On Sunday, French President Nicolas Sarkozy and German Chancellor Angela Merkel announced they have a “comprehensive” response to the European periphery’s sovereign debt troubles. Or, rather, will have, before the G-20 summit starts November 3. Leaders outside the eurozone—worried about spillover in their own banking systems—have steadily increased the pressure to find a solution, and Sarkozy and Merkel—as leaders of the eurozone core—don’t want to hit Cannes empty handed.
Though the two proclaimed their resolve to stabilize the euro, they won’t provide details until a mid-month summit with fellow eurozone leaders. This seems in keeping with how negotiations have gone thus far—leaders vow to have a plan, as soon as they talk about planning to have a plan. Not that deliberation’s bad—in our view, some foot dragging is preferable to sudden changes here.
Rumor has it the plan will shift focus from providing cash infusions for troubled nations to recapitalizing banks and backstopping Europe’s financial system—perhaps guaranteeing or insuring sovereign debt on banks’ balance sheets. This makes sense, considering bailout funds are largely available through the EFSF and, from 2013 on, the ESM. But neither provides safety mechanisms for longer-term debt restructuring. To date, write-downs on Greek debt total about 21%, but banks likely will have to take larger haircuts—having capital backstops in place before this happens is a sensible, likely necessary way to prevent contagion. That Sarkozy and Merkel seem to recognize this and are taking steps to make it happen is encouraging.
Markets seemed to react positively to the Franco-German pronouncement on Monday, mostly shrugging off news that a major European bank was nationalized. A few weeks ago, such an event would likely have roiled stocks. That’s not to say the market’s correction psychology has faded—rather, it speaks to how fickle markets can be from day to day.
In the same way, don’t expect a Sarkozy/Merkel plan to fall perfectly into place. Though markets cheered today, the process toward a solution has been fraught with fits and starts. We wouldn’t be surprised to see Sarkozy and Merkel’s plan follow the proverbial three steps forward, two steps back. Remember, the July 21st agreement on Greece’s second bailout seemed to be similarly momentous, but it’s taking substantial politicking to get it done. It won’t be finalized until next week (assuming Slovakia passes it, as seems increasingly likely)—almost three months after the initial handshake. Volatility reigned all the while.
Any new financially large, geographically broad plan could easily have a similarly rocky road to becoming reality. Maybe we see something akin to Finland’s demand for collateral in exchange for participating in Greece’s bailout, or national parliaments playing tug-of-war, à la Slovakia. Maybe officials decide to kick the can down the road a few more times, using Greece’s upcoming €8 billion aid tranche to buy time.
Chances are it takes a while for this “grand plan” to come to fruition—and more ongoing volatility (both up and down) can be expected. But Germany and France have told the world they know what they must do and will do it, signaling the political will to hold the eurozone together. For now, it appears Europe’s taking a few steps down the appropriate long-term path.