The long awaited EU summit is done but unfortunately, while some progress was made, not all the details were hammered out. Here’s an update on the three main issues that were discussed by EU finance ministers this past weekend.
A couple weeks back, I highlighted the importance of bank recapitalization, its potential effects on the European economy, and what methods the EU could implement to buff up European banks.
As it turns out, Germany was able to enforce its demands that responsibility for bank recapitalization would fall to bank shareholders first. If shareholders cannot come up with enough cash, then national governments would have to step up.
The only time the European Financial Stability Facility (EFSF) may be tapped is when shareholder and local government efforts have been exhausted.
For some, this was a step in the right direction, as it frees up the EFSF to be used for other emergency measures.
One wrinkle that did come out of the meeting though was that the finance ministers could not decide what level to set the minimum tier 1 capital ratio. EU officials had planned to set it at 9%, but word through the grapevine is that Spain, Italy, and Portugal refused to sign off on this unless an expansion or leveraging of the EFSF was part of the EU’s plans.
In the end, I do think these countries will give in to higher capital ratios, as long as they feel that the EFSF will be enough to cater to their needs should they need to access it sometime down the road.
Greek Prime Minister George Papandreou also pushed for a “definitive solution” for the Greek debt crisis. This basically meant that he wanted bondholders to accept bigger write-downs on Greek debt in order to lighten the burden on Greek citizens.
Rumor has it that banks offered to take haircuts of 40%, but finance ministers were asking for 50%, while Germany was demanding as much as a 60% reduction in the value of Greek bonds.
Take note that when Greece was given a second bailout last July, assumptions were that Greek bonds would have to be slashed by 21%. It’ll be interesting to see how this plays out in the political battlefield and if banks will be willing to take such big hits on their balance sheets.
European Financial Stability Facility (EFSF)
With regard to the EFSF, the European Union is basically left with two main options.
The first one is a sort of guarantee for those investors who have already bought the bonds of the debt-ridden euro zone nations. This option would limit the risk to investors because it would allow them to claim insurance in case of a default. The European Union hopes that this plan would attract more buyers to keep weak nations financed and yields low.
The second is to create a new and separate fund. The fund, which would be funded by private entities and other financial institutions, would be used to finance debt-laden European nations. Of course, some of the EFSF money would also be used in the fund.
These three issues are heavily-related. For instance, the amount that would be used for the recapitalization of banks would depend on how big the losses the private sector would be willing to accept on Greek bonds. Meanwhile, the expansion and development of the EFSF program would be largely dependent on how much indebted nations would need should bond yields continue to rise as contagion fears spread.
I must admit that things are looking up though. Financial officials are stepping up their game and showing that they are serious in finding a resolution to the debt crisis. At the same time, I can’t deny that time is running thin. They must act quickly or run the risk of risk aversion taking over again. Watch out for their next meeting this Wednesday as the plans will be clearer and more concrete.