Trader Talk

Markets Fall as EU Summit Hopes Fade (Updated)


Update: Stocks have rallied off their lows as a draft of the EU communique has apparently leaked out. The communique talks vaguely about their determination to move toward a "new fiscal compact."

The draft did confirm earlier reports that the EFSFwill run alongside the European Stability Mechanism (ESM), that it will have 500 billion euros on top of the EFSF, and that it will come a bit earlier than expected — in July 2012.

However, an anonymous German official has said that Germanywill reject allowing the EFSF and ESM to run concurrently, as well as any proposal to allow a banking license for the ESM, and also rejects eurobonds. Confused yet?


The markets midday drop: the fading of hope. After the ECB's Mario Draghi squelched talk of an expanded bond buying program, traders have now turned their attention to the EU Summit meeting. Here's the problem: many feel they know what is going to happen, and it still doesn't go far enough.

That's because we have the letter that Merkel and Sarkozy have sent to European Council President Herman Van Rompuy. This will serve as the framework for any agreement that comes out of the summit.

The letter says the two want euro states to adopt a balanced budget "translating the objectives and requirements of the Stability and Growth Pact into national legislation at constitutional or equivalent level."

What's that mean?The Stability and Growth Pact was adopted in 1997; it requires eurozone countries to have a) an annual budget deficit no higher than 3 percent of GDP, and b) a national debt lower than 60 percent of GDP or approaching that value.

This was never effectively enforced, and it is the root cause of the current problem. Merkel and Sarkozy want to correct that, but it's not clear the enforcement mechanism they are proposing will be any more effective than the prior mechanism.

The problem: enforcement of the rules would ultimately still be at the national level, not the supranational level. Merkel originally wanted the power to take states that did not keep their budgets within the limits to be taken to the European Court of Justice, and to have the Court legally enforce any agreement.

But Sarkozy pushed back on this, which would have involved some loss of national sovereignty. Instead we have this clause in the letter: "The European Court of Justice, on request of the European Commission or a Euro area Member State, should have the possibility to verify the transposition in the national legislation." Translation: the Court can only rule on whether a state is in compliance or not, it does not have enforcement power.

Oh, there is additional vague language that "there should be automatic consequences unless the Eurogroup, acting by qualified majority, decides otherwise. Exceptional circumstances should be taken into account." But you get the point.

The good news is they are making an attempt to move up the timetable for a new agreement, to the aggressive date of March 2012.

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