From Spiegel Online:

Business daily Financial Times Deutschland writes that the summit took some historically important decisions.

“It made it possible to decouple banking risks from the state risks. Ailing banks like those in Spain that need recapitalizing should no longer pull into the abyss the governments that support them and are finding the bailout increasingly hard to finance. Merkel gave in on this issue. She caved in, some German commentators are saying. If that is so, then she caved in cleverly. The compromise was necessary and sensible. The risk decoupling won’t just lead to a short-term calming of markets and end the famous ‘death spiral.’ It will also give governments enough time to structurally strengthen Europe against new crises.”

“But this summit agreement has a flaw too. The chancellor insisted on a functioning European banking supervisory authority being established first. Europe will again lose time as a result. Setting one up isn’t a matter of just a few weeks. The chancellor’s demand is justified. But it will tempt the Spanish government to delay the necessary banking consolidation. Why should it help banks now if it has to accept conditions and yield increases that it would be spared at a later date? Madrid’s delaying tactics are dangerous and only increase the danger of a euro exit.”

Conservative Frankfurter Allgemeine Zeitung writes:

“German Chancellor Merkel has largely herself to blame for being labelled as the loser of the EU summit by the opposition in the parliamentary vote on the ESM bailout fund. Her offhand remark ‘as long as I live’ following the statement that there would be no ‘total debt liability’ in the euro zone created the impression that the German position in the Brussels negotiations would be set in stone. But it’s the nature of negotiations, especially in the EU, that everyone involved makes concessions from their initial positions in order to reach a compromise. That also applies to Germany, even though it is the supporting pillar of the currency union.”

“The tactical ploys used to reach compromises are a different matter. Frau Merkel was blackmailed pretty brutally by politicians from the south who share fundamental long-term German principles, by the Italian Monti and the Spaniard Rajoy (with support from the Frenchman Hollande), because these countries need swift aid. It will soon become clear if the new Brussels agreement will achieve that. But it’s certain that these blackmail tactics will leave marks. Relations between Paris and Berlin in particular are severely strained. President Hollande will get a sense of that at the next opportunity.”

Conservative Die Welt writes:

“At the latest EU summit Germany — again — agreed to a lot of solidarity without getting much control in return. There is a big danger that the euro zone will get into an ever deeper imbalance as a result. If ailing economies can get at the money of solid states more easily, this will inevitably strengthen the opponents of a rigorous reform program in those countries. Rome and Madrid are unlikely to find it difficult to decide whether they would rather burden their citizens and their children and grandchildren or the German taxpayer. And Germany won’t even have a veto right in the permanent rescue fund in future because qualified majorities will suffice for aid. It remains to be seen whether the euro will survive the institutionalized irresponsibility.”

Left-wing Die Tageszeitung writes:

“It was an unsual image: Angela Merkel as the loser. She had to back down in Brussels. The ESM will dole out loans to crisis nations without imposing tough austerity. After Merkel’s vow to fight forever against mutualized debt in the EU, that didn’t look so good. The apparent defeat in Brussels is nothing new. It fits seamlessly into Merkel’s strategy – or rather, her pattern of reaction — since the euro crisis started. She always said no, only to abandon each no when it became opportune to do so.”

“Merkel followed a political cost-benefit calculation. A German victory in Brussels over an Italian technocrat government being crushed by interest rate burdens would have been more expensive than this defeat. An EU summit without a result would have brought the euro’s implosion dramatically closer. But Germany already won in the EU long ago. Berlin has europeanized the German economic model by imposing the fiscal pact. The price will be paid by less export-focused nations being forced into rigid austerity. And things look good for Merkel in Berlin too. Effectively, she’s governing not with a center-right government but with a grand coalition of conservatives, Greens and center-left Social Democrats. The liberals (the pro-business Free Democratic Party, junior partner in the center-right coalition) are allowed to complain a bit. Meanwhile, the Social Democrats are bravely trying to persuade themselves that they won’t be her junior partner again in 2013 (the next general election is scheduled for 2013. The SPD was the junior partner in a so-called grand coalition wit Merkel’s conservatives from 2005 until 2009).”

From El Pais (Google translation)

Rajoy denies that the bank rescue to impose conditions on the economy

The president avoids triumphalism and ensures that the agreements of the EU summit has strengthened the euro

Mariano Rajoy has learned the lesson. Following the European Council which has garnered the most international success so far, the Spanish prime minister has been more cautious than ever. If the June 10, after the Eurogroup approve the rescue of Spanish banks, boasted of having put pressure on their partners , today denied the existence of pressure, although with Italian Prime Minister, Mario Monti, blocked Thursday afternoon the approval of the plan for growth in the amount of 120,000 million to be given to stabilizing the financial markets. Rajoy has good reason to be cautious. His previous acts of arrogance angered his partners and, in addition, there are still too many loose ends to tie before declaring victory. Although the Spanish prime minister insisted on repeating that there will be strict conditions on the agreement reached on Thursday, as ECB President, Mario Draghi, the presidents of the European Commission Jose Manuel Durao Barroso and European Council, Hermann Van Rompuy reiterated in speeches that will be.

