Don’t Bank on the Big Bang

Like déjü vu all over again, Monday’s headlines were aflutter over German comments about the latest efforts to shore up the eurozone periphery’s debt troubles. Last weekend, it was Germany and France’s plan for a “grand plan.” This weekend, Germany seemingly backed off, as finance minister Wolfgang Schäuble, Chancellor Angela Merkel and her spokesman said not to expect a “big bang” cure or overnight fix.

But is that really an about-face? Consider, Merkel and French President Nicolas Sarkozy didn’t say they were working on an instant panacea, but a plan to prevent contagion as European banks write down Greek debt instead. Nothing the Germans said in recent days contradicts this. To mitigate the possibility of problems spreading beyond Greece, backstops should ideally be in place before banks begin taking these losses. However, this issue is somewhat separate from Greece itself, which will likely need aid for years—which is basically what Merkel said.

Thus far, all seems to be going largely as Merkel and Sarkozy outlined. G-20 finance ministers spent the weekend negotiating the plan’s details. As hearsay mounts, it appears increasingly likely the package will include eurozone bank recapitalizations, boosting Tier-1 capital ratios to 9% (from 5% in July’s stress tests), larger haircuts on Greek sovereign debt than the 21% already negotiated and EFSF guarantees on at least some of those losses. Talks are set to continue this week, and officials aim to finalize these measures on October 23, when the EU Summit begins—also consistent with Merkel and Sarkozy’s desire to have backstops agreed to by the G-20 Summit on November 3.

Most likely, in our view, Germany just wants the world to have the right expectations: Measures negotiated today are the latest steps in what has been and will be a gradual process. They’re meant to help backstop the eurozone banking system against potential contagion fears—a confidence wall, if you will—intended to work over a long time. Maybe they’ll suffice. But it’s entirely possible more backstops will be needed down the road, depending on the size of the eventual write-downs. If so, expect more planning, more politicking, more dithering, more uncertainty and likely more volatility.

Also possible, given the foot-dragging to date: Perhaps nothing comes out of the EU Summit. Maybe officials use Greece’s upcoming aid tranche to buy more time to find the right solution, if they find agreeing on Sunday would amount to rushing for the sake of “doing something.” We’ve long argued a gradual approach is likely best for Europe, and EU officials' setting an arbitrary deadline doesn’t change that. After all, what’s more important for the eurozone’s long-term health hasn’t changed since this saga began: There’s a huge amount of political will to find an orderly solution and keep the eurozone intact. Thus, over time, it remains likely politicians there continue doing what’s necessary—and taking their sweet time to do it.