CHICAGO – Europe has been experiencing a period of calm after the storm since European Central Bank President Mario Draghi’s “whatever it takes” speech in July and the ECB’s decision in September to proceed with its “outright monetary transactions” (OMT) program to purchase distressed eurozone members’ government bonds. The interest-rate spreads for Italian and Spanish government bonds have dropped dramatically, corporate-bond issues have resumed, and a sense of normalcy is slowly pervading the continent.
But it would be foolish to conclude that the euro’s problems have been solved. The economic fundamentals are far from stable, while the reduced financial tension is the fortunate outcome of an expectation game. As long as investors believe that Italy and Spain will eventually be rescued by the OMT, these countries’ borrowing costs will be low, and the rescue will not be needed. If, however, the slightest doubt about the OMT’s effectiveness arises, the expectation game will shift into reverse, and both countries’ bonds will quickly come under attack.
One such source of doubt may be the OMT’s safety catch. To become operational, all European governments must approve it. The rules vary among EU countries, but, in Germany, “government approval” implies parliamentary approval. In an emergency situation, it is difficult to imagine that Germany will not prefer approval to the disaster of an Italian or Spanish default. Still, any delay could be enough to trigger a bank run in either country. By the time the German Bundestag decided, it could be too late.
To eliminate this uncertainty, Italy and Spain should ask for the OMT intervention before it is desperately needed – a request that the Bundestag would most likely approve, viewing it as an insurance scheme rather than a pure transfer. Doing so would also eliminate the uncertainty surrounding the program itself and its implementation mechanisms. Identifying and addressing problems when intervention is not urgently needed is much easier than working them out under the threat of a pending sovereign default.