Therefore, in the press conference has been offered at the end of the European summit, Rajoy has insisted that it is a European triumph, rather than Spanish. ”The Council has launched a clear political signal,” he said, refusing to go into detail, arguing that “the most important is that the agreement strengthens the position of the euro , which today is stronger and more credible than yesterday, other minor issue. ”

But it is not irrelevant issues. The president has said that the agreement to recapitalize Spanish banks, currently under negotiation, “there is macroeconomic conditions” affecting the whole economy. However, the agreed text early this morning by the leaders of the 17 euro countries are said to aid the financial sector, amounting to 100,000 million, will include “the appropriate conditionality”, at the individual entity of each sector “or throughout the entire economy.” Both the European Central Bank President (ECB) and German Chancellor Angela Merkel have stressed the importance of these conditions are met.

Once the ECB supervisor assumes the status of single European banking system, the rescue of Spanish banks from the current European Financial Stability Fund (EFSF) to the new European Stability Mechanism (MEDE), and in that time, no will require that the Spanish state, through the Bank Restructuring Fund (FROB), is involved as an intermediary and guarantor, thus breaking the vicious circle that links the public debt with the banks. Rajoy has been assumed that this change will occur before the year ends, but the Eurogroup agreement only says that the European Council will consider it within that period, without venturing a date for its implementation. What has become clear is that the MEDE not have the priority creditor status, a requirement that had scared off potential investors, since relegated time to collect their debts.

Although the agreement allows for use “in a flexible and efficient” two European bailout funds-the provisional and the final-to stabilize financial markets by buying Spanish and Italian debt to halt the escalation in the risk premium , Rajoy ruled out recourse to this instrument. ”We did not consider anything in this regard,” he assured. The truth is that it is in this chapter that has had its greatest setback. The Spanish prime minister supported the proposal of the Italian Prime Minister for the fund to intervene in the secondary market debt whenever the risk premium exceeds a certain level, without carry macroeconomic conditions attached. The agreement, however, makes the intervention of the fund to implement the recommendations of the European Commission and the commitments made ​​by each country and notes that these requirements should be reflected in a Memorandum of Understanding, which is a rescue plan in all rule.

Maybe that’s why Rajoy has not even want to venture that the European Council agreement will relieve the pressure on Spanish debt, which this morning has begun to reposition themselves relaxing then on the threshold of 500 points. ”To me the concern now is to try to do things right,” he responded.

While denying that there are macroeconomic requirements, Rajoy has made ​​clear that the Government will continue its fiscal consolidation program, consolidation of public finances and structural reforms. And not just for “the commitments made ​​with partners” in Europe, but also because it responds to “deep convictions”. Rajoy has even refused to rule that before approving vacation one to rise in VAT , in line with the amount claimed by the European Commission. ”If we take a stand, do not worry that you will know,” he replied wryly.

From Corriere Della Sera (Google translation)

“FOR ITALY, THE BREAKEVEN BUDGET REMAINS FIXED AT 2013 ‘. DRAGONS ‘TANGIBLE RESULTS’.

EU summit, there is the agreement: 120 bln for growth Mountains satisfied Merkel: “Success”

The Eurogroup opens to an anti-spread. The Prime Minister: “Got what we wanted, but now I ask the shield”

BRUSSELS – The agreement was reached on the night: EU leaders reached agreement on direct recapitalization of banks and the role of money-saving state.Eurogroup leaders “have opened the possibility that countries use the funds saved were virtuous and ESFS ESM stability to reassure the markets.” This was announced at 4 am was the President of the EU Council Herman Van Rompuy , that during the final press conference, “spoke of a difficult and fruitful meeting, during which it was approved a pact for growth and employment can mobilize more than 120 billion euros.”

This is mainly a victory for Italy and Spain, who had made ​​common to Europe asking for greater willingness to reach out to countries ‘virtuous’, while addressing problems that recessive or budgetary consolidation measures, and have adopted policies cope with the crisis. And, conversely, is a surrender of Germany, although German Chancellor Angela Merkel , who also had German sources described as “irritated” with Rajoy, but especially with Mountains, at the end made ​​the best of a cattvo game: “We got what we wanted and achieved good results on ESM and EFSF tools, a good base to work. ”

MONTI: “NEXT STEPS” - The Italian Prime Minister Mario Monti said similar words: “We met, we got what we wanted.”But in the case of Italy it is a position actually corresponds to the mood of the delegation of government. ”In these two days we have made ​​significant progress – said the president of the Council -. Steps that correspond to those much that Italy has long maintained: it was adopted a pact for growth and employment, which contains important measures both at national and European level. “ ”We’re doing a little ‘action to promote in other countries – he added a number of Palazzo Chigi – the idea, but not always natural to us as such, including synergy between fiscal discipline and measures for growth ‘.”We are confident – said Monti – that this vision pervade all economic policies, even the French had made, especially in election period, with accents in the limelight a little ‘different’.

