Open Europe blog

Labels: ECB, EFSF, euro, eurozone bail-out, eurozone crisis, finance, Greece, Greek bailout, Greek euro exit

After being hit by lightning and left soaked by a rain shower during his first day as French President, you'd forgive Francois Hollande for thinking that something would go seriously wrong at his first meeting with German Chancellor Angela Merkel. However, as expected, yesterday's meeting wasn't overly exciting.

After the mandatory comments about the importance of the Franco-German relations, a German journalist asked Hollande whether France would ratify the fiscal treaty as it stands (the question on everyone's mind), to which Hollande answered:

"Our method will be to put all the ideas on the table and then see what legal implications they can have."

Sufficiently vague enough to allow for a compromise, i.e. fiscal treaty remaining intact but with some sort of add-on. Merkel was also stressed that "the fiscal treaty was signed by 25 [EU] countries last March", adding,

"We have different approaches to achieve growth, but we will share our ideas and see what the different paths to stimulate growth are."

The upcoming meeting of EU leaders on 23 May could be the first real test. For the moment, a new poll shows that half of French think their new President will not be able to twist Merkel's arm on the fiscal treaty.

The second big issue was Greece (what else?). Both leaders said that France and Germany want Greece to remain in the eurozone, and made some interesting remarks. In particular, Merkel said,

"We’re ready to do everything we can…to help Greece structurally."

Hollande said that Greece must respect its previous commitments, but added,

"People in Greece need to know that we will help them – through growth-enhancing measures, through support to [Greece’s] economic activity – to ensure their presence in the eurozone."

Is this a signal that Germany could be willing to give Greece more time to meet its deficit targets? Too early to tell. German Finance Minister Wolfgang Schäuble also ruled out re-negotiating the conditions attached to the EU-IMF Greek bailouts in an interview with German radio Deutschlandfunk this morning.

The most important outcome of the meeting was always going to be the tone it struck. Clearly, it was conciliatory, the focus was always on compromise. It will be interesting to see if this holds throughout the upcoming negotiations on Greece. Those expecting a clash between an irresistible force and an immovable object (the much maligned growth vs. austerity debate) may yet be disappointed.

Labels: eurobonds, eurozone, eurozone bail-out, France, franco-german axis, germany, Hollande, Merkel

On an extremely busy day in the eurozone, French President François Hollande has reportedly had a curious - and somewhat scary - accident on his way to Berlin. His plane was hit by a bolt of lightning, and had to return to the military airport of Villacoublay - where it had taken off some 40 minutes earlier.

Therefore, Hollande had to jump on another plane. He's now flying to Berlin, but will be late to his first meeting with German Chancellor Angela Merkel.

We're glad Hollande ans his team are sound and safe, but the new 'Merkhollande' couple is really off to a rocky start...

P.S.: We're pretty sure that the Chancellor will forgive Hollande's tardiness, given that he just appointed Jean-Marc Ayrault - who speaks good German and is widely seen as a 'Germanophile' - as the new French Prime Minister.

Labels: eurozone, France, franco-german axis, germany, Hollande, Merkel, merkozy

Today's negotiations in Greece on the creation of a government of technocrats have broken down. Talks will resume tomorrow morning, but only in order to appoint a caretaker cabinet which will remain in office until new elections take place - in all likelihood as early as mid-June.

Although widely expected, the outcome of today's meeting is going to create further political and economic uncertainty over the future of Greece in the eurozone. So what could happen now?

First off, it's by no means certain that a stable government will come out of the next elections. The latest polls indicate that left-wing SYRIZA could be the biggest party, but it would still have to form a coalition government. However, following the latest tough round of talks, the outspoken leader of SYRIZA Alexis Tsipras (in the picture with Greek President Karolos Papoulias) doesn't seem to have many friends - the Communist Party has ruled out a left-wing coalition since the very beginning of the electoral campaign, and Democratic Left leader Fotis Kouvelis said yesterday that he would no longer cooperate with Tsipras, even after new elections. On the other hand, Tsipras has repeatedly said that he doesn't want to become a 'complicit' of New Democracy and PASOK - the only two Greek parties that insist on the need for Greece to stick to the EU-IMF bailout programmes.

