Other then the fact that several key players are dissatisfied, I can't make heads or tails of this except to say what I said before the summit, "If they could make 2+2=4 it would have been done by now".
So far Peter Tchir seems to have the best grasp on what's going on although he is left guessing as to a number of provisions. So here's his take with a few comments by me in red.
This is worth reading, if not now, then later. It sounds to me that the ESM is going to come online too little too late with about $40 bb of effective lending capacity when introduced, this is going backwards, so check out the article, I will bold some of the important stuff.
Markets initially sold off across the board but have recovered somewhat this morning. Credit is weaker across the board with MAIN, SOVX, and FINS all wider on the day. Financials are underperforming and adding to yesterday’s losses and are back to their widest levels of the day. Italian and Spanish bonds are lower again. Italian 5 year yields almost hit 7% but have improved a little bit.
Stock futures have bounced back to positive but have been reasonably volatile and seem surprisingly strong in face of weak credit markets and pressure on the banking sector.
It seems strange that the person everyone is most concerned with is Draghi. What a strange world when policies that potentially change Europe really don’t matter much to the markets, all that matters whether this is enough for Draghi to change his mind from yesterday. I wouldn’t bet on that.
So what did we get:
A New Fiscal Compact
General government budgets shall be balanced or in surplus (anything better than a deficit of 0.5% is considered a surplus). What is a “general” budget? Is that primary or overall? Are there “special” circumstances? Somehow I don’t think this will get us balanced budgets.
Each country will be required to create some legislation that “automatically” forces them to have a balanced budget. So nothing is actually in place, and I bet this won’t be as easy as it sounds. I mentioned this early in the week, there will be no actual commitments at the summit and plenty of time for countries to back away.
“Member States shall converge towards their specific reference level, according to a calendar proposed by the Commission.” I really don’t know what this means, but “converge towards” “reference level” and “calendar proposed” doesn’t sound particularly solid.
The rules of “Excessive Deficit Procedure” will be reinforced. “There will be automatic consequences unless a qualified majority of euro area Member States is opposed”. So they don’t define the consequences but did define how they can be waived. Not exactly a strong statement either.
Budgets have to be shown to the Council and the Commission and there are pledges to work further towards fiscal integration.
This section was underwhelming at best.
Stronger policy coordination and governance
Blah blah blah. Some platitudes and a commitment to hold at least 2 Euro Summits a year. Yes, Euro Summits are part of the solution, I feel better already.
Strengthening the stabilization tools
This is where it at least gets a little interesting.
The “EFSF leveraging will be rapidly deployed through the two concrete options agreed upon by the Eurogroup on 29 November”. Calling what they have documented already as “concrete” seems a stretch. Why the mention of leveraging? Seems to me like they are trying too hard. Shouldn’t it have been sufficient to say EFSF? Sounds like they don’t believe it, so they figured writing the word leveraging would make it more real.
ESM will go into place once 90% of countries have ratified it. The target is July 2012. More votes. I guess it is okay that ESM is coming into place earlier, but with EFSF not even launched yet, but about to be “rapidly deployed” it doesn’t seem that exciting. The AAA countries are pushing for this because EFSF relies on their guarantees so they support all the funds, whereas ESM has paid-in capital so other countries can contribute. Yes, Italy can put in paid in capital to the ESM so that the ESM can buy Italian bonds. Problem solved. It does help if France pays in capital before they get downgraded to AA+ (or lower) as that impacts the EFSF much more than ESM.
“The EFSF will remain active in financing programmes that have started until mid-2013 as provided in the Framework Agreement”. So yes, the EFSF will function as has been stated over and over. Nothing exciting about this at all.
They will “reassess the adequacy of the overall ceiling of the EFSF/ESM of Eur 500 billion in March 2012”. This is interesting. First it confirms that the combined “firepower” of the two vehicles won’t exceed 500 billion. They will both be in operation but the capital available to them is 500 billion in total. Some people have been estimating that they will both function with 500 billion for a total of 1 trillion. That is clearly not the case. It is encouraging that they may look to increase this total in March 2012. That is a long way away in this market, and it makes the assumption that they will have the ability to do it if they choose to. Specifically the S&P ratings agency may downgrade the triple A's long before March 2012.
Oops, I got ahead of myself. “during the phasing in of the paid-in capital, we stand ready to accelerate payments of capital in order to maintain a minimum 15% ratio between paid-in capital and the outstanding amout of ESM issuances and to ensure a combined effective lending capacity of EUR 500 billion” Can’t they ever make anything simple? So there is a phase-in period? So rush rush rush, accelerate implementation of ESM, then have a long drawn out “phase in” period? What is the 15% thing? If ESM is supposed to have paid in capital, why is it contemplating issuance? Hmmmmmm.
“the provision of additional resources for the IMF of up to EUR 200 billion, in the form of bilateral loans, to ensure the IMF has adequate resources to deal with the crisis”. So the EU is bailing out the IMF? Or the EU is giving money to the IMF so it can bailout the EU? If the EU has the money why not lend directly, or wait, better yet, pay off some of the debt! Watch this carefully. I have to assume that it is better credits lending money so it can be funneled to weaker countries. This should be credit NEGATIVE for the better countries. I think this could impact yields over time at better countries, and may also be enough to see some ratings downgrades. Again, I’m really confused why the IMF is involved in this. Why they can’t do bilateral agreements within the EU is bizarre, and if anything, we have learned that whenever there are unnecessary steps or seemingly bizarre steps, it hasn’t worked out well.