“BUT WE DO NOT ask” - The Prime Minister further reiterated that Italy has no intention of asking the European coverage of the shield as soon relieved. At least not for now: “In the future, should serve as a form of encouragement for the economy, does not exclude the possibility that Italy might ask.But not now. “ Monti has also confirmed that for Italy the goal of a balanced budget is set at 2013, and currently the Executive does not expect to make additional financial maneuvering on site. ”The situation of the Italian economy is heavy – he admitted the Premier – and I never thought to turn it into the light in a few months, even as the government first had to give tools and carry out measures, from pension reform to that of work, that the political system was not up to that time managed to accomplish.”

THE SATISFACTION OF DRAGONS AND BARROSO-Satisfied with the result is called the European Central Bank president Mario Draghi : “results were achieved in the short term. The exemption of the preferred creditor status for Spain is one of those results. “ ”The future possibility of using the ESM to recapitalize the banks directly, something that the ECB calls for some ‘time, is also a good result – he stressed -. And we must keep in mind that all these things, to be credible, should be accompanied by strict conditionality. This is essential. “ For the Commission President Jose Manuel Barroso, the summit was a step towards a true monetary union of the Eurozone. Also according to Barroso, “EU leaders have been able to take measures of short and medium term, unthinkable until a few months ago.”

MERKEL IS HAPPY FACE - The German chancellor says so pleased with the outcome. In the press conference after the summit, Merkel hailed the appointment of Brussels’ a success on all fronts, served to stabilize the markets. “ But then he explained: “My position has not changed on Eurobond.” And the application of the States-saving interventions and anti-spread told to trust in particular in the European Central Bank: “We have great confidence in the ECB because it is an independent body and has interest in having a bank safe.” On the line of Merkel and French President is also the Dragons Francois Hollande , who spoke of “a good meeting,” in which he found “a global agreement” with “measures that will be quickly put to work.”

MEASURES TAKEN - With the approval of the shield anti-spreads, Italy hopes to avoid a “black Monday” at the reopening of markets: while not dovendolo immediate use, the mere existence of ‘”umbrella” Europe puts the country in a position markets and to better address their speculation. As with the opening on direct recapitalization of banks, Spain hopes to be able to receive aid up to EUR 100 billion to help its banks without the public debt to rise. The agreement “will be implemented by the Eurogroup in the very short term, by 9 July,” when they established the criteria for application.Countries that respect the stability pact and recommendations, it was decided, “not have to adhere to the monitoring of the troika,” but will continue to fulfill our commitments.

THE NEGOTIATION - Italy has struggled during the negotiations by pointing your feet and saying he was determined not firmareinsieme to Spain, the pact on growth when they were not introduced measures to contain the spread. Thursday evening van Rompuy speaking for the first time reporters had to admit the difficulties, while denying “a veto Italian.” Then it was the French president François Hollande to clarify a few hours later, that EU leaders had reached agreement on the pact for growth and jobs, but that Rome and Madrid had decided to postpone their signature.

AGREEMENT - But in the end the reserves of Italy and Spain have been taken: to proclaim it was Prime Minister of Luxembourg Jean-Claude Juncker, the past 4 am, at the end of the Eurogroup meeting. ”We affirm that it is imperative to break the vicious circle between banking and sovereign debt.”

So much for my previous post. And, yes, I’m surprised at the outcome.

The Euro Area Summit Official Statement (Full Text)

We affirm that it is imperative to break the vicious circle between banks and sovereigns. The Commission will present Proposals on the basis of Article 127(6) for a single supervisory mechanism shortly. We ask the Council to consider these Proposals as a matter of urgency by the end of 2012. When an effective single supervisory mechanism is established, involving the ECB, for banks in the euro area the ESM could, following a regular decision, have the possibility to recapitalize banks directly. [Key point] This would rely on appropriate conditionality, including compliance with state aid rules, which should be institution specific, sector-specific or economy-wide and would be formalised in a Memorandum of Understanding. The Eurogroup will examine the situation of the Irish financial sector with the view of further improving the sustainability of the well-performing adjustment programme. Similar cases will be treated equally.

We urge the rapid conclusion of the Memorandum of Understanding attached to the financial support to Spain for recapitalisation of its banking sector. We reaffirm that the financial assistance will be provided by the EFSF until the ESM becomes available, and that it will then be transferred to the ESM, without gaining seniority status. [Key point] We affirm our strong commitment to do what is necessary to ensure the financial stability of the euro area, in particular by using the existing EFSF/ESM instruments in a flexible and efficient manner in order to stabilise markets for Member States respecting their Country Specific Recommendations and their other commitments including their respective timelines, under the European Semester, the Stability and Growth Pact and the Macroeconomic Imbalances Procedure. These conditions should be reflected in a Memorandum of Understanding. We welcome that the ECB has agreed to serve as an agent to EFSF/ESM in conducting market operations in an effective and efficient manner.

