The Eurozone's Debt Crisis Continues to Rage

As the debt crisis in the Eurozone continues, traders in the U.S. have become accustomed to the endless sea of headlines emanating from across the Atlantic.

Wednesday night, German leaders in parliament agreed in principle to pass the Fiscal Compact later this month, a step which would lead to them also passing the permanent bailout mechanism--the European Stability Mechanism (ESM). This is an important step because it brings European nations closer to a fiscal union and debt mutualization.

German Chancellor Angela Merkel has recently rejected the idea of having the European Stability Mechanism buy bonds in the open market. Some analysts had been hoping that the ESM would be used for such a cause. Merkel has rejected the notion that the ESM could be given a banking license, allowing it issue debt and therefore mutualize European debt. If the ESM could buy bonds and issue debt, individual countries' debts would effectively be replaced by ESM bonds, which would be the first step towards Eurobonds.

Germany has stood firmly against Eurobonds as a solution to the European Debt Crisis, only admitting that Eurobonds could be a longer-term solution. This idea is not factually unfounded, as the countries currently have vastly different economies, capital accounts, and inflation situations. Until the economies are more aligned and economic data is more symmetrical across the continent, a pure fiscal union involving Eurobonds is unlikely. Germany is open to such a system in the future when the economies are better suited for a fiscal union.

Another recent part of the crisis response has involved a banking union in Europe, however this seems increasingly unlikely. Some politicians and policy makers have been pushing for a European Banking Union to be incorporated into the European Monetary Union. Currently, individual countries are responsible for banking regulation, and a pan-European banking union would lead to pan-European deposit insurance, effectively allowing core nations to backstop the deposits of weak banks in peripheral nations.

This would be a market positive, however, it appears ever more likely that such a scheme will not come to fruition. As written previously, there are many problems with a banking union, first and foremost the expediency with which it is rolled out. Any banking union would require a new banking regulator and potentially changes to European treaties. If treaty changes are required, each of the 17 domestic parliaments would need to approve it. Currently, it has taken almost a year for four nations to pass the ESM, so passing a banking union would most likely take at least as long. If the union could not be in effect now, it may not even be worth considering until the crisis is over.

The crisis has recently entered a new phase, with Spain being thrust to the forefront of the crisis. Spanish yields have climbed to euro-area record highs over the last few days, as fears that the sovereign nation's credit rating would be hurt by the necessity for it to recapitalize its ailing banks.

Spain sold $2.817 billion in bonds with maturities ranging from 2- to 5-year maturities. Even though demand was good producing a strong bid-to-cover, yields climbed. 2-year yields climbed to 4.706% from 2.069% at the previous auction March 1. 3-year yields also climbed, pricing at 5.547% from 4.876% at the last auction May 17. Lastly, 5-year yields spiked to 6.072% from 4.960% on May 3. Spain may be experiencing punishment for its ailing financial system and its reluctance to act sooner. Analysts are stating that at current yields, Spain will be forced into a full-blown sovereign bailout like Greece, Ireland, and Spain, as interest costs could bankrupt the Iberian nation.

The European Debt Crisis has been raging on for the better part of three years now, and analysts are now expecting more years of rolling crisis.