Tuesday, November 9, 2010

The "Merkel mechanism" agreed at EU summit

At the EU summit last month, the member states agreed to Germany’s proposal that, in future bailouts, bondholders may face maturity extensions or principal haircuts. In other words, Germany will not the the lender or guarantor of last resort for the union.

It is unclear to me whether this is political window-dressing for German voters, or is instead for real. It is also unclear whether this plan supersedes the bailout plan agreed in May (which had no bail-in provisions).

Despite the uncertainties listed above, I can only observe that an official contemplation of  bond defaults by eurozone member states substantially increases the riskiness of bonds issues by the peripheral states. Until now, there remained at least the possibility of a full bailout or guarantee. This possibility now appears to be ruled out.

In view of the fact that the weakest of the peripherals have lost access to the debt markets, and that their austerity plans keep needing to be revised, it is hard to make the case that Greece, Ireland and perhaps others will not ultimately default.

It should also be observed that the so-called “private investors” who will be asked to “contribute” to the restructuring process are mainly large eurozone banks. Which means that European taxpayers will have to bailout the banks. In the end, the French and German taxpayers will still be on the hook for the eurozone mess.

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