Eve of the EU Summit: Guide to the German-Franco Proposal

The upshot of the recent meetings between German PM, Angela Merkel, and French PM, Nicolas Sarkozy, is a six point proposal that will likely be voted on by all 27 nation members at the EU Summit tomorrow.  While the details won't be finalized until March 2012, here is a brief summary of some of its more important contents:

1. Speedier, Separate, and Investor Friendly ESM (European Stability Mechanism).  Private sector holders of EU periphery debt won't be compelled to take losses in future ESM bailouts.  The agreement views the last round of writedowns taken on Greek debt as "an extreme case not to be repeated... investors will only encounter risks in Europe that they already know from everywhere else in the world."  The ESM would also be separate from the EFSF and start earlier than anticipated in 2012.

That private creditors would take writedowns was a huge sticking point for Merkel when the ESM was first created.  Clearly, this is a big win for Sarkozy but definitely a loss for the viability of the proposal as a "solution." Although Sarkozy is protecting his already shaky French banking system and staving off a downgrade, this only delays the necessary and inevitable debt restructuring.  Consider now the position of the ECB. They will have no choice, but to purchase more periphery sovereign debt and possibly make matters worse.

2. Automatic Sanctions. Countries whose fiscal deficits exceed 3 percent of GDP will be subject to sanctions unless a qualified majority of members votes to block them.  The previous iteration of this proposal involved a bit more politics - a qualified majority of member had to support the sanctions. It's interesting that Merkel conceded their demand for writedowns in exchange for "less politics" and more centralized oversight of fiscal budgets.  Not exactly "Fiskalunion," but it's still representative of the German desire for the further consolidation of sovereignty.