We task the Eurogroup to implement these decisions by 9 July 2012.

Links:

http://www.bloomberg.com/news/2012-06-29/eu-leaders-ease-debt-crisis-rules-for-spain-as-merkel-retreats.html

http://online.wsj.com/article/SB10001424052702304830704577494693764255190.html?mod=wsj_streaming_stream

http://www.bbc.co.uk/news/world-europe-18620965

http://www.reuters.com/article/2012/06/29/us-eurozone-idUSBRE85O0CS20120629

http://www.nytimes.com/2012/06/29/world/europe/european-union-meeting-opens-without-french-german-accord.html?hp

Nothing as yet from the FT.

The Financial Times is providing blanket coverage of the EU summit meeting, the importance of of which cannot be overstated. This post includes significant portions of the FT’s live blog of the event. All times are London times, which are five hours ahead of New York time.

Thus far, the key development is that Italy has held up a €120bn package of measures to enhance economic growth and create jobs by refusing to give the green light unless and until Germany supports short-term measures to provide relief from the debt crisis. This has been predicted to be the concrete achievement of the summit.

Whether the summit can recover from this impasse remains to be seen. If it cannot, all hell is likely to break loose in world financial markets.

—————————————–

July 28

12:42: Big news in a Wall Street Journal interview with Wolfgang Schäuble, the German finance minister, who the paper quotes as saying his country may be willing to move faster than previously thought towards common sharing of Europe’s debt burden.

Note however, that the second word of the story is “may” and Mr Schauble says: “There will be no jointly guaranteed bonds without a common fiscal policy.” Which is quite a big if. Our immediate reaction here is that this is not quite as clear cut as the Journal’s “Berlin blinks” headline would have us think.

Schauble says: “As soon as we have a joint EU fiscal policy, we can consider joint liability—the sequencing is key…”. Here at FT Towers, we won’t hold our breath on that one.

12:57: And it appears that the German finance ministry also agrees with the FT interpretation of the Schäuble comments. This from Reuters [their capital letters not ours, denoting the importance of their report]:

“GERMAN FINANCE MINISTER SPOKESMAN SAYS REPORT THAT GERMANY HAS CHANGED ITS POSITION ON EURO BONDS IS NOT TRUE REUTERS

GERMAN FINMIN: ‘WE’VE ALWAYS SAID WE CAN TALK ABOUT SHARED DEBT MANAGEMENT ONLY AT THE END OF A PROCESS TOWARDS A GENUINE FISCAL UNION’

14.25: Quentin Peel, the FT’s Berlin bureau chief, has been to a German government briefing ahead of the summit, where a  senior German government official dropped a heavy hint  that Italy and Spain could tap into the eurozone’s €440bn rescue fund – the European Financial Stability Facility – to provide insurance to bond buyers and thus reduce the interest rate on their government borrowing.

Germany is adamant that the tools already exist to help eurozone countries in difficulty, and there is no need constantly to invent new ways of seeking to tackle the region’s financial crisis.

He said the summit was supposed to focus on a €130bn growth plan, and on long-range reforms of the European monetary union, but the German government would discuss any crisis resolution proposals put forward by its partners.

“There is a toolbox which is available,” he said, referring in particular to the EFSF and the permanent €500bn European Stability Mechanism that is supposed to be set up in July. He stressed that applications for support from the funds were subject to “certain procedures and conditions”.

14.55: Reuters has compiled the best quotes form the leaders as they arrived at the summit. Some of the highlights:

German chancellor Angela Merkel on the summit’s aims:

“Today we will talk about the pact for growth and jobs. We have created a good programme here in particular regarding investments in the future and more over what will create more job opportunities specially for young people.

“I hope that we will be able to agree on this today and with that make an important signal, also for the fiscal pact, that we need solid budgets on the one hand and on the other hand growth and jobs.

“Twenty percent of Europe’s young are without jobs, that’s much too high a figure. The council today feel obliged to create more jobs for these people and tomorrow I will tell you about the other points for discussion.”

Dutch PM Mark Rutte on dealing with the eurozone’s banking and sovereign debt problems:

“I’m not prepared to think up all kinds of new instruments. There are existing instruments, under strict conditions, which countries can use who can’t make it on their own.”

“We don’t solve problems in Europe by transferring sovereignty, we solve the problems by sticking to what we have agreed to.”

“There is no medicine, no paracetamol to solve these issues. These countries will have to continue with their reforms. There are instruments available for countries who say they can’t cope on their own in the short term but I don’t see no necessity to think up new instruments.”

Rutte on Spain and Italy:

“The only way for Spain and Italy to get out of this crisis is to bite the bullet and to continue with what has not happened sufficiently in past years: to reform their labour markets, to make savings and make reforms.”

