The European Union’s $1 trillion rescue plan will reassure financial markets for a while.
But at some point the bond markets are going to ask “So how are they going to pay for this?”
In the coming days you’re going to hear lots of comparisons between this $1 trillion plan and the $700 billion rescue package that the U.S. government put together to stabilizer the U.S. financial system after Lehman Brothers collapsed and American International Group threatened to head down the same path.
But there is one critical difference. The U.S. bailout transferred risk from the balance sheets of private companies to the balance sheet of such public entities as the Federal Reserve and the U.S. Treasury. The ultimate backstop, of course, was the U.S. taxpayer.
The European Union rescue transfers risk from public balance sheets at fiscally challenged periphery countries such as Greece, Portugal, and Spain to public balance sheets for the European Union as a whole.
In some ways this reminds me of the financial engineering Wall Street practiced during the subprime mortgage boom.
If you took enough risky debt, Wall Street argued, and packaged it all together you would reduce the risk of the whole deal. Not risky assets would go down at the same time.
Well, that turned out to be wrong.
And I have to wonder if the idea of packaging the risky debt of Portugal, Greece, Spain, Italy, and Ireland all together will ultimately work any better.
The final backstop for this rescue is composed of the taxpayers of France and Germany. They are the countries that have pledged the most to the rescue. They are the strongest economies of the European Union. And they’re really the only countries that might conceivably have the resources to actually pay off on the guarantees of this package.
But France and Germany aren’t exactly swimming in cash. The French budget deficit hit 7.5% in 2009 Public debt climbed to 78% of GDP in 2009. That’s up from 68% in 2008. In March Insee, the French national statistic office, projected that debt levels will rise again in 2010, hitting 83% of GDP. Debt levels, Insee calculates, won’t begin to fall until 2013 from a level of 87% reached in 2012.
That leaves the German taxpayer to carry a huge share of the burden. And it’s pretty clear that even if the German economy, the strongest in the Euro zone, could, the German taxpayer isn’t in a mood to pony up.
Over the weekend, voters in the German state of North Rhine-Westphalia dealt a stunning defeat to the Christian Democrats and their leader Chancellor Angela Merkel. The vote cost the Christian Democrats their majority in the upper house of the German legislature. Politicians in Germany pin the defeat on voter anger over the bailout package for Greece. The state is part of the historical industrial heartland of Germany and has been hard hit by the decline of German industries such as steel.
With that as a first indicator, I wouldn’t say that the leaders of the European Union can count on German taxpayers to go along with rescuing the rest of the troubled economies of Europe.
In other words, I think that today’s package will produce relief in global financial markets and will buy time for the European Union to work on a solution, but I don’t think it marks the end of this crisis.
And it would behoove the United States and other deficit nations to use the time to put together their own plans for a return to fiscal responsibility.
Think that’s likely?