The EU Contingency Plan: Doomed by Its Main Strength

It was an impressive piece of political compromise, with something critical for everyone.

Markets got a bit more details, enough to calm a bit and let the euro pull out of its dive, as the solution addressed not just Greece but any EU member in trouble.

Greece got confidence boosting support that might keep its borrowing costs affordable, and saved face by not having technically asked for assistance.

Key politicians got what they required:

• German PM Merkel (bailout no, loans maybe)
• French PM Sarkozy (possibly no IMF role and glory for political rival and IMF head Dominique Strauss-Kahn except as a last resort),
• No one really is committed to spending anything yet (aid must be approved by all EU members, likely – but never assured). Nor are the ‘trigger conditions’ for supplying the aid completely clear.
• The EU proves it may be able to handle a crisis. After weeks of ineffectual squabbling, the EU was able to demonstrate some capacity for decisive, autonomous (sort of, if the IMF stays out) action when dealing with fiscally wayward members. A clear step in the right direction.

In sum, it was agreed that an EMU member country in serious fiscal difficulties will be able to receive bi-lateral assistance from its euro zone partners as well as draw support from the IMF, but only if they are really shut out of debt markets – definition of what that meant not fully clarified.

See the problem?

The very ambiguities that allowed the EU to come together are likely to scare off investors, keeping Greek bond rates too high for Greece to afford, defeating the entire purpose of the plan.

As of Monday, Reuters reports soft demand for Greece’s latest €5 bln bond sale. Greece blames the slow start on the holiday week, and that could be a contributing factor.

However, the EU contingency plan’s entire goal was to create certainty where there was uncertainty. It didn’t, and that is likely to be its undoing. Scared markets will ask for an unacceptably high risk premium, and force Greece to turn to the EU/IMF for a cheaper rate, which means the plan will actually be tested.

Then the fun really begins.

Will Merkel tell her voters to pay up? Will Sarkozy allow his rival to steal the glory? Will the EU unanimously agree the time has come to shell out cash?

Who really knows?

Disclosure: No positions