM is authorized to buy Italian bonds. Germany still holds the key.

On Friday Angela Merkel got the Bundestag approval she was seeking. Germany approved the Fiscal Compact and the ESM. Germany views the Fiscal Compact as a way to enforce austerity in the periphery countries.
FT: - ... the Bundestag passed the fiscal compact with 491 of 608 votes cast and the ESM with 493 of 604 votes, giving Ms Merkel a comfortable two-thirds majority which she needed for passage of each bill.
This vote was already planned and had nothing to do with the summit. But Merkel had to defend her decision to concede on direct bank bailouts and the use of the ESM to buy sovereign paper. Her argument is that the ESM has by no means been given a blanket bailout authority.
FT: - “There will be conditionality,” she added. A country such as Italy would have to apply for market intervention and sign a memorandum of understanding based on the European Commission’s recommendations before bond-buying would be approved in the primary market.
It basically means that nations will sill need to apply for a bailout just as they had to do prior to the summit. The stigma associated with the process will still be there. The difference is that the mechanism for such bailouts would assure a (supposedly) rapid approval and a direct response. But the Germans can still "veto" potential actions by the ESM going forward.

And Germany's unease with the summit agreement is already visible. The opposition politicians are unhappy about both the direct bank bailouts and the sovereign paper purchases.
FT: - The opposition Social Democrats earlier summoned Wolfgang Schäuble, finance minister, to attend an emergency meeting of the Bundestag’s powerful budget committee, with senior lawmaker Carsten Schneider demanding he explain Ms Merkel’s “180-degree about-turn” from previously blocking direct cash injections.

Dissatisfaction was also voiced by members of Ms Merkel’s coalition, who worried she might have compromised her principle of giving aid only with tough conditions.

Wolfgang Bosbach, a lawmaker from Ms Merkel’s Christian Democratic Union and long-standing opponent of eurozone aid, said summit decisions about direct bank aid and readier help to lower sovereign-bond rates had seen Germany “finally and irrevocably” abandon the EU’s no bailout clause.
Clearly the Germans know their national exposure to the periphery will be increasing. And depending on the ECB's decision to ease policy next week, the risk to Bundesbank will increase as well. This is sure to make Germany's authorities uneasy about further bailout approvals.

There is also the issue of the German Constitutional Court that is looking into the ESM scheme. The approval could take weeks and could potentially be linked to a constitutional change or even a public referendum. And that would open a Pandora's box.
Reuters: - There is a chance it could link approval to a change in the constitution - which would require Germany's first national referendum in the post-war era. At the very least, experts say, the court could say approval for any future integration, beyond the ESM and fiscal compact, would require constitutional change.
Thus in spite of Mario Monti's apparent "victory" at the summit, there will be a great number of hoops to jump through before the ESM is actually ready to buy Italian bonds. Some of the risk asset rally we've had on Friday may therefore be reversed once market participants fully absorb this reality.
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