“I can be prepared to use existing instruments to help those countries to get back on track if they carry out difficult reforms but one measure can never replace the other. Italy and Spain can never stop reforms because they are on a European emergency infusion.”

French president François Hollande on his hopes for the summit:

“I have come so that Europe can have a medium-term framework to give confidence. I have come so that growth will be at the heart of our commitments and that there will be decisions that, I hope, will be accepted and that will allow us to generate extra (economic) activity for countries that need it.

“And I have come so that there are very rapid solutions to support the countries that are most in difficulty on the markets, while they have made considerable efforts to straighten out their public finances. So I come in a spirit of giving to Europe the necessary force, coherence and solidarity.”

“If we succeed in having more growth through the pact that we’re going to adopt, a long-term vision and immediate measures to support countries that have made efforts but who can’t support excessively high interest rates – we will have worked well.”

“The important thing was that we go beyond words. Growth cannot simply be noted in a final communique.

“I wanted a growth pact with a number not simply for show, but a translation – 1 percent of European GNP, 120 to 130 billion euros – which we will make sure is spent rapidly and in ways that will be useful for economies and investment.

“All this will allow use to create jobs and prepare for the future. So I think that this summit has already been useful, on condition that it accepts the growth pact.”

15.05: There’s a lot of talk today about the European rescue funds buying Spanish and Italian bonds – a bailout lite – and how it might be done. Peter Spiegel, the FT’s resident Brussels wonk last week compiled an excellent explainer on the subject.

16.30: A sense of realism is biting in Brussels, it seems, especially on the issue of eurobonds. Martin Schulz, the president of the European parliament, told ZDF television of Germany: “I think we should stop talking about eurobonds now because, with the German government’s “no,” with this definitive “no” from Mrs. Merkel, eurobonds are now a non-issue. I personally continue to see it as a good solution, a sensible one, but there is no sense in conducting theoretical debates when the house is on fire.”

18.20: As promised, Brussels bureau chief Peter Spiegel explains what you need to know about where things stand: EU leaders are now considering buying up government debt directly at auction.

While Germany and its northern allies have stood their ground on how, exactly, the eurozone would intervene to help Italian and Spanish bonds (only using existing tools – no newfangled contraptions), he argues a close reading of recent comments reveals that “in that seeming intransigence lies a subtle shift”:

Until now, the German-led alliance has been reluctant to take more action to lower Spanish and Italian borrowing costs, arguing that such short-term action was counterproductive unless Madrid and Rome did more to get their own economic house in order.

Now, eurozone leaders are actively considering which of a burgeoning array of tools created over the course of the last year they should now deploy to bring down Italian and Spanish borrowing costs, both of which continued to rise on Thursday.
…
Officials said the focus of the deliberations had shifted to purchasing bonds on the primary market – essentially buying bonds directly from governments as they auction them. For creditor countries, such a plan has clear advantages, particularly the fact that rescue money could be doled out in much smaller amounts, depending on the size of the auction.

Under already agreed guidelines, the European Financial Stability Facility – the bailout fund – could promise to buy up to 50 per cent of bonds issued, in essence creating a price floor that could lure private investors back in.

But there are drawbacks for Italy – and it’s unclear that the ESFS has enough money to bail out Spain’s banks.

Read the whole story here.

18.30: Benoit Cœuré, ECB executive board member, has sounded a warning on any rush to eurozone bonds. This from a speech just delivered in Rio, flagged by the FT’s James Wilson in Frankfurt:

Common funding instruments would require shared decision making on national debts and deficits and probably joint control on fiscal expenditures and taxation. They can only result from further political integration; they cannot precede it.

Likewise, and importantly, a fiscal union can only come about once the participating countries have successfully restored domestic fiscal sustainability and solidified the conditions for long-term growth. Joint debt issuance cannot be a substitute for putting national fiscal houses in order and restoring competitiveness.

19.21: Tomorrow’s news today – the FT’s Peter Spiegel and Quentin Peel have a wrap-up of today’s “flurry of activity” in Brussels:

After weeks of insisting they would not budge on short-term measures, the sudden German acquiescence led to a flurry of activity in Brussels, where EU leaders gathered for the latest in a series of high-stakes summits intended to solve the crisis.

Unexpectedly, senior officials from all 17 eurozone finance ministries met on the sidelines of the summit to weigh emergency plans for Rome and Madrid, which focused on using the rescue fund to buy Italian and Spanish bonds to reverse the recent spike in yields.

The group, known as the “euro working group”, last met during an EU summit amid the interminable negotiations over a Greek bailout last year, and was the most concrete signal yet that officials were preparing to launch a multi-pronged assistance programme.
…

According to officials involved in the talks, Paris was pushing for wide-ranging help that included purchases of Italian and Spanish debt by the European Central Bank in addition to action by the eurozone rescue fund, known as the European Financial Stability Facility.