The ESM can have a “qualified majority” of 85% to make some emergency decisions. Remember, the ESM needs to be approved still, and I would think some countries may be very reluctant to have “paid in capital” at risk that they can’t veto. (this clause is already qualified as subject to confirmation by the Finnish parliament).This was mentioned late last night, several f the bigger donor countries don't want to give up their veto powers and have their money go to pay debt that they don't approve, ratification may not be possible and throws the entire launch date in to question if there's a launch at all.
They end it with “we welcome the measures taken by Italy, we also welcome the commitment of the new Greek government, supported by all parties, to fully implement its programme, as well as the significant progress achieved by Ireland and Portugal in implementing their programmes.”
Summary
Nothing really new here or unexpected or earth shattering or even approved. The bilateral loan thing is new (subject to confirmation) but something about that seems too bizarre to get excited about. If they have the EUR 200 billion lying around to lend, why use the IMF.
In the end I don’t see much here. I cannot imagine we are going to get any new support from the ECB on the back of this. I don’t think this is enough to get the rating agencies to take the countries off of watch. Nothing has been really agreed to. I’m not even sure that if everything is implemented it is enough to avoid some countries getting downgraded.
Since I started reading this, markets have improved a bit, but once again, as people read more and get past the headlines and the lipstick, this is very disappointing. The UK has taken a further step away from the EU and may have opened the door for more countries to take that step over time since everything that was “agreed to” still needs to be ratified and implemented and defined.
More color:
So the ESM is going to be implemented ahead of schedule. Or at least that is the current plan, although it seems that Finland is insisting that it retains unanimous voting and most (all?) countries still need to ratify it.
The ECB will oversee the ESM and EFSF, which is good as they have more market experience than the EFSF head, but does mean they will be reluctant to print which is what the market really wants.
The ESM will have an effective lending capacity of €500 billion. That document states that the lending capacity of €500 billion includes any capacity being used by the EFSF. The EU statement confirms that. So between EFSF and ESM, the combined lending capacity is €500 billion.
Capital Structure
So let’s look at how the original ESM was designed. By accelerating it, they may change the capital structure, but since that sounds like effort on their part, it is probably safe to assume the first attempt will copy the March plan.
“The ESM will have a total subscribed capital of €700 billion” So far so good.
“Of this amount, €80 billion will be in the form of paid-in capital provided by the euro-area Member States” (€700 billion of subscribed capital becomes €80 billion of paid in capital?)
“of which €40 billion bill be available from July 2013 with the remaining share being phased in over the three following years” So at launch it would have €40 billion of paid in capital and then would add €13.3 billion per annum for 3 years? Where is Jon Stewart when you need him. He would do a much better job of making you laugh while he incredulously walks through how 700 becomes 40. As mentioned, at launch the ESM will have $40 billion of capital assuming countries like Finland even ratify this and contribute.
So the existing ESM looks like EFSF except that it has 8% of the lending capacity in cash up front. Yes, 8% is paid in capital on day one. It is not contemplated that it would have more than 16% of paid in capital. Maybe the new details will be different, but I highly doubt it since the EU is big fan of providing guarantees rather than cash because the vigilantes have trouble tracking all the guarantees (once again, I ask how much has France guaranteed to the IMF, EFSF, EMS, EIB, EU, Dexia?).
There is no mention of the ESM being able to use leverage. There is no mention of either leveraging option. If so, the ESM is then even smaller than the EFSF could be (theoretically since they haven’t demonstrated any ability to actually leverage the EFSF).
ESM loans are meant to be senior to regular debt. I’m not sure how that will work if they are buying bonds in the primary and secondary market, but it is their intention that any loans made by the ESM would be senior to other creditors. Again, I don’t see how that could apply if they just buy bonds, but is worth considering. It may be a reason that the countries are rushing to implement ESM over EFSF. Maybe they think they are getting preferred creditor status? That wouldn’t surprise me if they believed that and were trying to take less risk. This may be dropped when they go through the ratification process but doesn’t really make sense since the policies have shifted more to involvement in the public bond markets rather than private loans. If it isn’t dropped, bond investors will become concerned about getting subordinated.
The ESM would be subordinated to IMF loans. Is this why the national central banks are lending to the IMF who is then lending to countries? Is it so that the IMF can get preferred creditor status?
Also, if France is downgraded, then ESM’s effective capacity is DOA unless they go for actual paid in capital. I am not sure that countries will ratify a proposal that really makes them commit capital.
You see how confusing this is and seemngly a step backwards with much less capital coming online and several major donor nations at best, not committed to joining. This also will take creditor nations capital status and reduce it, something the S&P may slap a downgrade on them for.
I can't see how the S&P buys this, I would be watching for mass downgrades and I would think the S&P is already printing the VERY long list.
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