background

The Maastricht Treaty (or Treaty on European Union), signed in 1992, laid down the minimum economic requirements for entering, and remaining in, the EU.  It specified, among other things, that any member country’s budget deficit should be no more than 3% of GDP and its outstanding government borrowings should be below 60% of GDP.

Members would be entitled to use the common currency, the euro–thus becoming part of the Eurozone.

One quirk of the arrangement was that the economic rules could be enforced only at the point of initially applying for membership–by denying entry to the EU to countries that didn’t qualify.  After that, there was nothing.  Why not?  No country wanted to give up sovereignty.

Italy, for reasons of bella figura, underwent an heroic restructuring of its economy so it could be among the charter members–and began backsliding almost immediately.  Greece probably never qualified for membership, but the EU overlooked its well-cooked books to advance its pan-European reach.

One other thing:  most EU members adopted the euro.  A few, notably the UK and Sweden, did not.  The latter are in the EU but not in the Eurozone.

the crisis

Trouble had been brewing for years. Even less creditworthy countries could borrow large amounts of money at favorable rates by issuing sovereign debt in euros, on the idea it would be guaranteed by the full Eurozone.  The situation reached a boiling point in 2010 when Greece announced it had been falsifying its national accounts for years.  Belatedly, lenders began to worry that the Eurozone would not stand behind all euro-denominated debt.  Worries soon expanded to include Berlusconi-led Italy.

the problem

Moral hazard.  Germany balked at stepping in to bail out Greece–and potentially Italy–without a way of enforcing the Maastricht economic criteria.  Otherwise, it risked throwing good money after bad.

where we are now

At the latest in a series of “summits,” the Eurozone countries agreed last week to amend the Treaty on European Union to give EU institutions the power to enforce the Maastricht economic criteria.  That was the final condition Germany wanted before it would be willing to stand behind Italian debt.

But…

…the UK vetoed the idea of using EU government institutions to police Eurozone member countries.  Why?  It wants concessions that will preserve its position as the premiere financial market in the EU.   (This, even though the UK’s “regulation light” philosophy nearly brought the country to its knees, gave protection to the perpetrators of the US sub-prime mortgage debacle, and resulted in sketchy ex-Soviet bloc mining companies becoming major forces on the stock exchange).

So the Eurozone countries say they’ll develop an alternative enforcement mechanism by Christmas.  But until they do, the securities markets will continue about the survival of the Eurozone.

my thoughts

It seems to me that a necessary condition for politicians to back any measure that will bring pain to their constituents is that the alternative appear worse, so that they can cast themselves as heroes for having “rescued” voters from a worse fate–even if they themselves have created the worse alternative by their inaction.  That’s just life.

The Eurozone countries are making progress, though.

Either the Eurozone will cobble together a new enforcement mechanism or–more likely, I think–it will grant some concessions to the UK in return for permission to have Brussels enforce the new Eurozone economic rules.  After all, I don’t think the UK wants to be left completely on the outside of Europe, looking in.

In any event, ratification of the new rules won’t be completed until next March.  Until then, I don’t expect to see significant Eurozone action to support the bonds issued by Italy.

My guess is that support will come, but not until Spring.

For equity investors like us, I think two factors are important:

–Europe will be in recession in 2012.  The question is only how deep it will be.  This is a time to think through how well our holdings of global companies are insulated from European demand weakness, with an eye to emphasizing those with the least EU exposure.

–it’s still too early, in my opinion, to be bottom-fishing in the EU.  There’ll be time enough for that in, say, February.