Europe's latest panacea

Press reports out of the G-20 summit in Mexico say that Italy and France have suggested that the EFSF/ESM buy the bonds of PIIGS who are engaged in fiscal consolidation, but who have been priced out of the market. This would, it is thought, allow the funds to buy these country’s bonds at subsidized interest rates, and thus reward them for their virtuous behavior. It is felt that this would allow countries such as Spain and Italy to receive assistance without having to submit to IMF/EU conditionality.

Angela Merkel, under pressure from everyone, did not dismiss the suggestion out of hand. (However, her proposal is for an EU fiscal union, which has not been embraced by Hollande.)

I must be missing something, because the treaty establishing the ESM states that: The granting of any required financial assistance under the mechanism will be made subject to strict conditionality. Everybody in the room may have agreed to ignore this provision, but the Federal Constitutional Court in Karlsruhe is a stickler on things like laws and treaties.

But let us assume that the plan can be implemented and that the ESM will be established on schedule next month. The ESM will be have EUR 80 billion in paid-in capital which can be leveraged up to EUR 500 billion using contingent guarantees (EUR 700 billion including the EFSF). The ESM is expected to be rated AAA by the three agencies, but I don’t consider that a given. The rating hangs on the AAA ratings of Germany, France and the Netherlands. France has already lost one of its AAAs, and is at risk of losing the other two.