Needless to say, this would complicate Greece's position vis-à-vis its eurozone partners. As Eurogroup Chairman Jean-Claude Juncker told reporters in Brussels yesterday, there could be some room for Greece to negotiate a relaxation of its deficit targets if a serious new government can be formed. As we pointed out here, Greece may well be heading towards a series of inconclusive elections. This would make it very difficult indeed for Germany and the others to justify the disbursement of future tranches of bailout money.

Greece's euro exit is becoming increasingly likely - not just because it's being talked about by a growing number of top European politicians - although we still think that Greece's anti-bailout parties may ultimately soften their stance, potentially paving the way for a compromise. What's most interesting is the fact that figures are being put on the impact of a Greek euro exit (and consequent default). A couple of hours ahead of Francois Hollande's inauguration ceremony, outgoing French Economy Minister Francois Baroin told Europe 1 that Greece's euro exit and default "would have a net cost of €50bn" for France, "plus the debt held by banks and insurance firms in their portfolios." Le Figaro did its own estimates, and put the cost at up to €58.5bn - that is, €895 per Frenchman.

Quite a busy eurozone day. As usual, you can follow our live updates on Twitter @OpenEurope, and continue to check out our blog for updated analysis. 

Labels: France, germany, Greece, Greek bailout, greek elections, Greek euro exit, New Democracy, Pasok, SYRIZA, Tsipras

Over on the Telegraph blog, we argue: 

There’s a paradox at the heart of the Greek euro debate: voters have comprehensively rejected EU-mandated austerity – parties that are (more or less) in favour of ripping up the bailout conditions mustered 68pc of the votes. And yet, according to a new poll, 78pc of Greeks are still in favour of the new government doing “whatever it takes” for the country to stay inside the Eurozone.

On one level, this phenomenon is an extreme case of having your cake and eating it. Clearly, Greece needs root-and-branch reform if it’s going to have any hope of remaining inside the euro, and naturally, Germans and other creditors will want guarantees in return for putting up cash.

But this paradox may also hold three clues to Greece’s future inside the eurozone.

First, it illustrates the conflicting view inside Greece of "Europe". The country has been an EU member for 31 out of 38 years as a democracy (at least in modern times). EU membership is still associated with stability, prosperity and democracy, which explains why four out of five Greeks remain committed to the euro. Therefore, when German ministers, central bankers and others dare Greece to tear up the bailout deal and face an imminent euro exit, they also dare Athens to risk all which marks the break from its chequered past of colonels and instability. Rhetoric aside, are Greek parties really willing to pull the trigger?

 At the same time, though, on the current austerity path there must be a tipping point for Greece, when the euro and/or the EU becomes predominantly associated with a whole range of negatives, including undermining democracy, meaning Greece will almost certainly decide to leave. Though we’re not there yet, there are plenty of signs already.

Secondly, the Greek population is in some ways rational in its opposition to a euro exit. Yes, the country is stuck with a hopelessly overvalued currency. Yes, it was a mistake to allow it in and the rest of it. But whether staying or going, Greece is in for a very rough ride. Just to illustrate: the Greek banking sector is completely reliant on the eurozone for recapitalisation and liquidity (via the EFSF and ECB). If Greece exited, the newly independent Greek Central Bank would be forced to fill this void by essentially printing huge amounts of money, perhaps equal to half of Greek GDP. Hyperinflation would be a real threat as would the collapse of the banking sector. Would SYRIZA and others dare to risk it?

Thirdly, the Greek population isn’t entirely irrational in its opposition to the EU/ECB/IMF programme either. This programme is based on unrealistic assumptions and is choking off any chance of growth. This is not an endorsement of debt-funded growth à la Hollande – which is what put Greece in this mess in the first place – but of giving Greece some flexibility to enact structural reforms, for example via a full restructuring (which is now much harder due to the ‘private sector involvement’ in the second bailout). If the Troika could loosen the reins slightly, and a new Greek government use that to boost chances for growth while also and saving face at home, perhaps there’s a compromise to be had between Greece, Germany and the IMF – and Greece can live another day inside the euro. Though the euro still would have plenty of issues, at least, this could give Greece time to recapitalise its banking sector and achieve a primary surplus, both of which would make managing an exit easier.

