New European Treaty Won’t Solve Current Liquidity Crisis

The agreement European leaders reached Thursday night was taken by some as a sign that the eurozone would avoid breakup. Not so fast. Economists, political leaders and other observers caution that the new pact does not go far enough to address the immediate liquidity crisis threatening European banks and governments.
To shore up those institutions, the European Central Bank would have to take more drastic action by buying up large amounts of government debt. And so far it’s been unwilling to do that. On Thursday, ECB President Mario Draghi said that he was “surprised” by some observers’ interpretation of his Dec. 1 comments that the ECB might buy large amounts of government debt.


Every country in the European Union except the United Kingdom agreed on Thursday to sign a treaty enforcing stricter budget rules on member nations. The treaty would give central European authorities the power to sanction countries that overspend and strike down national laws that break budget rules. The markets rallied only modestly after the news, with the Dow rising 186 points on Friday.
The agreement must be approved by the individual countries’ legislatures, which could take three months, according to Reuters. It’s unlikely that the ECB would step in to offer more aid until the pact has been ratified.
Some observers said that the ECB is deliberately delaying large bond purchases in order to extract as many concessions from European governments as possible. “It’s been brinksmanship,” said Diane Swonk, senior managing director and chief economist at Mesirow Financial. “It’s an important negotiating lever, and it’s important to understand, but it also doesn’t rule out that they will do more.”
Draghi hailed the agreement in Brussels, saying, “It’s going to be the basis for a good fiscal compact and more discipline in economic policy.” But he did not hint at any further government bond purchases.
Borrowing costs for troubled European countries eased slightly after the announcement of the agreement, but not nearly enough to stem the liquidity crisis. On Friday, interest rates on 10-year Italian government debt fell to 6.85 percent, and interest rates on 10-year Spanish government debt fell to 5.77 percent, according to Thomson Reuters. Economists say that interest rates of about 7 percent are ultimately unsustainable. Countries such as Italy, Spain and Portugal need interest rates on their long-term debt to fall to about 4 percent for their debt burdens to be ultimately sustainable, according to a July report by Wells Fargo Securities.