THE shelf-life of European 'solutions' to the banking and sovereign-debt crisis is now down to about a week. The Brussels package announced 10 days ago has already failed to attain the paramount objective of stabilising the Italian bond market. Italy faces bond yields which are unsustainable, even at very short maturities.
A total of €300bn in Italian debt needs to be refinanced up to the end of 2012. On Friday, Italian premier Silvio Berlusconi turned down an IMF offer of a stand-by loan facility, to the apparent discomfiture of his finance minister.
The previous day, the European Central Bank president had declined the opportunity to emphasise that institution's commitment to bond market support. Whatever about Greece, failure to ensure liquidity for Italy means a renewed threat of financial meltdown and the endgame for saving the eurozone.
The package offered to Greece requires acceptance by its government of a 10-year horizon, leading, if all goes well, not to solvency but to a monster debt ratio around 120 per cent of GDP in 2020.
There is no point to an inadequate sovereign default. If default must be chosen, it needs to be big enough to ensure that the markets do not expect a repetition. There should have been a Greek default first time around in May 2010, at which stage it should have been clear to the EU Commission and to the European Central Bank that Greece's debts could not plausibly be serviced.
This was the virtually unanimous verdict of economic and financial commentators at the time and the markets have never wavered in their view that Greece will eventually default. The haircut announced in Brussels was not enough, reflecting the remarkable role played in its design by the bank creditors.
The package was also driven by the over-riding objective of minimising bank recapitalisation costs for the French and German treasuries and included use of European funds to mitigate those costs.
No such concern has been evident at any stage in European policy towards this
country, which has been bankrupted through shouldering bank losses at European insistence.
The haircut on sovereign bonds, as well as being too small to restore financial viability to Greece, is also too small to create political viability for its government. It is difficult to believe that the authors of the latest Brussels deal failed to understand the inadequacy of the measures for Greece, for bank recapitalisation across the eurozone and for insulating the Italian and Spanish sovereign-debt markets. This is a crisis of credibility and the European leadership has squandered another large slice of what little credibility remains.
The Greek referendum, had it gone ahead, would have posed a choice between accepting a terrible deal for Greece, which offers no solution to the eurozone crisis (it has moved across the Adriatic to Italy) or opting for financial chaos and political breakdown.
A 'Yes' vote would have secured fulsome congratulations from an impressive list of Euro-worthies and placed Greece back in the soup in short order. A 'No' vote would have placed Greece in the soup straight away. It is as well for Greece that this pointless choice will not now be put to the electorate.
But Greece's difficulties are fast becoming a sideshow. The flashpoint is the too-big-to-save Italian bond market. Unlike Greece, Portugal and Ireland, Italy is not in an EU/IMF rescue programme and could quite likely work its way out of its budget crisis on its own, as indeed could Spain. But if the interest cost Italy faces to roll over its debt continues to rise, the sums cease to add up and the Italians could be forced out of the bond market.
Nothing short of an unambiguous commitment from the ECB to purchase Italian bonds in unlimited quantities, and at interest rates within Italy's debt-servicing capabilities, will stop the rot. It may be possible to manage a Greek exit from the euro and even a disorderly default but Italy is different and nobody has the resources -- except the ECB -- to draw a line under the Italian crisis. The new ECB president, Mario Draghi, reiterated the reluctance of that institution to backstop the bond market in his debut press conference on Thursday, thus ensuring another exciting week ahead in the markets.
It is extraordinary that things have been allowed to come to this sorry pass.
The nadir was reached last Friday week, when Klaus Regling, who heads the EFSF, the European bailout fund, scurried to Beijing to seek financial commitments from the Chinese government. The eurozone economy is twice the size of China's, does not have a balance of payments deficit and does not need capital inflows from China or anywhere else.
No doubt Mr Regling was received with the public courtesy accorded nowadays to European emissaries to the Middle Kingdom. But there must have been private amazement that he was rattling a tin to which neither the French nor German governments are willing to contribute.
UK Prime Minister David Cameron has been at pains to stress that he will not be contributing either. The failure to shift a modest €3bn of EFSF bonds on Wednesday is a further straw in the wind. This AAA-rated stability fund, designed to borrow on behalf of those who cannot, has joined the club itself and had to defer a bond issue.
The yield on its bonds in the secondary market has drifted out to a 1.5 per cent premium over Germany, up from a mere 0.5 per cent earlier this year. It is inevitable that the ratings agencies will downgrade the EFSF if this continues.
The resources to deal with the financial panic in Europe are already available to the European leadership. When sovereign bonds cannot be sold and banks will not lend to one another, decisive intervention means that Europe must deploy the central bank balance sheet, not the balance sheet of the Chinese, the Brazilians, the IMF or Oxfam.
The design weaknesses in the eurozone which have helped create the crisis are now inhibiting its resolution. The principal design weakness is the absence of a proper central bank with explicit obligations to ensure financial stability.
The shenanigans over Papandreou's ill-considered solo run have one big negative implication for Ireland, as Dan O'Brien noted in his Irish Times column on Friday. It was another mistake from the Merkozy duo to speculate in Cannes about a possible Greek exit from the euro. Bank deposits are already draining away from the European periphery and the Merkozy threat will accelerate the process.
The same duo destabilised the European sovereign bond markets in the summer of 2010 with public musings about default clauses in sovereign debt issues at their meeting in Deauville. The French seaside resorts are having a bad crisis.
The combination of indecision and bullying on display from the Franco-German leadership in Cannes is particularly worrying for the more vulnerable eurozone members and any country contemplating eurozone entry should think long and hard.
The Irish government had little choice but to pay the unguaranteed bondholders in Anglo Irish Bank during the week, but the enormity of what it was forced to do should be understood. This bank is closed, having written off half of its loan book and lost eight times its capital. The bonds were not guaranteed by the Irish Government.
The fair market value of unguaranteed bonds in a bank which is bust and closed is zero. That a country which is unable to borrow and is in a bailout programme should pay full par value, or anything at all, is extraordinary. That it should be forced to do so by its own central bank (the ECB) is quite unprecedented.
Writing in the Irish Times on Wednesday, Taoiseach Enda Kenny explained: "Part of the existing agreement with our external partners is not to allow any Irish bank, including Anglo Irish Bank, default on its debts to bondholders for fear of paralysing wider European financial markets"
No such clause appears in any published agreement to my knowledge. If it appears in some side letter, it is time to release it. The "fear of paralysing wider European financial markets" to which the Taoiseach refers is risible at this stage.
There has been no market for unguaranteed unsecured European bank debt for many months and seasoned market observers believe it may never return. European financial markets have been well and truly paralysed by those making the threats to Enda Kenny.