This past weekend, EU leaders opened doors for a permanent bailout fund to replace the temporary European Financial Stability Facility (EFSF) when it ends in 2013.
The idea of the fund, otherwise known as the European Stabilization Mechanism (ESM), came about after Ireland asked for a bailout and more recently, concerns that Spain or Portugal may need one too.
To allow the EU the right to establish the mechanism, EU leaders decided to tweak the rules a lil’ bit on the original Lisbon Treaty (otherwise known as the “We all better agree on it before implementing it, or we might end up bustin’ cap on each other” Treaty). They added:
“The Member States whose currency is the euro may establish a stability mechanism to be activated if indispensable to safeguard the stability of the euro area as a whole. The granting of any required financial assistance under the mechanism will be made subject to strict conditionality. ”
What all that basically means is that they can implement a permanent bailout fund in case any more eurozone members *cough* PIIGS *cough* need to get bailed out.
And of course, they put in a clause for “strict conditionality,” which will allow EU leaders to implement strict rules in order to tap into the mechanism.
But wait -there’s more! My market spies read between the lines of the two-sentence amendment and found out a few other things:
First, the IMF is expected to have a hand in the “strict conditionality” part of financial aid decisions. Like the rules governing the Irish and Greek bailouts, countries that ask for financial help will have to follow strict austerity measures.
This isn’t too surprising, as it is only natural that a lender will want to make sure that the borrower will take the right steps so that they can pay back their debts later down the road.
Next, it looks like the EU officials did everything short of dancing in public in bikinis to avoid increasing the funds for financial aid. According to some market hotshots, EU leaders were concerned that an increase in the fund might signal that they believe that a Spanish or Italian bailout is inevitable.
Lastly, the EU is expected to make its final stamp on the amendment by March 2011 at the latest by turning the draft into a solid decision. If all 27 members agree to it, then the amendment will be enforced by January 2013, and the mechanism will be established by June 2013.
This would mark the first concrete decision made by the EU since the common currency was threatened by the debt crisis. Talk about making progress!
So yes, the ESM looks like a solid plan – on paper that is. The question is, will it work?
Although German President Angela Merkel is probably feeling like a 5-year-old on Christmas morning now, a few economic gurus are raising their eyebrows like the Grinch, doubting if there will be enough cooperation among EU countries for the plan to be carried out.
Recall that Germany pushed for a permanent bailout fund to be established in order for bondholders to share the burden of debt instead of leaving the cost of financial rescues dependent on the pockets of superstar EU-countries.
But with the ESM most likely to have a clear-cut set of rules, some are worried that countries who are better off than others may insist on concrete guidelines, like tougher austerity measures, which may be too strict for the struggling countries to follow.
This isn’t really hard to imagine since the Germans have thrown tantrums before over the Greek and Irish bailouts, and the most recent one talks about increasing the EFSF.
The summit passed with little fanfare this weekend but keep tabs on how the EU’s plan unfolds as this could play a crucial role in the euro zone’s integration, much like how Even Stevens became the measly show that became Shia LaBeouf’s stepping stone to his Hollywood stardom.