In any case, in the ongoing game of chicken between Germany and the Greek anti-austerity parties, given the huge stakes, it may well be the Greek parties that blink first.

Labels: eurozone, eurozone bail-out, eurozone crisis, germany, Greek euro exit, sovereign debt, SYRIZA

Negotiations to form a coalition government carried on over the weekend in Greece, and are due to continue this evening - in parallel with the meeting of eurozone finance ministers in Brussels.

Here is a quick update of where the situation is at:

• On Sunday, the leader of left-wing Syriza, Alexis Tsipras, announced that New Democracy, Pasok and Democratic Left had reached an agreement to form an emergency cabinet due to last for two years - i.e. until the end of the second EU-IMF bailout programme;

• Democratic Left leader, Fotis Kouvelis (in the picture), denied Tsipras' claims as "defamatory lies". He made clear that no national unity government is possible without Syriza's participation;

• In a last-ditch attempt at striking a deal, Greek President Karolos Papoulias has convened the leaders of New Democracy, Pasok, Syriza and Democratic Left for this evening (at 7.30pm in Athens, 5.30pm in London);

• Tsipras has said he will not attend a meeting with "selected" political leaders. Instead, he challenged President Papoulias to hold talks with the leaders of all parties that won seats in the Greek parliament - with the exception of Neo-Nazis Golden Dawn party;

• Syriza leader Alexis Tsipras' recalcitrant stance has not gone down well with Democratic Left leader Fotis Kouvelis. He just told Greek Real FM radio that he has no intention of cooperating with Syriza, even after new elections.

The move by Syriza to call for cross party talks tonight could very well be little more than political posturing. Following the break-down of talks over the weekend Tsipras didn't come off too well, with all the other parties blaming him for the lack of progress. The recent polls showing that 78% of Greeks want to see a coalition which supports the euro could have played a role in convincing him to come back to the table - if only to save face and look to be participating constructively ahead of the new elections.

The situation remains very uncertain, but the general feeling is that tonight's round of talks with President Papoulias could really be the last chance to avoid new elections. Essentially, for this to happen, Kouvelis has to U-turn on his electoral promises and accept to enter a coalition with New Democracy and Pasok. However, the latest developments seem to suggest that new elections could, at this stage, be inevitable.

“The EU can’t increase its budget, but has to use its resources better than it has done so far… We need to re-think of the use of EU funds. Calculating what share of each country’s contribution comes back in the form of European subsidies is no longer fit for purpose. This ultimately leads to aberrations such as EU subsidies going to day-spas or romantic hotels. We are all familiar with absurd examples of this type of subsidies in our own country. With European taxpayers’ money, we must achieve better efficiency quotas and demand better results.”

- German Foreign Minister Guido Westerwelle speaking in the Bundestag on Friday.

Hear hear! As we have flagged up repeatedly, because of its flawed design, the EU budget is particularly prone to mis-allocation of resources and poor project selection.

Seriously, for how much longer can Europe afford having such an economically irrational policy at the heart of its common project?

Incidentally, if you're around Brussels tomorrow, we're organising an event on this very question, i.e. on how the EU budget should be reformed.

Labels: CAP, EU budget, EU reform, structural funds, westerwelle

Labels: bank capital, banking sector, default, ECB, emu. bail-out, eurozone, eurozone crisis, finance, Rajoy, Spain, stress tests

Well, it didn't take long. You may have thought that yesterday's comments from people allegedly close to Bundesbank President Jens Weidmann to the effect that Germany could live with the shocking inflation rate of 2-3% were in any way a sign that Germany was about to cave in on its resistance to anything that resembles high inflation. Well the front page of Bild Zeitung - the gold standard of European tabloids (pun intended) - says it all:

The “Bundesbank is going soft on the euro”, adding that:

“Over the next few years prices in Germany will rise much faster than before. Our venerable Bundesbank, the sacred guardian of price stability, will do nothing about this since it considers it to be ‘manageable’”.

