Muddling through to the very last breath

Last week I predicted that, contrary to expectaions, the Greek crisis would force the European Union to abandon their "muddling through" approach to security regulation volcanoes everything under the sun economic policy and start some serious centralization.  Not that this was a great option — but all the other options were even less palatable. 

So, did the weekend package confirm my hunch?  Well, Anne Applebaum seems to think so: 

Though the European Union has always required a partial surrender of sovereignty from its member states, Greece no longer has much sovereignty at all. IMF agreements also impose conditions, but the language is somewhat different: The indebted country requests help, the IMF responds. In this case, the EU has decided what Greece "shall" do. I don’t believe anybody knew that the EU had so much power over its member states, least of all the Greeks.

Well, yes, but on the overall question of the centralization of eurozone decision-making, I think the weekend’s events actually prove me wrong.   Indeed, this New York Times story by Steven Erlanger, Katrin Bennhold, and David Sanger suggests that the member states have managed to come up with yet a new way to muddle through without arrogating power to the Commission: 

Germany was insisting on a solution that involved bilateral loans from European member states, similar to the much smaller Greek bailout agreed to a week earlier. But countries like Italy and Spain feared that they would be unable to raise the amounts required and lobbied for loan guarantees on funds raised by the European Commission.

As the evening unfolded, Germany, Britain and the Netherlands all opposed the commission’s proposal to raise money on capital markets guaranteed by member states. The British and Dutch said the proposal was tantamount to giving a “blank check” to the European Union’s governing commission, according to a European diplomat who spoke on condition of anonymity.

Near midnight Sunday night, the talks appeared deadlocked, these participants said. “The deal is exploding,” read the text message of one French official to Paris, where Mr. Sarkozy was demanding regular updates and was pushing for a bigger agreement.

Then came the deal-making idea — put together, according to different officials from different countries, by the French, the Italians, the Dutch and a crucial German banker.

Axel Weber, the president of the conservative Bundesbank, who is favored to succeed Jean-Claude Trichet as the next president of the European Central Bank, suggested a mechanism for Europewide loan guarantees that finally won support from a reluctant German government during a midnight call, participants said.

The idea was for a new mechanism euphemistically called “a special purpose vehicle” — essentially eurobonds created by intergovernmental agreement among euro zone countries. That vehicle, supposedly to last only three years, would raise up to 440 billion euros on the markets with loans and loan guarantees, depending on the need.

The Germans, together with other northern Europeans like the Dutch, British and Austrians, insisted that the European Commission not control the vehicle but only manage it — in conjunction, as with the Greek deal, with the International Monetary Fund. The fund would provide discipline, as well as roughly one euro for every two from Europe.

The “special purpose vehicle” finally broke the French-German deadlock.

Yeah, about that special purpose vehicle:

[F]or all the excitement about the scale of the effort, it is important to remember that the core fund does not now exist. The fund, known as a special purpose vehicle, would raise money by issuing debt and making loans to support ailing economies. The European countries would guarantee that fund.

So the package is merely a commitment for the vehicle to borrow money if a large economy like Spain, which represents 12 percent of the output in the euro zone, asks for assistance. The International Monetary Fund is pledging 250 billion euros to support the effort. Sixty billion euros under an existing lending program pushes the total to near $1 trillion.

The fund is therefore more a theoretical construct than the Troubled Asset Relief Program that was created in the United States, and that is where things get tricky.

By definition, if Spain came to a point where it could no longer finance itself, interest rates would be on the rise. The several hundred billion euros for the fund would not only come at a high cost, but would bring additional pain to already indebted countries like Portugal, France, Italy and the United Kingdom, which back the special purpose entity, thus compounding the region’s debt woes.

So, in other words, because Germany and others don’t want to transfer either real power or real ability to borrow to the European Commission, the result is a jerry-rigged bailout fund that has some disturbing dynamics if things go further south.    

We’ll see how the markets respond in the coming days and months.  For everyone’s sake, I hope I’m wrong and the EU can muddle through.  But my fear is that this strategy is not going to be viable for that much longer.