New Soap Opera: The Comedy of Euros

NEW YORK ( TheStreet) -- The term "European Theater" was first coined during World War II. Today in the financial markets, the term has come to symbolize an ongoing soap opera, where the audience is continually held in suspense as the bad actors (the politicians) promise actions and solutions to current crises, which have been created by their prior actions. Each time solutions are proposed, the audience breathes a sigh of relief (i.e., relief rally in the equity markets) only to be disappointed when they find out that the solutions won't work or can't be implemented.

As a result, the crisis and suspense continues, keeping the audience's total attention (even while dinner on the stove at home is burning). Meanwhile, a new issue or crisis appears, it seems, on a daily basis.

Likely New Episodes

Daily we watch yields on Spanish and Italian debt move ever higher, now in zones where other countries have cried "uncle" and asked for bailout help. At the same time, the credit default swaps on Spanish and Italian debt have risen to record levels.

New Episode: Will the capital markets force a Spanish bailout by locking Spain out of the debt markets?
  • Spanish bank recapitalization: We have recently learned that the European Central Bank is willing to impose losses on the shareholders and junior bondholders of some of the Spanish savings banks. (When they bailed out Ireland, all bondholders were saved.) The draft of the document meant to give Spain's banks 100 billion euros has this provision, but the periphery's finance ministers are opposing it.

    New Episode: Is 100 billion euros enough for Spain's banks? The general rule of thumb appears to be that the ultimate amount needed is usually higher by a factor of at least two.
  • Spain's regional provinces are now coming hat in hand for bailouts of their own. And those regional governments must refinance more than 35 billion euros in the near future.

    New Episode: Are there enough resources in the European Financial Stability Facility (EFSF), the temporary bailout fund, and the European Stability Mechanism (ESM), the proposed permanent bailout fund, to bail out Spain and its regions? What about Italy?
  • The problematic link between Spain's sovereign and its bank's balance sheets has not been severed, as the audience was led to believe during the "Summit" episode.

    New Episode: Will the ESM require the Spanish government to guarantee the bank capital? If so, will market reaction drive borrowing rates for Spain even higher, or lock them out of the capital markets altogether?
  • Greece now appears unable to produce an austerity plan acceptable to the Troika (EU Commission, ECB and International Monetary Fund). Greece has a 3.8 billion euro bond payment due in August. And the ECB just announced that it will no longer accept Greek government bonds as collateral for loans, thus locking Greece out of ECB borrowing.

    New Episode: Will the Troika impose its own plan, or will it withhold bailout funding? Without access to the ECB, will Greece default again? And, will this lead to Greece's immediate and disorderly exit from the monetary union?
  • Each monetary union country is required to put capital into the ESM. Italy will be required to pony up 20% of the ESM capital.

    New Episode: What sense does it make for Italy to borrow at 7% when the ESM would offer a rate of return that is closer to 3%?
  • The ECB holds tons of Greek debt on their balance sheet at par (i.e., 100% of face value) (Portuguese, Spanish and Italian debt, too). If (when) Greece leaves the monetary union, they will renounce this debt, causing the ECB to need more capital to cover this loss.

    New Episode: Will the remaining members be able to contribute even more capital? That will put additional pressure on the weaklings -- again, Portugal, Spain and Italy will have to go to the capital markets to borrow at extremely high rates to meet their capital contribution requirements.
  • Will the ESM be allowed to purchase sovereign debt in the secondary market as promised in the "Summit" episode? This is meant to support Spain and lower the interest rate it has to pay to borrow. The Dutch, Finns and probably the Germans may say 'Nein.'

Politicians in a Box

The bad actors in this soap opera, the politicians, know that if they attempt to do the right thing, they will be voted out of office by populations who value their entitlements more than anything else. Look at Greece and the near victory by the Syriza party (anti-austerity) in the last set of elections. And now, we see riots in Spain.

These bad actors have proposed so-called "fixes" that merely kick the can down the road, from bailouts (Greece, Portugal, Spain, Ireland) to a banking union in order to avoid addressing the core issues. The fixes enacted calm the audience for shorter and shorter periods. For example, the deposit flight from Spain's banks now continues unabated, despite the capital plan for Spanish banks announced during the recent "Summit".

This soap opera will continue to play out because liquidity does not produce solvency. The ECB and politicians can throw all of the money they can create at the problem, but, until debt restructuring occurs (i.e., dealing with the debt), the soap opera will continue.

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