And in case the 13 million or so Bild readers didn't get the message, page 2 features a giant picture of a one trillion DM banknote from the Weimar era:



An op-ed by the paper's chief editor Nikolas Blome argues that:

“[inflation] will above all hit workers, employees and pensioners. Precisely those who kept a cool head and ploughed on through the crisis. This is unfair. It gnaws at our trust in money and our major institutions, in politics and central banks… since Germans have bitterly experienced it themselves they know that high inflation ultimately breaks down every society”. 

It wasn't only Bild though. The man himself, Weidmann, moved swiftly to deny the reports, claiming in an interview with Süddeutsche that this was an “absurd discussion”. He clarified that keeping inflation below 2% in the eurozone as a whole meant that “in some cases” German inflation would be higher, but that “we will ensure [in the ECB’s governing council] that inflation in Germany will not run out of control. Citizens can rely on the vigilance of the Bundesbank”.

This is one national core belief you don't mess with.

Labels: Bild Zeitung, bundesbank, ECB, germany, inflation, one-size-fits-all monetary policy, weidmann

With Europe as fluid as ever, talk of some sort of EU referendum is heating up in the UK (well at least in the Westminster bubble).

The always excellent James Forsyth of the Spectator argued in the magazine yesterday that London Mayor Boris Johnson’s support for a referendum and UKIP’s rise taken together “make it highly likely that Britain will have its first vote on Europe since 1975 within the next five years."

He also notes that,

"The popularity of Cameron’s EU veto made his circle realise how much of a political asset Euroscepticism could be, if used in the right way. There is also concern in No. 10 that if the Tories don’t offer the public a vote, Labour will."

He goes on to say that,

"One source intimately involved in Tory electoral strategy told me recently that a referendum in the next manifesto was ‘basically a certainty’...My understanding is that, at the moment, the favoured option is to propose renegotiation, followed by a referendum on the new arrangements within 18 months. During the campaign, the Tories would argue for staying in if new terms could be agreed but leaving if the rest of Europe refused to play ball." 

The equally excellent Paul Goodman over on Conservative Home today echoes Forsyth, listing a range of reasons why a referendum draws nearer.

And Forsyth's colleague Alex Massie also picks up on this on the Speccie's Coffee House blog, looking at all the complications involved in trying to square an EU renegotiation with a referendum (the "on what?" question always looms large). We've looked at the various options for a referendum in detail before, so this is all familiar (if you're interested in the different options, we strongly recommend reading this piece).  Massie makes a good point though. An EU referendum is too often seen in Tory leadership ranks as being about "a matter of party morale, discipline and tactical positioning", not getting something that actually works for the UK.

We agree. The thing is, this is far too complicated an issue to make a matter of mere party management. It will be part of the equation, of course, but making it subject to pure party politics will reduce the discussion to the usual Westminster back-and-forth on vague concepts such as "influence", "isolation" or "sovereignty" - it will be Mandelson land.

But where Massie - and a whole range of other commentators and politicians - get it wrong is when they say that in contrast to the renegotiation option, "an in/out plebiscite at least offers a choice between easily-grasped options."

No it doesn't. Staying in raises a whole range of complicated questions - what does the UK do if the eurozone takes that quantum leap towards further integration? What happens if the EU merely becomes a political extension of the eurozone (which Britain can't join)? In other words, if we want things to stay as they are, things will have to change.

And the "out" option? It sounds easy at a superficial glance, but in a serious discussion, it would raise far more questions than answers. In fact, there's virtually no "out" option (save perhaps one) - all options to withdraw from the EU treaties (which is what 'out' must mean, though it is rarely defined), involves joining something else. Doing a "Norway" would be suicide for UK, i.e. accepting 2/3 of EU laws but with no say over them; a Switzerland would be slightly better but still immensely complicated. A different type of Free Trade Agreement altogether involving business paying hefty fees or facing new admin burdens on exports to the EU, which contain some imported components? A customs union a la Turkey meaning being stuffed on market access on services? Simply falling back on the WTO's Most Favoured Nation (MFN) rules, with a range of costly barriers to trade and movement?

