It's Complicated..

Since last spring, the ECB has bought about 70 billion Euro bonds from debt-laden euro zone countries including Portugal and Ireland to reduce their financing costs. Since last spring, many European nations (i.e. PIGS) have experienced rising sovereign spreads, an indication of investors’ pessimistic outlook on the future of these countries. Yesterday, Spain borrowed 2.4 billion Euro at a yield of 5.45% on the new 10 year bonds. The yield was 4.62% on the same 10-year just a month ago. Its 15-year bond yield rose to 5.95%, up from 4.54% in October (well thanks Moody’s). Spain will need to finance 290 billion Euro in 2011.. Greek 10 year yield is approaching 12%. Greece, already benefited from bailouts, is hit by another strike over its austerity plan and received a warning from Moody's. of a potential downgrade.

750 billion Euro rescue fund was set up (1/3 of the fund supplied by the IMF) and Ireland’s recent rescue drained it of 85 billion Euro. From today’s summit. European Union leaders agreed on a new crisis-resolution mechanism that will kick into gear in 2013 (when the 750 billion rescue fund expires in three years). The new European Stability Mechanism (ESM) will offer loans, on strict conditions, to countries that cannot roll over their debt because of punishing yields. IN SOME CASES, private bondholders will have to take writedowns on their sovereign bond holdings to avoid loading the cost of bailouts entirely on taxpayers. More details of the ESM will be decided at future summits.

On Thursday, the ECB announced that it will almost double its capital base to 10.76 billion Euro from 5.76 billion Euro, which will be used to buy government bonds to ease rising cost of debt.

A Political Tug of War

Solving the debt crises faced by many European nations will definitely create winners and losers among the European countries. Germany has much more sound economy than all of the other economies and German Chancellor Angela Merkel is adamant that any revamped crisis fix-it mechanism for the euro would not involve an increase in the euro area’s bailout fund, or a reshaping of the fund to allow it to buy the bonds of distressed countries. By the way, some members have suggested that the fund would need to be revamped up to 1.5 trillion Euro rather than 750 billion Euro. Italy and Luxembourg suggested joint borrowing of funds by European Union by issuing bonds as a whole (euro bonds) but Germany fears that it would create a perverse incentive by removing the pressure on countries that have lived beyond their means to rein in their spending. In my opinion, this would also create a free rider problem as more fiscally sound countries would have to be punished because of less fiscally responsible states. Germany, however, endorses the ECB’s plan to boost its capital base.  

Maybe the idea of combining different European economies under one union is not sustainable in the first place. These member states were leading different economies, and operating under one currency and monetary policy was not such a great idea after all.. It's a good lesson to be learned for Canada, the U.S. and Mexico. Also, did you know that quite a significant portion of debt emanates from bailing out ailing banks such as Anglo and Allied Irish Banks Plc.? And now the government is trying to cut back on spending on services for its people.  Do we need so much courage to let those people who made bad investment decisions suffer at least a bit (rather than in some cases) rather than tax payers having to pay for those mistakes?..   

I suspect that today's summit result along with the IMF's new loan to Ireland will likely be deemed as good news by the market.. But the ESM lacks details until the next summit. The fact is.. no matter what the outcome of the summit was, the debts are still there.