Investors seem to have no doubt that Mrs Merkel will indeed endorse an end to fiscal austerity in the Eurozone and, in the process, further breach the constitution of the ECB and ignore the ghost of Herr Haverstein (Germany’s Weimar/hyperinflation central banker). These are truly existential decisions for any Chancellor of Germany to make and it is too dangerous to invest clients’ hard-earned savings on a bet that The Chancellor will sacrifice everything for the political union project.

Time is ticking away and a decision will have to be made within weeks if a European recession, which will raise severe questions about the survivability of the European political union, is to be averted. We will know soon enough just how large the ghost of Herr Haverstein still looms in Germany, as a failure to endorse helicopter money within a few weeks most likely means Germany is ultimately backing away from the European political union project. This is amongst the most important political decisions of the 21st century and one full of pain for global equity investors if Germany decides not to act. Early clues as to which way The Chancellor might swing are to be found in Italy.

The Solid Ground has been warning for well over a year that the introduction of the Bank Resolution and Recovery Directive (BRRD) would undermine the stability of European banks and, if actually implemented, would cause bank-runs across Europe. The collapse in European bank share-prices since January does suggest that bank stability has been undermined. Now we face the prospect of a BRRD implementation in Italy and the biggest public policy error since Hank Paulson allowed Lehman Brothers to fail.

Eoin Treacy's view

Here is a link to the full report. 

Here is a link to the text of the European Commission’s Bank Resolution and Recovery Directive dated June 12th 2014. I’ve highlighted one of the more relevant sections below.  

If that facility were guaranteed by a State, an institution accessing such a facility would be subject to the State aid framework. In order to preserve financial stability, in particular in the case of a systemic liquidity shortage, State guarantees on liquidity facilities provided by central banks or State guarantees of newly issued liabilities to remedy a serious disturbance in the economy of a Member State should not trigger the resolution framework provided that a number of conditions are met. In particular, the State guarantee measures should be approved under the State aid framework and should not be part of a larger aid package, and the use of the guarantee measures should be strictly limited in time. Member States guarantees for equity claims should be prohibited. When providing a guarantee for newly issued liabilities other than equity, a Member State should ensure that the guarantee is sufficiently remunerated by the institution. Furthermore, the provision of extraordinary public financial support should not trigger resolution where, as a precautionary measure, a Member State takes an equity stake in an institution, including an institution which is publicly owned, which complies with its capital requirements. This may be the case, for example, where an institution is required to raise new capital due to the outcome of a scenario-based stress test or of the equivalent exercise conducted by macroprudential authorities which includes a requirement that is set to maintain financial stability in the context of a systemic crisis, but the institution is unable to raise capital privately in markets. An institution should not be considered to be failing or likely to fail solely on the basis that extraordinary public financial support was provided before the entry into force of this Directive. Finally, access to liquidity facilities including emergency liquidity assistance by central banks may constitute State aid pursuant to the State aid framework.

I believe it would be a mistake to think the European Commission would be willing to impose the kind of solution on the Italian banking sector that it did on Cyprus for a number of reasons. Perhaps the most important is that the Eurozone’s creditor nations have a great deal to lose by imposing such a resolution while they were relatively immune to the fallout from Cyprus’ collapse. Italy is a founding member of the EU and its demise would represent a truly existential risk which the EC will attempt to avoid.

This interview with the former governor of the Cyprus central bank appeared in the Economist in March 2013 and highlights how politics plays an integral role in the decision making of European institutions. Here is a section: 

In the previous three programmes [Greece, Ireland and Portugal] the SPD supported Merkel's government on making the loans, but they were not as close to the election as this one. The SPD, I believe was trying to differentiate its position. This presented a dilemma for Merkel's government. If she suggested that a loan be given to Cyprus to bail out money from Russia, this would not go well with the debate in Germany. So it was incredibly convenient to say that all the depositors, including Russian depositors, be asked to be bailed in. To support this reasoning, unsubstantiated statements were being made in German press that deposits in Cypriot banks reflect money laundering and that the banking model of Cyprus could not be allowed to continue. The objective of the March 16 plan to confiscate part of deposits was none other than to damage irreparably the Cypriot banking system.

The politics, in my mind, is what makes this episode so ugly, that some governments, to serve their own national or narrow political interests, arrived at a decision that inflicts irreparable damage to Cyprus.

The reality is the Europhiles face a major threat to their single market and in order to save the project they are going to have to make sacrifices. The Dow Jones Euro Stoxx Banks Index is heavily weighted by Italian banks and has found at least near-term support in the region of the 2009 and 2012 lows. Potential for an unwinding of the short-term oversold condition has improved but a sustained move above the trend mean will be required to break the medium-term downtrend. 

Political considerations are likely to continue to represent a major influence on the direction of Eurozone policy. For example it is by no means certain that Angela Merkel will prevail in next year’s German federal election. The EC will likely be at pains to avoid helicopter money becoming a German election issue but the challenges facing the Italian banking and wider financial sector might yet make that prospect all but unavoidable. The ECB is therefore likely to continue to make ample liquidity available indefinitely. Meanwhile the size of central banks’ balance sheets continue to expand suggesting the ECB is not the only central bank with loose policy.