Answers anyone? The truth is that most of the complications that apply to renegotiation, also apply to the "out" option, including the need for some sort of "approval" from other countries for whatever alternative arrangement the UK enters into (apart from the WTO option) possibly. The truth is that all three options: staying in on current terms, renegotiation or withdrawal from the EU treaties are massively complicated. To whet your appetite, we're about to publish a comprehensive report looking at the different options for the UK was it to vote to decide to leave. And trust us, it's complicated.

What we do know is that both Britain and the eurozone will simply have to move. It's therefore right that No 10 is now considering different options.

But again, it should be for the right reasons.

Labels: britain in europe, Cameron, EU reform, norway, referendum, renegotiation, switzerland, trade, wto

Shock horror. According to Reuters Deutschland, an unnamed central banker close to Bundesbank President Jens Weidmann today said the following, in response to the wide rumours that the Bundesbank may be willing to accept higher inflation to help solve the eurozone crisis:

“By this it is meant [that with] a rate of inflation that is moderately above the target of the ECB which is just under 2 per cent...No one need be afraid of massive currency devaluation”. 

 Apparently, the belief is that the Bundesbank 'can live with' 2.5% or 2.6% inflation.  

This follows an interview with German Finance Minister Wolfgang Schäuble,  published by Focus over the weekend, in which he said thus:

“It is fine if German wages are currently increasing more sharply than in all other EU countries”. 

After many years of reforms, he said, Germany has done its homework and can afford higher collective wage settlements than other countries.

So is this a sign that Germany is starting to follow the advice of a whole host of Anglo-Saxon commentators who see higher inflation in Germany as vital if the euro is to survive? 

We wouldn't bet on it. When commentators talk about higher inflation, they have something much higher than 2.5% in mind (though some commentators may not realise that themselves) - this certainly doesn't seem high enough to encourage the re-balancing and evening-out of competitiveness which many believe the eurozone needs to survive in the long term. The media may be getting ahead of itself on this one.

Labels: bundesbank, ECB, germany, inflation, one-size-fits-all monetary policy, schauble, wages, weidmann

The political situation in Greece following Sunday's elections is getting even messier. Following the failure of conservative New Democracy to even begin a serious discussion about forming a government (negotiations lasted all of six hours), the Radical Left (SYRIZA) yesterday also threw in the towel. The "dream" of a leftist Coalition government had failed, said SYRIZA's leader Alexis Tsipras, but added that his party had nonetheless forced Europe to reconsider the Greek bailout package (perhaps a bit premature). 

The buck has now been passed to socialist PASOK, the former governing party which slumped to third in the elections. PASOK leader Evangelos Venizelos said yesterday that he will ask Greek President Karolos Papoulias - who by now must be a seriously nervous man - to give him the go-ahead to start discussions with other parties in a last-ditch effort to try to form a government. If that fails, we're definitely looking at fresh elections, probably in June. The prospects for PASOK succeeding are slim - to say the least.

So what's going to happen? Frankly, heaven knows. As we have noted before, even fresh elections may not generate a stable government, though there's a chance that those people who voted on smaller parties that didn't get over the 3% threshold to enter the Greek parliament, may shift their votes to bigger parties. SYRIZA clearly remains the X-factor, and could potentially pick up more votes. The party has outlined a five point plan - including completely ripping up the bailout agreement - that is simply fundamentally incompatible with the position of the Germans and the IMF. The politics are immensely complicated, but if SYRIZA's support is required for forming a government, then we're basically looking at three potential outcomes:

1) SYRIZA and Germany/IMF stick to their guns, the bailout cash is frozen, Greece defaults and almost certainly leaves the euro
2) SYRIZA caves and Greece is given the next tranche of bailout cash and the charade continues for a bit longer
3) Germany/IMF cave, the bailout terms are revised and Greece is given the cash

Perhaps a path between the second and third options would be possible too - and given the stakes, not unlikely. In any case, it ain't lookin' good.