But those measures were strongly resisted by a German-led group of northern creditor countries, who were concerned about ECB independence and wanted to limit action to the EFSF.

“There is a toolbox which is available,” said a senior German official.

Full story is on FT.com.

21.37: Straight from the horse’s mouth: European Council president Herman Van Rompuy announces a €120bn growth initiative.

22.42: Quentin Peel has this update from what’s turning into a late night in Brussels:

It looks like it’s Spain and Italy blocking the growth pact to get a better deal on interest rate reduction. ”It’s ironic that the countries that need help think they can dictate the terms,” was one (unofficial) German comment. Sherpas and finance officials labour on to find some interest rate solution.

23.12: Now Bloomberg is also quoting (unnamed) Italian officials confirming Italy is holding out for lower borrowing costs:

Italian Prime Minister Mario Monti may block the 120 billion-euro ($149 billion) growth initiative announced by European Union President Herman Van Rompuy without an effort to reduce its borrowing costs, two Italian officials said.

Italy is withholding its official endorsement as it pushes for collective action at an EU summit in Brussels to push down its bond yields, said the officials who spoke on the condition that they not be named.

23.42: By all accounts, it’s Spain and Italy who are holding up agreement on the €120bn growth pact, demanding action on their credit costs. Germany says it won’t accept any new financial instruments. So where does that leave France? Our Paris bureau chief Hugh Carnegy sends this dispatch from the wee hours in Brussels:

Italy’s refusal to sign off on the growth pact might look like an awkward moment for François Hollande, the French president who made such a play during his successful election campaign of the need for the eurozone to shift the emphasis from German hair-short austerity to stimulating growth and jobs.

But Hollande has been working very closely with Mario Monti, the Italian prime minister, with French officials saying they are in close agreement on the need for short-term moves to ease Italian and Spanish borrowing costs. The two had a bilateral meeting before the summit began.

Monti’s high-stakes negotiating tactics may unsettle the summit, but Hollande will not mind if the outcome is a deal on both the growth pact and approval of more intervention in financial markets by the eurozone’s rescue funds and even the European Central Bank.

That will help him sell the deal back home – and help to cover the awkward fact that he will also have to swallow the German-driven fiscal discipline treaty agreed in March (before he was elected), which he pledged to renegotiate.

July 29

00.10: How things stand, shortly after 1 in the morning in Brussels – from our FT.com story on the night’s developments:

Italy has held up a €120bn package of measures to enhance economic growth and create jobs that was to be the one concrete achievement of the EU summit, refusing to give the green light until Germany supported short-term measures to provide relief from the debt crisis.
…
a eurozone diplomat said the Italian tactics had soured the summit before Friday’s session, when proposals for short-term measures were to be discussed. “The atmosphere is horrid,” said the diplomat.

Both Italy and Spain had agreed the growth measures with France and Germany at a meeting last week – and continue to support them – but were refusing to sign off on them as a bargaining tactic.

“They simply held the whole thing hostage,” one eurozone diplomat said. “They won’t accept the growth pact until they get their short-term measures.”

They want the eurozone rescue funds and the European Central Bank to intervene more aggressively on financial markets to buy Spanish and Italian bonds to ease the very high yields the two countries have been forced to pay on their sovereign debt.

But Angela Merkel, the German chancellor, told the meeting such an approach threatened to derail the whole summit.

Read the rest here.

00.18: Bloomberg reports that François Hollande, the French president, says he will withhold endorsement of a European Union fiscal pact at least until the end of the summit on Friday.

00.26: From the AP:

The French president says discussions on the future deepening of the Europe’s economic and monetary union, as proposed by four senior EU officials, have been put off until October.

The item had been on the agenda of a summit of European Union leaders in Brussels on Thursday. Talks were tense, however. Spain and Italy declined to sign off on a proposed stimulus package unless they received assurances that action would be taken to reduce their borrowing costs.

French President Francois Hollande said early Friday, “If you were expecting a decision tonight on a federal Europe, you were misinformed.”

However an EU official had said the item would be discussed, with an interim report on progress due in October.

Hollande said he was disappointed with the summit’s results.

00.49: Still awake in Brussels, the FT’s Quentin Peel sends highlights from French president François Hollande’s press conference:

Hollande threw his weight behind the Spanish and Italian leaders, saying: “We need to have lower interest rates than today for Italy and Spain.”

He said the two countries had warned him and Angela Merkel about their position in advance, that they could only agree on the growth pact if it were linked to measures to cut their borrowing costs.

The non-eurozone leaders left the meeting in the early hours, so that the 17 partners sharing the common currency could concentrate on those “stability measures”, the French president said.

He said that tools already provided by the eurozone rescue funds should be used to help the two Mediterranean countries, a position shared by Ms Merkel.

He said there would be no decisions on longer-range integration measures, but they should include a banking union, budgetary union, common economic strategy to boost growth and competitiveness, and finally measures to ensure democratic legitimacy for such an integrated system.

