EU crisis: why the Franco-German veto means ‘game over’.

The veto of an enlarged bailout fund will kill the eurozone

Germany and France have rejected calls by Brussels for a rapid increase in the size and powers of the EU’s rescue machinery, once again exposing serious differences at the heart of monetary union. Following its now rigid policy of putting a nice shine on every EU development, the FT led this morning with the line that Germany is backing proposals to give new powers and lending capacity to the €440bn EFSF, but this is just the same old loaves and fishes poppycock we got three weeks ago. The reality is that Merkel hasn’t budged, Sarkozy is backing her, and the rest is just diplomatic flim-flam.

The facts are very simple: Barroso began the session earlier this week by asking bluntly for an increased fund size to calm the markets down. The Franco-German response has been to award the fund ‘a broader role’. There is no explanation of what that might be, but the bollocks of it all is obvious: the EFSF is a bailout fund – what broader role might it have of any interest to the markets?

One begins to lose faith in the FT, which has – all up – been wrong at pretty much every stage of the eurozone unravelling. It is instead instructive to look at how more objective financial specialists see the current situation.

Yesterday, for example, the Portuguese Government talked up the bond auction big-time. But it was a relatively small volume affair – and even the Pink’un itself was forced to concede that triumphalism was premature. I think immature would’ve been a more accurate description: the Lisbon bond sale was what some folk call a ‘salted auction’ – where false bidders in the crowd create an atmosphere of desirability. For this we have the ECB to thank again, given it hoovered up tons of Portuguese debt over the last ten days in a bid to keep the rate below 7%. Once again, a clearly manipulated market.

American analysts – as ever two moves ahead of the EU politics – have now moved on to Spain. Their various assessments yesterday were devastating.

“Spainhas looked at its failing cajas, and seen that they are  small enough to fail, so the solution is to make them merge together with other cajas to create bigger institutions that would be too big to fail,” said one, “but unlike in the US, there is no credible bakstop in the EU…combining strong banks with weak ones is the exact opposite of what Spain should do if it wants the situation to get better. In 2011, Spain has to roll over €150 billion of debt. That’s €15 for every €100 of Spanish production.”

Moody’s predicts that Spanish “cajas” will need an additional €25 billion in bailout funds and its mainstream banks another €90 billion. Add that lot up and you’ve wiped out 65% of the EFSF even without Portugal needing help.

Talking of the Franco-German fund expansion veto, another US expert adds, “The unwillingness to provide 100% guarantees for bank debt is of particular importance in Spain, where the problem is real estate debt held in private hands that is well below water with inadequate capital in the country to clear up the mess. The EU and ECB do not have enough euros to bail out Spain.”

This sentiment is reflected (albeit to a slightly less extreme degree) aong the European continent’s anaylsts and traders.

“In recent weeks, the same EU and ECB bankers and ministers, led by the
Germans, have been telling everyone they will not backstop bank bondholders after 2013,” says one. “Well, plenty of banks hold plenty of sovereign debt that is somewhat dodgy which means regulators are saying we will, indirectly, not back up sovereign debt.”

Finally, I’m not sure how many people have spotted that – scheduled to start in 2016 – Germany will have a tighter Constitutional amendment expressly prohibiting governments from having a deficit at more than a fraction of one percent of GDP. After that time –  whatever moonshine the ECB and others emit – there will be no German euros for support of bondholders, banks, or indeed anything else.

The maths are thus once again clear-cut for those who can be bothered to do the addition and subtraction. The EFSF could bail out Portugal, and give Italy a bit of help. But Italy needs more than a bit of help….and Athens sources are already readily admitting that their repayment schedule is causing problems. There is virtually no money to deal with this. And given the realities of German law, there is no money at all for Spain.

If Berlin and Paris hold the line on this, the Eurozone is dead. And the contagion from such a consequence will be horrific. Not even Bernanke has the QE clout to inflate US equity markets in the face of a selloff caused by an end-game EU debt crisis. He’ll have no alternative but to focus on saving the financial system. The brakes will come off gold, and the Dow will plunge.

Don’t believe anyone who tells you otherwise: the Sarkozy-Merkel hardball on bailout funds will guarantee a collapse in the euro – and in equities just about everywhere.