By Satyajit Das, derivatives expert and the author of Extreme Money: The Masters of the Universe and the Cult of Risk (2011). Jointly posted with Roubini Global Economics
The Pavlovian response of financial markets to the European leaders’ summit of 28 and 29 June 2012 was remarkable. The frugal communiqué of 322 words fired the “animal spirits” of financial markets, which now believe that the European debt crisis has been “solved”. As comedian Robin Williams joked: “reality is just a crutch for people who can’t handle drugs.”
Summiting Once More…
The summit supported a single regulatory body for all European banks.
The previously agreed Euro 100 billion capital injection for Spanish banks was ratified. Payments will now be made directly by the European Financial Stability Fund (“EFSF”) and its successor the European Stability Mechanism (“ESM”) to the banks rather than as loans to the relevant country. Loans will also not have priority of repayment over commercial lenders.
The EFSF/ ESM will take whatever actions are “necessary to ensure the financial stability of the euro area… in a flexible and efficient manner”. This was taken to mean that they will purchase bonds of beleaguered countries like Spain and Italy to reduce the cost.
The European Union (“EU”) will provide Euro 120-130 billion of financing for investment to boost growth.
The language was vague and the details sketchy. After the meeting German Chancellor Angela Merkel told the Bundestag that differing communications” from various Euro-Zone leaders about the exact agreement had “led to a whole number of misunderstandings”.
The initiatives may require complex and time consuming changes in European treaties.
The German Constitutional Court must rule on some aspects of the current proposal.
In essence, implementation risks remain.
Bank recapitalisation will require the establishment of the EU central bank supervisory body, which