THE RESULT OF UNRAVELLING A BALL OF WOOL… FROM THE WRONG END, by François Leclerc

Guest post. Translated from the French by Tim Gupwell

François Hollande has confirmed that the Government is going to propose for adoption an organic law (which a simple law cannot undo) in order to have the balanced budget rule adopted, on the advantageous pretext that it is provisional. There have been many occasions in recent French history when special measures have been adopted for their presumed importance, without ever leaving good memories behind.

At the same time, the debate in Europe continues to move on, focusing once again on the reduction of the banks’ debts. Thanks to the Wall Street Journal, we have learnt that during their latest meeting, the ECB advised the European Finance Ministers to force the senior debt-holders to participate in the bail-out of the Spanish banks. A 180° U-turn which was not actually followed, since the draft of the memorandum which is supposed to be adopted during the next Eurogroup meeting on the 20th July makes no mention of it.

According to the newspaper’s sources, the ministers did not wish to follow Mario Draghi’s proposals at the meeting, as they were afraid of how the markets would react. It was also out of fear that the Irish government would demand equal treatment, since to save the European banks – in particular the British ones – the Irish Government had to borrow money to pay off the senior creditors of their country’s banks. Nor would the Greek and Portuguese Governments have failed to jump on the bandwagon.

In changing its position, the ECB has placed greater emphasis on the banking system to get involved in its own rescue, and on helping to relieve the pressure on the states. Is it not, quite simply, an acknowledgement that it cannot do anything else, overburdened as it already is?

Meanwhile, the European Banking Authority (EBA), its prerogatives threatened by plans to entrust to the ECB the role of supervising the banks, has just provided them, and the governments protecting them, with a forcible remainder of its presence. Following on from its announcement that the “majority” of the 27 banks asked to reinforce their capital ratios had successfully managed to do so, it decided that these measures, which had initially been presented as temporary, would now be made permanent.

Following on from the ECB’s, this constitutes a second bombshell, at a time when the banks are exercising intense and discrete pressure on the Basel Committee to water down the new regulations. At the very most, it has been conceded that a bank which is on the right track but falls off it due to incurring losses, would only have to present a plan detailing how it will reinforce its capital rather than having to immediately reconstitute it.

Unlike in France, a debate is raging on the other side of the Rhine on the subject of the methods to be adopted for the debt-reduction strategy, at a time when observers are wondering whether Angela Merkel will be able to obtain a ‘Chancellor’s majority’ (with the votes from her party and coalition partners) with regard to the bailout of the Spanish banks, which still needs to be adopted to enter into force. The SPD and the Greens will vote for it, guaranteeing its adoption.

But the debate is also focused on the next stage after this, on the possibility of a direct bailout of the banks by the ESM, a divisive subject. Angela Merkel is trying to duck the issue with an improbable announcement that the issue has not been discussed at a European level, contradicting the leader of the CSU, Horst Seehofer, and the future director of the ESM, Klaus Regling. The fundamental issue is who is going to assume the risk associated with further bank bailouts: the state in which their headquarters is situated, or the ESM, which means every single state involved with it. The mutualisation debate keeps on coming up time after time.

A significant development, though it has largely passed unnoticed, is that EADS (the defense and aeronautical group) is looking into the possibility of asking for a banking license so as to become its own bank and manage its 10 billion Euros fund all by itself. That is one way of taking shelter.

The next question, on everyone’s tightly pursed lips, concerns Italy. Like their Spanish peers, the Italian banks are stuffed full of their own country’s sovereign debt, rendering the country’s financial infrastructure extremely fragile. How is Italy going to get through the summer, since its debt refinancing program cannot be put off indefinitely? Will it be able to avoid taking its turn to ask for a financial aid package from Europe – in one form or another, now that Spain has shown that all roads lead…..to Rome. The possibility of this prospect may well explain the pressure which Jean-Claude Juncker, the head of the Eurogroup, has exerted on the German Constitutional Court to validate the Bundestag’s approval of the creation of the ESM. Because the EFSF would not be sufficient, if Italy needed to be saved, its capacities having already being fully engaged to aid the Spanish banks. The Court has just announced that the decision is due to be announced on the 12th of September.

Playing its last trump cards, the Italian government has set up a program of assets sales worth 120 billion Euros between now and 2017. Vittorio Grilli, the Finance Minister, has pointed out that the plan expects to sell the equivalent of 1% of the country’s GDP each year, neglecting to mention however that the predicted shrinkage in GDP due to the recession is even greater. Taxes and duties continue to be increased and budget cuts effected, but the cost of servicing the debt continues to rise, the rate over 10 years standing at around 6%. The Italian debt accounted for 120% of GDP in 2011 and is still on the increase, which explains the strong impact of the rise in bond rates as the refinancing continues.

The exposure of French banks to Italian public and private debt, the first and foremost of these being BNP Paribas, is such that they would undergo a major shock if the worst were to happen. In this respect, the importance of the stance taken by the ECB on Spain can be seen, particularly if it were to be renewed and actively pursued. The game may soon be up, especially if it continues in the same direction.

In Madrid, a spontaneous protest of several thousand people started yesterday via social networks, at the headquarters of the Partido Popular in power at the National assembly, to cries of “Hands up, this is a hold up!” and “They do not represent us!”

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