“The eurozone cannot stay in the state it is in today, without a budgetary union and above all a banking union,” he said. “That is indispensable.”

01.18: On FT.com, Peter Spiegel has more details on the late-night negotiations:

The finance ministers’ group, known as the “euro working group”, was forced to continue deliberations into the early morning hours Friday after the Italian and Spanish prime ministers threatened to scupper agreement on the rest of the summit agenda without a deal on new aid.

François Hollande, the French president, said Spain’s Mariano Rajoy was holding out for changes in Spain’s €100bn EU bank rescue plan so that bailout aid would be injected directly into teetering Spanish financial institutions. Under current rules, such funds must be funneled through the Spanish state, adding massively to Madrid’s sovereign debt levels. Germany has insisted on such a structure to ensure repayment.

In addition, Mr Hollande said Mr Rajoy wanted to ensure the new bailout loans did not have seniority over current private debt holders; such seniority for government loans is a requirment once a new eurozone rescue fund comes into effect next month.

Mario Monti, the Italian prime minister, continued to insist on an instrument that would automatically trigger the rescue fund buy Italian bonds if borrowing costs rose too high, Mr Hollande said. Such a mechanism does not currently exist, and the German-led group of creditor countries have refused to create new tools for bond buying beyond those already on the books.

From the Financial Times:

After months of denials by Spanish leaders that the country needed a bailout, it fell to Luis de Guindos, the economy minister, to declare in Madrid on Saturday that “the government of Spain declares its intention to request European financing” for its banking system.

– http://www.ft.com/intl/cms/s/0/b4deeb3a-b256-11e1-99ff-00144feabdc0.html#axzz1x2Eim5lB:

The formal request by Spain to the EU is expected before June 21, when Eurozone finance ministers meet in Luxembourg and after a detailed report is issued by two government-appointed advisers on the banks’ capital needs.

The amount? Up to 100 billion euros ($125 billion). From a statement issued by Jean-Claude Juncker, Luxembourg’s Prime Minister and head of the Eurogroup of finance ministers:

“The loan amount must cover estimated capital requirements with an additional safety margin, estimated as summing up to EUR 100 billion in total.”

– http://www.consilium.europa.eu/uedocs/cms_Data/docs/pressdata/en/ecofin/130778.pdf

The bailout will come either from the Eurozone’s temporary bailout fund (the European Financial Stability Facility) or, as soon as it is operational in July, the permanent rescue vehicle (the European Stability Mechanism).

According to the FT, the bailout funds will be channeled through the Spanish government’s Fund for Ordinary Bank Restructuruing (FROB), which will then inject the funds into the banks, shoring-up their capital positions.

Here’s the critical point (again from the FT):

“Because FROB is part of the Spanish government, bailout loans would still be on Madrid’s sovereign books and the government would bear ultimate responsibility for repayment.”

This means that the bailout will cause the Spanish government’s debt-to-GDP ratio to increase. If recent history is a guide, the increase in this ratio will result in higher interest rates on future Spanish government bond offerings. In my view, then, the bailout is nothing more than a band-aid that will stop the current bleeding but worsen the infection.

Market participants will be well aware that agreement on this bailout mechanism means that the Spanish government failed to secure a deal in which the bailout funds would directly inject capital into Spanish banks, thereby avoiding an addition to government’s debt.

According to the Wall Street Journal , de Guindos said

“The Spanish government is determined to do its best to protect the stability of the euro” and added that the conditions attached to the loans “will be imposed to banks, not to Spanish society, nor to its fiscal or economic policy.”

– http://online.wsj.com/article/SB10001424052702303753904577456044240154190.html?mod=WSJ_hps_LEFTTopStories

This strikes me as wishful thinking, at best, or delusional, at worst.

On the same day that IMF Chief Lagarde warned that dangerous cycles “are now threatening the very existence of the European project,” two notable (political) economists — Niall Ferguson and Nouriel Roubini — have penned a call to action in the Financial Times. In “Berlin is ignoring the lessons of the 1930s,” they say that

We find it extraordinary that it should be Germany, of all countries, that is failing to learn from history. Fixated on the non-threat of inflation, today’s Germans appear to attach more importance to 1923 (the year of hyperinflation) than to 1933 (the year democracy died). They would do well to remember how a European banking crisis [which began the collapse of Austria's Kreditanstalt] two years before 1933 contributed directly to the breakdown of democracy not just in their own country but right across the European continent.

Later, Ferguson and Roubini add that

Germans must understand that bank recapitalisation, European deposit insurance and debt mutualisation are not optional; they are essential to avoid an irreversible disintegration of Europe’s monetary union. If they are still not convinced, they must understand that the costs of a eurozone break-up would be astronomically high – for themselves as much as anyone.

