Photo: Erik Stabile on Flickr
There are lots of cooks in the kitchen in the eurozone.It’s hard to remain grounded with EU leaders yelling—or worse, politicking—at each other all the time, let alone keep track of all the rumours that are driving markets crazy.
Regardless of the daily drama, the debates taking place between leaders, investors, banks, and the media about how to fix the euro debt crisis are complex and polarising.
Everyone's bickering and rumours are swirling over whether or not the European Central Bank should take on a bigger role in the bailout.
There are lots of good reasons for them not to, but it's hard to see any alternatives right now.
As much as they promise they're on the same page, everyone knows that Germany and France are secretly at each other's throats about what to do to fix the euro.
In particular, this debate has taken shape around the European Central Bank. France thinks the European Financial Stability should have a banking licence that would allow it to access to virtually unlimited ECB funds. Germany says no way.
Can anyone say, power struggle?
But unlike Greece, Italy is not insolvent and actually runs a budget surplus. In fact, some analysts think it could even support double-digit yields for years if it had to.
The problem is that investors will be hesitant to invest in Italian sovereign debt if there's any risk involved at all. A vicious cycle of fear could end up making the country illiquid.
With fear festering across the euro area, banks are becoming more and more hesitant to lend to one another. This is slowly causing a full-blown liquidity crisis.
French banks are particularly vulnerable to the effects of tightening liquidity, given their high exposure to the vulnerable Italy.
And if French banks go, then so could France's already questionable AAA-rating, and that could send the whole euro rescue effort toppling down.
Countries that use the euro currency are are now bickering with those that don't over a proposed financial tax and changes to the EU treaties. And it seems like the more they argue, the more vehement their disagreements become.
These divisions will likely escalate when eurozone leaders are forced to take more drastic measures to prevent contagion from spreading and save their currency.
The academic clamor over whether austerity measures are actually the way to get countries debt back on the path to sustainability is growing louder. Not to mention the protests and riots that have resulted from a drastic reduction in government spending and the resultant economic contraction.
A staunch commitment to harsh austerity could topple the political balance of struggling Italy and Greece, and it remains to be seen whether these countries' new leaders can strike a balance between growth and fiscal discipline.
The renegotiation of a credit swap deal for private holders of Greek bonds has left the prospect of a credit event up in the air. We--like many analysts--are sceptical that bondholders will voluntarily take a 50% haircut on their holdings of Greek bonds after many were reluctant to take a 21% haircut earlier this year.
But coercion and a credit event might not be such a bad idea. Although credit default swap payouts would have far-reaching implications, the CDS market for Greek debt is not so large, and payouts could bolster confidence in EU leaders' willingness to play by the rules. Also, Greece would get rid of more of its debt.