Labels: eurozone, germany, Greece, Greek bailout, greek elections, imf, New Democracy, Pasok, sovereign debt, SYRIZA

The Queen delivered her "Queen's Speech" earlier today - which, for non-UK readers, isn't her speech at all but rather the government's, setting out its agenda for the forthcoming year (a rather odd ceremony but good opportunity to see Ken Clarke in a wig if nothing else).

For those interested in the ever-so-opaque EU dimension, the Queen said in passing:

"My Government will seek the approval of Parliament relating to the agreed financial stability mechanism within the euro area."

And

 "My Government will seek the approval of Parliament on the anticipated accession of Croatia to the European Union."

The latter won't be much of an issue - most MPs will play along as further enlargement rightly enjoys buy-in across the political spectrum.

The former is a different story. This relates to the EU treaty change dating back to December 2010, when the Germans managed to get agreement for tweaking the Lisbon's Treaty Article 136 to allow the eurozone's permanent bailout fund, the ESM, to be put on a more legally sound footing (at least that's how Berlin sees it). This treaty change has now finally come up for UK ratification in Parliament. Before carrying on, just to clarify, this is not the EU treaty change that Cameron vetoed in December 2011, and which gave rise to the separate Fiscal Treaty.

The December 2010 agreement didn't cause a whole lot of fuss at the time, and MPs gave their preliminary approval. Back then, Cameron had far greater control over both events and his own backbenchers. And the UK media was still waking up to the massive - and ongoing - continental political shift unleashed by the euro crisis.

2012 is a different matter altogether.

The ESM won't actually impact on the UK itself, so the 'referendum lock' wouldn't kick in. However, the treaty change that Cameron vetoed back in December wouldn't actually have had a direct impact on the UK either - that veto was about getting guarantees that UK interests were protected as the eurozone integrates further, and the rules of the game are effectively changed.

Exactly the same logic could apply to the Treaty change to put the ESM on legal footing. Like the Fiscal Treaty, the ESM will lead to greater integration in the eurozone (indeed, the two go together - see here), so Tory MPs could use the same line of reasoning they did leading up to the December summit in calling for the UK to block the measure, in return for EU concessions. Remember, an EU treaty change is not a change at all until it has been ratified by all member states.

Will they? So far, there are no signs that this issue is fully on MPs' radar and the UK government prays it will stay that way. But a lot of things to look out for:

• The UK government is likely to sell the measure as a guarantee that it will never again be forced to indirectly contribute to eurozone bailout funds - a few papers have already run with that story. At the same December summit, Britain won a political declaration and an EU decision that the article that forced it to contribute to the EU-wide bailout funds, the EFSM, won't be used again (Article 122 - for background, see here and here). However, the legal status of this guarantee is uncertain. It is not part of the treaty change itself, and MPs may argue that a guarantee that isn't anchored in the Treaties could well prove ineffective. After all, the UK has received guarantees before which proved to be pretty worthless (clue: Charter of Fundamental Rights, Working Time Directive). If MPs wake up to the legal ambiguity underpinning the 'guarantee' they may ask for something firmer in return for ratifying the treaty change.

• The timing of the ratification will be crucial, i.e. if it coincides with some cataclysmic event or political row in Europe (there will be a few to choose from), it would make life potentially much more difficult for the UK government. The ratification certainly won't happen before the summer' that's for sure. 

• Under the current agreement between eurozone leaders, the ESM is supposed to be up and running by 1 July (in parallel with the temporary bailout fund, the EFSF). This is important, because without the ESM in force, the lending capacity of the euro bailout funds will be a lot lower than markets are expecting, meaning more market nervousness, in particular as Spain is struggling.  

