Wednesday, 17 October 2012

Eurozone Bank Supervisor Plan Found To be "Illegal"

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While we have largely resumed ignoring the non-newsflow out of Europe, as it has reverted back to one made up on the fly lie after another, or just simple rumor and political talking point innuendo in the most recent attempt to get hedge funds starved for yield (and chasing year end performance) to pursue every and any piece of Italian and Spanish debt (at least the until euphoria ends and the selling on fundamentals resumes) the latest development from the FT bears noting as it has major implications for Europe's make it up as you go along "recovery." According to the FT: "A plan to create a single eurozone banking supervisor is illegal, according to a secret legal opinion for EU finance ministers that deals a further blow to a reform deemed vital to solving the bloc’s debt crisis. A paper from the EU Council’s top legal adviser, obtained by the Financial Times, argues the plan goes “beyond the powers” permitted under law to change governance rules at the European Central Bank." The punchline: "The legal service concludes that without altering EU treaties it would be impossible to give a bank supervision board within the ECB any formal decision-making powers as suggested in the blueprint drawn up by the European Commission."

Keep in mind this has been Germany's position all along, which has absolutely no intention of handing over supervision of Deutsche Bank (whose ongoing bailout this is all about), to the ECB. But more importantly, recall that the ESM as a bank recapitalizing CDO mechanism can only work under an active banking supervision regime, which in turn means that the uber Deus Ex Machina, that of recapping insolvent and locked out banks directly and bypassing the ECB's direct debt purchasing using a third party surrogate instead, will not be possible. This is bad news for Spain, but the country is still celebrating its "Schrodinger" status of a country which is both investment grade and needing an imminent bail out any second now.
More from the FT:
Those non-eurozone countries that want to opt into the bank supervision regime would also be legally unable to vote on any ECB decisions – a key demand of countries such as Sweden and Poland.

While it is common for lawyers from different EU institutions to disagree on aspects of proposals, diplomats involved in the talks said the sharp difference in legal opinion would complicate efforts to overcome the deep-set concerns of some member states. Banking union will be a central topic at the EU leaders summit on Thursday.

While EU leaders are still aiming to agree the supervision plan by the end of the year, talks have made little progress to date, in part because of strong German objections. Some participants privately suggest the talks may drag on for a year or more.

Other elements of the commission proposal were also challenged in the legal opinion, notably in asserting the rights of member states to decide how rules on their banks are applied, even when under the supervision of the ECB.

“The major question that follows from this opinion is a practical one,” said Alexandria Carr, a former UK legal adviser now at Mayer Brown International.

“Will the ECB have the capability and capacity to be the ultimate decision maker in respect of all supervisory decisions over complex, global institutions and to apply at least 17 different pieces of domestic legislation?”
Which hits at the heart of the matter. Becase while Europe may have a central bank, one which is controlled by an ex-Goldmanite with a purely reflationary agenda, the real fiscal and monetary powerhouse (because at the end of the day if Weidmann quites the ECB, what happens next is anyone's guess) continues to be Germany. And that's just the way Germany likes it. And whether there will be inflation in Germany (which Deutsche Bank certainly needs but in moderation so as not to spook the German population), will be Germany's decision. At least that is how Germany sees things.
So to summarize:
  • The June Eurosummit, which was hailed as a grand victory for Mario and Mariano, and which sent stocks soaring on the misperception that Germany has finally yielded to the PIIGS demands, has not yet been effected (just out from Bloomberg: "Rajoy Says June Summit Accords Must Be Implemented Soon").
  • The ECB's OMP was disclosed a month ago, but has yet to buy a single bond.
  • The ECB has said the OMP will be pari passu with the private sector, yet the ECB refuses to take any capital hits on its Greek bonds, confirming there is no clear plan how OMP purchases will be potentially impaired (see "Draghi Again Confirms ECB Pari Passu Status Is A Pipe Dream")
  • The ESM will have insufficient funds, when one takes out the paid-in capital components and the funds already pledged, to prefund Spanish 2013 bond issuance, let alone Spain and Italy (as we said months ago, and as IFR confirmed last week)
  • The ESM will certainly not have enough cash to prefund Spanish and Italian funding needs once the current bout of euphoria ends (see "Brussels we have a problem")
  • Now we learn that the ESM will be hobbled, and one of its most critical functions (assuming it can find the funding of course) - recapitalizing insolvent PIIGS banks - will now almost certainly not happen.
  • If AEP is right, Germany will demand an arm and a leg in exchange for providing ongoing assistance to the PIIGS, and wants to become Europe's defact "currency commissioner", which makes the ECB even more irrelevant in the great scramble for monetary authority power.
  • Spain's Rajoy has been delighed to take advantage of the market correctly assuming that it is insolvent and will need to be bailed out, but so far has refused to admit reality, and while issuing debt at bailout-inclusive levels, does not want to pay the piper and face the population once he admits failure. Moody's laugahble report that the pro forma bailed out country is Investment Grade is simply further proof of Europe's current policy-driven idiocy.
  • The Greek economy is imploding now faster than ever, with the country's biggest company, Coca Cola, leaving the country, heading to Switzerland, in the process causing another major spike in the unemployment rate, leading to less tax revenues, and an even greater fiscal mess. In fact, Greece will likely gets its marching orders shortly, but certainly not before the US election. 
  • The cherry on top is that having delayed long enough, Germany is now rapidly entering the recession that its neighbors have been hit by. And making things worse, the ironic outcome where the EUR is stronger on more ECB easing simply means that German exporters will be more and more impaired with every day that the EURUSD rises, such as today. This in turn means more core weakness, and less German ability to hold the eurozone on its shoulders.
In a nutshell, not only has nothing actually happened in Europe, aside from lots of talk of course, but things are even worse than they were several months ago. But at least bonds are tighter, giving everyone a false sense of confidence and allowing peripheral countries the comfort of believing that everything is under control.

It isn't. Instead, what it is, is one big confidence game. Literally.

For those who want to know the media scripted outcome of the European tragicomedy, we again refer you to the article highlighting Lee Buccheit's "Next Steps" for Europe.  Because unlike contradictory flashing red headlines every 10 minutes, it explains cleanly and accurately precisely what happens in Europe in the next few quarters (spoiler alert: there is no happy ending).

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