The problems in the Euro-area are more political than financial with the Slovakian Parliament recently rejecting a plan to expand the powers of the European Financial Stability Fund (EFSF) in an effort to solve the current sovereign debt situation.  This came as a shock after all of the other 16 Euro-zone countries ratified the plan. When Slovakia eventually ratifies the plan the EFSF can use a €440bn facility to buy the distressed debt of stressed member nations, currently the EFSF is only able to sell bonds to finance rescue loans.

While Slovakia is the smallest member of the EFSF, with GDP of US$89bn or less than 1% of the Euro area’s US$12,455bn GDP, it’s voice still counts because of the structure of the EFSF. The EFSF acts like a company, under articles of incorporation, whereby each member state appoints a director to the board. The articles of incorporation require that directors give unanimous approval to bail-out loans.

When questioned about the vote in a recent Der Spiegel interview, President Sulik, the leader of the governing Freedom and Solidarity party acknowledged the Euro-zone is facing a ponzi problem, it’s issuing new debt to pay off old debt and not taking the pragmatic approach, tackling the issue head on. He went on to say the things that the larger countries should have been saying, namely, that member countries shouldn’t be liable for other’s debts. Greece needs to default on bonds (causing investors to take a 50-70% haircut which is greater than the 30-50% being discussed by the market at present), and member countries need to manage their budgets responsibly.

The problem began because of financial issues and now it has largely been shifted to the political arena. When politicians are more worried about keeping their jobs and placating the people by increasing debt, which allows countries to spend beyond their means, the task of balancing budgets is pushed further down the track. The initial Slovakian vote was linked to a no-confidence vote, which means the existing Government put their jobs on the line to make a stand. The smallest kid in the playground has stood up and faced the menacing bully only to be given an obligatory smack in the face.

Since the initial vote, the existing Slovakian Government was able to come to an agreement with the minorities which will see an election and ratification of the EFSF. There is still a lot of political water to go under the sovereign debt bridge before the situation is solved. We’ll likely see some sort of default by Greece, a concerted effort by central banks, combined with a further increase in the flexibility for the EFSF, allowing it to deal with the issues before Europe is able to get back on the road to a new normal.

Sam Gibb