• To make matters even more complicated, the treaty change itself isn't actually what's needed to approve the ESM in eurozone countries - for that, eurozone leaders have agreed a separate 'ESM treaty' which is now going through national parliaments in the eurozone. As you'd expect, this is by no means plain sailing as the treaty - for obvious reasons related to taxpayers' cash - is subject to controversy in Germany and the Netherlands, which are still to ratify it. Before the ESM treaty can become operational and lend money to countries and banks, it needs to be approved by eurozone countries accounting for at least 90% of the contributions to the fund (meaning that Germany, France, Italy and Spain have an effective veto).

• And this is where things get rather bizarre.  Even if all euro countries manage to ratify the ESM treaty, the Germans originally said that they absolutely need the separate EU Treaty change for the ESM to be fully legal. However, since the UK won't have ratified the EU treaty changes by 1 July, the ESM will be up and running before the 'vital' Treaty change designed to make the whole construction legal is actually ratified in national parliaments. In other words, expect another batch of court cases to soon land in the in-tray of the German Constitutional Court in Karlsruhe.

Pretty messy - but then again, we're talking eurozone politics and EU 'law'. That one short line in the Queen's Speech hides so many complications...

Labels: bailout, britain in europe, esm, eurozone, German Constitutional Court, germany, Karlsruhe, Lisbon Treaty, Netherlands, treaty change

Another day, another U-turn in the eurozone – although this time it may mark the Spanish government’s acceptance of the huge problems in the country’s banking system.

The Spanish government announced on Monday that it will be injecting Bankia, the country’s third largest bank, with up to €10bn in capital, using the state-backed FROB bank restructuring fund, despite previously dismissing the possibility of doing so. Given the timing of the announcement – on the same day that Greece went through political upheaval – one can’t help but think that the Spanish government harboured some hope that the declaration might fly under the radar.

Given the size of Bankia and the implications of the bail-out such hopes were deeply misplaced. Bankia has one of the largest exposures to the country’s bust real estate and construction sector at €38bn, of which €18bn is considered problematic. It was also the poster child for what now looks to be the laudable but ultimately doomed structural reform of Spanish banks which took place last year. It is the largest of the consolidated ‘cajas’ (Spanish regional banks) and the problems on its balance sheet highlight how little the banking consolidation solved.

Taxpayer-backed bank bailouts are never ideal but if Spain chooses to go down this road, getting the correct mix of support and strong conditions is vital.

The most likely form of any future intervention is the widely mooted ‘bad bank’ plan. A plan to remove the huge amount of risky assets lurking on bank balance sheets sounds great in theory but it is never that simple.

The first question, as always, is where will the money come from? Currently Spanish banks have €54bn in provisions against €136bn in doubtful loans. The latter number looks set to increase as conditions worsen, particularly with much larger falls in real estate prices expected – we predict that provisions will need to be at least doubled, while the corresponding capital need to underpin a ‘bad bank’ would be large. Bankia is likely to be only the tip of the iceberg both in terms of problems in Spanish banks and the use of public funds.

Securing private funding will be near impossible, leaving two sources of public funds: the Spanish FROB bank restructuring fund and the EFSF/ESM eurozone bailout funds. The FROB in theory has a lending capacity of €99bn, but most of the cash must be raised by issuing debt, with only €18bn directly guaranteed by the state. There are rightly questions over whether the fund could borrow cheaply if it backed a bad bank, potentially leaving the majority of the gap to be filled by eurozone bailout funds.

Given the growing political opposition to both the bailouts themselves and the austerity conditions which they come with, such a large transfer of European funds could be political dynamite in Europe.

The main concern is the huge moral hazard associated with bailing out banks – this was a trend which many in Europe hoped had been bucked, opening it up again would do significant damage to credibility in the eurozone. The aim is ultimately to encourage banks to start lending and aiding economic growth again but this is notoriously difficult – who’s to say they won’t continue hoarding funds over wider fears of a eurozone break-up. The most important part of the process will be an honest external valuation of these doubtful loans, something which Spain and the eurozone have shied away from before.