After all, Germany’s prosperity is in large measure a consequence of monetary union. The euro has given German exporters a far more competitive exchange rate than the old Deutschmark would have. And the rest of the eurozone remains the destination for 42 per cent of German exports. Plunging half of that market into a new Depression can hardly be good for Germany.

It is unlikely to be a coincidence that Lagarde’s, Ferguson’s and Roubini’s utterances come on the same day as President Obama’s first-ever Eurozone-focused press conference.

Something is happening or will soon happen. Time is getting short. Seemingly everyone except the Germans has concluded that German policy is leading to a European economic collapse.

Today will probably be remembered as the day that the U.S. became firmly and publicly involved in the Eurozone crisis. Late this morning, the President held a press conference that was unusual in at least two respects: (1) it was on a Friday – and a summer Friday, at that, and (2) after an introductory paragraph, the next six paragraphs dealt with the Eurozone crisis. Here’s the six paragraphs, with my highlighting:

Right now, one concern is Europe, which faces a threat of renewed recession as countries deal with a financial crisis.  Obviously this matters to us because Europe is our largest economic trading partner.  If there’s less demand for our products in places like Paris or Madrid it could mean less businesses — or less business for manufacturers in places like Pittsburgh or Milwaukee.

The good news is there is a path out of this challenge.  These decisions are fundamentally in the hands of Europe’s leaders, and fortunately, they understand the seriousness of the situation and the urgent need to act.  I’ve been in frequent contact with them over the past several weeks, and we know that there are specific steps they can take right now to prevent the situation there from getting worse.

In the short term, they’ve got to stabilize their financial system.  And part of that is taking clear action as soon as possible to inject capital into weak banks.  Just as important, leaders can lay out a framework and a vision for a stronger eurozone, including deeper collaboration on budgets and banking policy.  Getting there is going to take some time, but showing the political commitment to share the benefits and responsibilities of a integrated Europe will be a strong step.

With respect to Greece, which has important elections next weekend, we’ve said that it is in everybody’s interest for Greece to remain in the eurozone while respecting its commitments to reform.  We recognize the sacrifices that the Greek people have made, and European leaders understand the need to provide support if the Greek people choose to remain in the eurozone.  But the Greek people also need to recognize that their hardships will likely be worse if they choose to exit from the eurozone.

Over the longer term, even as European countries with large debt burdens carry out necessary fiscal reforms, they’ve also got to promote economic growth and job creation.  As some countries have discovered, it’s a lot harder to rein in deficits and debt if your economy isn’t growing.  So it’s a positive thing that the conversation has moved in that direction, and leaders like Angela Merkel and Francois Hollande are working to put in place a growth agenda alongside responsible fiscal plans.

The bottom line is the solutions to these problems are hard, but there are solutions.  The decisions required are tough, but Europe has the capacity to make them.  And they have America’s support.  Their success is good for us.  And the sooner that they act, and the more decisive and concrete their actions, the sooner people and markets will regain some confidence and the cheaper the costs of cleanup will be down the road.

As far as I know, this is the first time that the Eurozone has taken center stage in a presidential statement. The timing and content suggest to me that some important decisions by European leaders may be taken over the weekend. Further, despite the nod to Merkel, Obama’s words can be interpreted as an attempt to exert pressure on the German Chancellor to relax Germany’s insistence on austerity. Having said this, however, it’s far from clear to me what concrete steps the U.S. can take that would persuade the German government to alter its policies.

“I fear that austerity without end will bring about a return to the unstable populist politics the European Union was designed to prevent. That could shatter the eurozone and, with it, the EU, thereby ending the most successful attempt to build peace and prosperity in Europe since the fall of the Roman Empire. Moreover, it is clear – and has long been so – that the responsibility for preventing that outcome rests on Germany, Europe’s central power, in every sense. As Charles Kindleberger argued, in a panic, the creditworthy country has to lend freely if a fixed exchange rate system (or in this case a currency union) is to survive.

It is often forgotten, not least in Germany, that the rise of Adolf Hitler to power was preceded not by the great inflation, which occurred a decade before, but by the great depression and the austerity of Heinrich Brüning, in response. Thus, votes for the Nazi party jumped from a relatively insignificant 810,000 in 1928, to 6.4m in 1930, and 13.7m in July 1932. Deep economic collapses are dangerous.

Deep economic collapses are very dangerous. Mr Schuknecht, with his emphasis on the long term, completely ignores these dangers.  If trying to avoid such a dire outcome is “short-termism”, so be it. I think of it as trying to find a practical exit from the current trap. Without it, the eurozone may never reach the long term.

Fiat justitia, et pereat mundus (let justice be done, even if the world perishes) is a dangerous motto.”

The above quote is from Martin Wolf’s reply to Ludger Schuknecht, the Director General of the German Ministry of Finance. Herr Schuknecht took strong exception to a recent column (“The riddle of German self-interest“) by Mr. Wolf.

Regarding populist politics — of the right-wing variety, this article in the FT is a warning of what may become a more commonplace occurrence.

From McSweeney’s: