by Mark Hanna, Market Montage
Deep in the European night, some additional steps were agreed to in the multi year European crisis. While I'll leave the heavy analysis to other sites, the big picture is there was an incremental win for the "Club Med" countries with a rescue fund (the ESM) being authorized to essentially be a "bad bank" if you will, in that it will inject money into troubled banks in return for shares. By being a shareholder rather than a bondholder it gets poor treatment in the capital structure in case said banks go belly up – hence takes on much more risk. In a way this sounds "TARP-ish". The other bonus is that by using this method it bypasses the state government and puts the liability onto the ESM rather than say Spain or Italy itself – a big advancement. The ESM will also be able to buy sovereign debt directly.
It appears Spain and Italy banded together in negotiations and refused to go along with the 120B euro "stimulus" package until they got their way on this new form of bailout. As for said stimulus package the more I read about it, the less impressive it seems as all but 10% of the money has apparently already been committed – it sounds mostly like repackaging. Going back to the ESM situation, of course that rescue fund does not have unlimited resources like a central bank does, so in many ways it's just a reshuffling of the debts with a finite amount of firepower but that's good enough (for now) in these crazy headline driven markets.
Well telegraphed ahead of the meeting, was a move to a 'banking union' – in this case a central regulator for the continent's banking system. This was also announced last night.
Via Reuters:
- Responding to pleas from Spanish and Italian leaders, a midnight summit of the 17-nation currency area agreed that euro area rescue funds could be used to stabilize bond markets without forcing countries that comply with EU budget rules to adopt extra austerity measures or economic reforms.
- After hours of argument, they also agreed that the bloc's future permanent bailout fund, the European Stability Mechanism, would be able to lend directly to recapitalize banks without increasing a country's budget deficit, and without preferential seniority status.
- Countries that requested bond support from the rescue fund would have to sign a memorandum of understanding setting out their existing policy commitments and agreeing a timetable. But they would not face the intrusive oversight of a "troika" of international lenders.
- European Council chairman Herman Van Rompuy said the aim was to create a supervisory mechanism for euro zone banks involving the European Central Bank to break the "vicious circle" of dependence between banks and sovereign governments.
- Euro zone leaders will return on Friday to discuss longer-term plans to build a much closer fiscal and banking union, on which they asked Van Rompuy and the heads of the European Commission, ECB and Eurogroup finance ministers to present detailed proposals by October.
Not surprisingly, once announced, world markets went into a tizzy as they do each time these grand events happen. Of course as we've seen over the past few years, each announcement seems to have less and less effect so we need to see how 'lasting' this one has. Do Spanish and Italian bond yields fall substantially and on a permanent basis? Or after the knee jerk reaction – however long it is (hours/days/weeks) are we back to a new leg of the Euromess. With trillions in sovereign debt and a rescue bucket that "only" has hundreds of billions (500B euros) there appears to be a mismatch in demand v supply, but we'll see how it plays out in the coming weeks. Market participants want the ECB to go all the (Ponzi) way and turn into the Fed with unlimited buying power behind the EU debt market – Europe is not there yet. The other option is turning the ESM into a "bank" (banking license) and hence allowing it to lever up, borrow from the ECB, and then do all the buying – which is essentially nothing more than the ECB going full monty as a buyer of debt but by using the ESM as the middleman.
As for the market from the lows around 2:30 PM yesterday to the opening print this morning will be a head spinning reversal. The S&P should be back into the 1340s and we'll be in the upper third of the recent range. As long as today's move holds I believe this will be a third follow through day during this 3 month correction (and second in a few weeks!). If it happens, psychologically it will be easy to doubt this one since there is recency bias and the last one failed so quickly, so maybe it will be the one which sticks. Ironically, as I wrote yesterday, this is happening just as almost every group has now been washed out as the last holdouts (high growth consumer discretionary) were pulverized this week. Hence we have broken charts everywhere – but to be fair that was the case in late 2011 as well.
Outside of Euromess, we're still left with all the macro economic weakness and corporate earning issues – and a holiday week of trading coming around the bend. Never a dull moment.