Any funds must therefore come with clear conditions. The key element to enforcing these will be allowing some banks to fail or be wound down, if too large a percentage of their assets need to be shifted to the bad bank. In the end, many of these banks have unworkable balance sheets in the aftermath of the housing bust. This will be the clearest signal to show that public funds are not being used to solely prop up banks, that only viable businesses will survive and that the Spanish government is committed to reform.

In many ways the use of public funds to help Bankia could be a turning point for the crisis in Spain. The good news is that the Spanish government finally accepts the need to tackle the wider problems with its banks, presenting an opportunity to flush out the sector once and for all. On the other hand, it significantly increases the likelihood of taxpayer-backed Spanish and eurozone funds being used to bail out banks once again. What’s clear is that, until the problems are fully addressed, the Spanish banking sector malaise will still threaten to engulf the whole economy and potentially drive the country into a full bail-out programme.

Italian daily La Repubblica had an interesting story over the weekend. Apparently, Italian Prime Minister Mario Monti and his team are trying to win support for watering down the EU's deficit and debt rules.

Italy is suggesting that 'virtuous investments' (i.e. public spending aimed at boosting 'growth') should not be counted when calculating a country's deficit and debt under the EU's budget rules (3% deficit, 60% debt-to-GDP ratio). The same exception should be applied to the re-payment of money currently owed by the various public administrations to private firms - some €70 billion in Italy's case.

The always well-informed Marco Zatterin - Brussels correspondent for La Stampa - writes on his blog that Italian Europe Minister Enzo Moavero Milanesi has already been talking to EU Commissioners for Internal Market (Michel Barnier), the Budget (Janusz Lewandowski), and Industry (Antonio Tajani, Italy's man in the Commission) over the past few days. EU Economics and Monetary Affairs Commissioner Olli Rehn is reportedly willing to consider the proposal. The Monti government hopes that EU leaders will discuss the proposal at the European Council at the end of June.

These exceptions, Italy's reasoning goes, would make the fiscal treaty "more sustainable" once it comes into effect. But is this really a good idea? As we pointed out before (see here and here), the fiscal treaty already has some serious credibility issues and has already been watered down.

Allowing for some debt to be swept under the carpet doesn't exactly inspire confidence. Do people remember how we got here in the first place?

Meanwhile, mayoral elections took place in Italy over the weekend (we understand if you didn't notice given everything else that was going on during the eurozone's 'Super Sunday'). Still, a couple of interesting facts are worth flagging up:

• Candidates from Silvio Berlusconi's People of Freedom party did not make it to the second round in any of the bigger cities where elections took place (Genoa, Palermo, Parma and others). Following the results, the party's Secretary General, Angelino Alfano, said that backing for Monti's government continues, but no more 'mini-summits' with the centre and centre-left leaders supporting Italy's technocratic cabinet in parliament will be held from now on. This could have an impact on Monti's ability to push through his reform agenda, especially since he has no electoral mandate to fall back on when things get tough;
 

• Lega Nord, Berlusconi's former ally, also did quite badly in the wake of the scandals that forced its leader Umberto Bossi to step down last month. Lega Nord managed to keep Verona, but lost several towns traditionally considered strongholds in the Lombardy region;
 

• Turnout was about 67% - almost 7% lower than in the previous local elections;

• The Movimento Cinque Stelle (Five Star Movement), led by Italian stand-up comedian Beppe Grillo (in the picture) came out as the real winner. Its candidates achieved double-digit percentages in a couple of important cities (including Genoa, Beppe Grillo's home town, and Parma, where the Five Star Movement's candidate Federico Pizzarotti made it to the final run-off, with 19.5% of votes). A political maverick, Grillo has been campaigning for the need to clean up Italian politics, for instance by barring convicted people from running for the Italian parliament. Most interestingly, he has recently been claiming that Italy should drop the euro (but remain in the EU) and refuse to pay back at least part of its public debt. 

The general elections will be a different ballgame altogether, but it's interesting how the Italians, too, are now looking for something different.

Labels: elections, eurozone, eurozone bail-out, eurozone crisis, general election, italy, mario monti, Merkel, Olli Rehn, Sarkozy