Stock markets around the world rallied in the closing days of June — as did the euro, along with French and Italian bonds — after the European Council said it would let the fledgling European Stability Mechanism (ESM) make payments directly to troubled banks. A similar market move unfolded 10 days earlier when Greece voted to keep the euro. Yet another move took place 10 days before that when Spain agreed to the terms of a $125 billion bailout — the same bailout that drove up Spanish interest rates and forced the ESM decision.
In each case, however, traders made money by selling into rallies — because each of the solutions that sparked each of the rallies turned out, upon inspection, to be built on the kind of wishful thinking that worked well in the high-water years of the Internet boom and the housing bubble. That has proven woefully inadequate now that the tide has gone out.
This latest flurry of disappointing stopgap measures began late last year when the EU decided to bid an early adieu to the European Financial Stability Facility (EFSF). The EFSF was the largest of the emergency lending facilities that the European Union set up two years ago to provide a safety net for faltering EU economies — a safety net that relies on two of the weakest economies for 30% of its support (see “European financial regulation update,” September 2011) — and saw its own credit rating cut in January. The EFSF and the European Financial Stabilization Mechanism (EFSM) already were slated to be folded into the ESM next year, but EU leaders moved that date up to July.
This time, however, the market is demanding follow-through and yet, 10 days after the late June announcement — in other words, 10 days into the month in which it was to debut — the ESM remained in limbo and the euro was making fresh lows against the dollar.
“They’ve been kicking the can since 2008, and markets don’t believe them anymore,” says Holger Schindler, a Hamburg-based risk manager who, two years ago, was among the handful of analysts that took the possibility of a Greek exit from the Eurozone seriously (see “World rattles on wobbly euro/dollar axis,” March 2010).
Back then, he says, a Greek exit might have been a good thing, but no longer. “It’s less likely now, even though more people are talking about it, and it would be a disaster if it happened,” he says. “The time for a clean break was 2010 — and that time has passed.”
The problem, he says, is that European leaders have spent the last two years treating insolvency as if it were just a liquidity problem — implementing quick-fixes when a major overhaul was necessary, in the hope that things would get better on their own. It’s a habit, he says, that developed slowly over the past half-century with good intentions, but over the last few years it let Greece’s problems spread across the Eurozone in the form of bad loans and unpaid obligations.
“They should have recognized Greece as a symptom of something much larger, instead of treating it as an isolated illness,” he says.