Euro Zone Progress: Hollande, Monti, and Rajoy Convince Merkel to Relax Bailout


The European Union finally made some headway this week in its battle to thwart a financial meltdown and the demise of the euro.

 The Italian Prime Minister, Mario Monti, was the hero of these latest negotiations. He joined forces with the Spaniards and France to obtain significant concessions from Angela Merkel, the headstrong German Chancellor. Monti was under intense pressure at home to craft a road map to economic recovery with his European counterparts. By most accounts, he stepped in at crucial moments to keep the negotiations alive and forced a compromise.

 The Wall Street Journal  has provided a chart, which succinctly describes four measures that could be the basis for substantial progress in the European debacle.  The first measure is the creation of a Euro zone bank supervisor. This agency will enable the E.U. to conduct meaningful diligence over banks that receive bailout assistance. Banks throughout the continent are having very difficult times, especially in Spain where they have suffered serious real estate loan losses. Other banks in Italy, Greece and France are also struggling. Germany is not willing to support bailouts without assurances that bailout money is being used properly to recapitalize problem banks.

 Second, Germany agreed to allow bailout funds to be injected directly into banks rather than through governments. This is a tricky issue because the local governments will still be responsible for their banks. This methodology will, however, keep new debt off the books of the federal governments, which is important optically. From a credit standpoint, a lender would generally prefer to extend funds to a government than to a failing bank.

 Thirdly, it was agreed that funds extended to Spanish banks would be ranked equal to existing bondholders. The latter group was concerned that their accommodations would be subordinated to new loans made to the banks. The impact of this will be some appreciation of the bonds.

 And fourth, it will be easier to buy government bonds. This will encourage bailouts intervention without burdensome conditions and could facilitate private investor interest.  The market reaction to these developments was exceptional as the Dow Jones increased 277 points, or 2.2%. Additionally, the euro gained nearly 2% against the dollar.

 Most savvy analysts believed that Germany would eventually lessen their demands on its weak European sisters. A continuing or worsening crisis is very bad for all the parties and for the global economy. But, to Merkel’s credit, she has created a new awareness among her free-spending neighbors. Her austerity demands will continue, and if southern Europe complies, Germany, in turn, will likely support further bailouts of banks as well as some growth initiatives.