At last week's summit of EU finance ministers, it was thought that a plan had been agreed to that allowed the EU's emergency fund to loan directly to banks, rather than having the cash flow through the government, thus adding to the sovereign debt of the member.
Stocks took off after that agreement, and bond yeilds dropped for Italy and Spain. But it turns out what was thought to be the parameters of the deal were not quite what they appeared to be.
Wall Street Journal:
Euro-zone countries would still have to guarantee the loans their banks receive from the region's permanent bailout fund, the European Stability Mechanism, even if it directly recapitalizes them, a senior European Union official with direct knowledge of the situation said.
The remarks Friday cast doubt on what was seen as a breakthrough at a euro-zone leaders' meeting last week, where it was decided that once a central euro-zone bank supervisor was in place, the ESM would be able to directly recapitalize banks.
"I need to make clear what the ESM can do: The ESM is able... to take an equity share in a bank. But only against full guarantee by the sovereign concerned," the official said. He added that while the member state's guarantee wouldn't directly show on the government's official debt burden, the loan "remains the risk of the sovereign."
Allowing the ESM to directly recapitalize banks was meant to snap the link between sovereign-debt and bank woes. Each time a country receives bailout assistance to help prop up its banks, the government's debt burden rises, deepening investor worries about the sovereign's situation and lifting borrowing costs. That, in turn, hurts the banks whose portfolios are stuffed with domestic government bonds.
The news added to the upward pressure on regional bond yields which had fallen sharply after the leaders announced what seemed to be key anticrisis initiatives in the early hours of June 29. Spain's 10-year government bond yield, which has started rising again on Tuesday, hit 6.97% Friday, approaching record highs, according to Trade web.
Bottom line: Germany does not want to be left holding the bag if a spate of bank failures in Spain and Italy cause a default and the ESM loses its shirt. The same could be said for the entire European Central Bank. Germany won't allow the ECB to buy up bonds from at-risk countries out of fear that the bonds could end up being worthless in a default. German tax payers, who largely fund the ECB, would take a huge hit if that were to happen.
So the euro-zone is pretty much back to square one. And the banking crisis, thought to have eased last week, is now front and center again.