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Don't Unfasten Your Seatbelt Yet

Jason Stipp

Jason Stipp: I'm Jason Stipp from Morningstar. The combined IMF-EU bailout for troubled European countries seems to have soothed the market on Monday, but what could be the short- and long-term consequences? Here with me to talk about that is Morningstar's markets editor, Jeremy Glaser. Jeremy, thanks for being here.

Jeremy Glaser: Jason, my pleasure.

Stipp: So, first off, this bailout plan: the markets are up today, global markets are up. It seems like it is being received well. What exactly is it? What's behind the bailout? How have they structured it?

Glaser: This is really a bailout of almost unprecedented proportions. If you think about it in terms of dollar terms, it is bigger than TARP, and this really is the European Union coming out and saying: "We are going to stand behind the euro, and we are going to do whatever we need to do to keep these countries from defaulting, such as Greece and potentially even Portugal, Spain, or Italy."

So there is a couple of different moving parts, and the exact specifics of it aren't so important to most investors, but basically there is an initial fund that they will be able to come up with very quickly that will be able to disperse money.

Then there is a second larger fund that will create a special purpose entity that will be able to borrow money based on the credit of all of the European or the Eurozone nations, will be able to disperse up to 440 billion euros out to countries that need that money to make their debt payments.

The International Monetary Fund will step in with 50 cents of a dollar of the money that was put into the special purpose entity, and then the countries that take the money will have to agree to the IMF austerity terms. They will have to bring their budget deficits down pretty substantially and make sure that they are on the road to actually improving their finances and aren't just taking the money.

Then there will also be conditions for some countries that could potentially get into trouble, as Portugal and Spain, to get their deficits under control faster than they originally expected.

There is a lot of moving parts here, but the overall thought is that this is going to just probably put a bunch of money behind it and flush liquidity into countries that really need it. Separately, the European Central Bank is also going to start buying debt, which is something that they haven't done before and something that even just a few days ago said they weren't even considering and that will help ease the movement in the markets and try to bring some of those spreads down.

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Stipp: So this sort of solution... I mean, would you characterize this as a cure for the problems or is it more like a band-aid?

Glaser: It is absolutely not a cure. It may provide the time that will let these countries work out their problems, but it in no way solves them.

The problem that Greece is facing is a solvency crisis, not a liquidity crisis. So it is not as if they get a little bit of money to get over this hump, all of a sudden everything is going to be fine in Greece. The country is actually insolvent. They are spending way more money out in expenditures than they are bringing in in revenue, and this is something that isn't sustainable forever, and they are going to have to bring that budget deficit down quite dramatically.

I think as we saw people rioting in Athens that these austerity measures are not very popular. So this program is only going to be effective in the long term if it actually gives these countries the time to make these reductions, and there is a political will there for these reductions and for these austerity measures to actually take place.

Stipp: So now that they have implemented these solutions that will hopefully at least help through in the short term, they will have to deal with some of the longer-term issues as we go forward, but I think a lot of investors are worried about the kind of volatility that we saw last week, the kind of big dips that we saw, what are the chances that as this program sort of plays out we might have some hitches or some hurdles that could cause another big drop? Should we be prepared for a day like we saw at the end of last week?

Glaser: Yeah, absolutely. There could be some volatility coming. I don't think it's by any stretch of the imagination guaranteed, but there is a lot of potential landmines on the path to actually getting this plan working.

The special purpose entity that will disperse the vast majority of these funds isn't set up yet, and it is something the European Union has never tried to do before. They are relying on some relatively liberal readings of some treaties in order to have the entity pass legal muster to begin with, and I think it's something that could take a little bit of political negotiations, especially considering the situation in Germany and the political situation in the UK. There could be some hiccups on the way to actually getting us there.

So for some reason that entity isn't able to be set up or when it does get set up, it isn't actually able to borrow based on the credit of the rest of the European Union, you could see a lot of trouble as that would negate a lot of the advantages that we have talked about in this bailout plan and that would help some of these countries get past some of their short-term pain.

Stipp: So investors should by no means unfasten their seatbelts at this point?

Glaser: No, they can get their hand on their buckle, but I don't think it is time to unfasten.

Stipp: OK. So, you know, after we just came through the downturn 2008 with unprecedented government involvement, here we are again, we are hearing the word "bailout" again, and we still don't even know what the long-term impact of the first round of bailouts from the first downturn may have. What could be the long-term impact of some of the bailouts that we are seeing here? What might we need to have on our radar for the next several years even if this does work out in the short to medium term?

Glaser: There certainly is going to be some tremendous repercussions across all of Europe for the long term. This is really a move into creating greater both political and fiscal unity among the Eurozone, something that has been resisted for a reasonably long period of time now. The idea of issuing euro bonds or bonds backed by all of the European countries is something that has been talked about before, but a lot of countries have very staunchly resisted it and now we are essentially issuing those bonds.

The European Central Bank is supposed to be focused exclusively on inflation and instead we see them moving into this kind of dual mandated role and buying these bonds and worrying about some of the fiscal problems that are happening in the Union. It looks like they might be losing some of their independence that they have been fighting so hard for.

So a lot of these questions up in the air as to how much closer must the political union get if we are going to start having euro-bonds that are backed by all of the countries and how much closer we are going to get if you have a central banker that is under some more political pressure from some of the larger eurozone members. I think that these are open questions and are something that's going to have a big impact on the European politics and the European economy for decades to come.

Stipp: We will certainly have you back in that seat over the next few days and months as this drama unfolds. Thanks for joining me, Jeremy.

Glaser: You are welcome, Jason.

Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.