No sooner had some astute Euro commentators noted that Draghi might have found a path through the Euro mess to keep it patched up long enough for to impose austerity on the periphery and drive all of Europe into a lovely depression, various elements of his plan look as if they were coming unglued.

First, careful readings of the German press suggest, as we had warned, that the commitments he has gotten to bond buying, both from German pols and from northern central banks ex the Bundesbank, are qualified: only near term maturities (less than two years) and only in limited amounts (“limited” has not been translated into a particular number, it appears). Yet the media seems to think quite the reverse, that Draghi is going to engage in unlimited bond buying. A representative quote from the Financial Times:

After denying for months that Spain will require anything resembling a sovereign bailout, Madrid hinted on Friday that it could, after all, take up Mario Draghi’s conditional offer of buying short-term debt.

Unlimited bond buying by the ECB would surely soon follow

Um, no. It appears that anything like that would lead to a revolt by the northern bloc. Absent a September 2008 level meltdown, it does not look like they will give the ECB what it wants quickly or easily.

Second, as the FT piece (and other sources) point out, Spain is now playing coy about asking for funds (the drill is the about-to-be-subject nation has to ask for a rescue, then agree to a Memorandum of Understanding which sets forth the details of the fiscal tortures that will be inflicted on it). Per the FT:

Mariano Rajoy, Spain’s prime minister has insisted on seeing what the ECB has on offer before signing up to a memorandum of understanding. But the ECB is unlikely to reveal more about the details of its new bond buying programme until its September policy vote.

Ironically, Draghi may be a victim of his own success in jawboning. He’s driven down short term yields enough that Spain feels less anxious about access to markets, plus its next bond sale isn’t until October. But Italy has already said (effectively) that it won’t ask for funds before Spain. Now up to a point, that was exactly what Draghi wanted, to keep everything on hold until at least Sept. 12, when the treaty allowing the establishment of the ESM will presumably be signed by the German president, German constitutional court willing. But too much complacency on the part of Spain and Italy is not seen as desirable by the Eurocrats.

Just as a mere ten days ago, reports that German Finance minister Schaeuble had approved ECB bond-buying was followed by a denials, so to do reports that German politicians are moving towards supporting bond buying seem to be less conclusive than the initial news reports suggested. Per Ambrose Evans-Pritchard of the Telegraph:

“We must make it clear to Mr Monti that we Germans will not shut down our democracy to pay Italian debts,” said Alexander Dobrindt, secretary-general of Bavaria’s Social Christians (CSU).

Bundestag president Norbert Lammert said parliament’s integrity cannot be subordinated to the ups and downs of the markets….

“The tone of the debate has turned dangerous. We must be careful that Europe does not rip itself apart,” said German foreign minister, Guido Westerwelle. He himself fanned the flames over the weekend, saying he was “categorically” against further expansion of the EU rescue machinery or bond purchases by the European Central Bank. “I can’t imagine that a majority of the Bundestag will back unlimited debt liabilities,” he said.

The outburst leaves it unclear whether Germany will agree to activate the eurozone rescue fund (EFSF) on acceptable terms if Spain and Italy request bail-outs, the political trigger needed for ECB bond purchases under the “Draghi Plan”. Mrs Merkel and finance minister Wolfgang Schauble back ECB action but revolt within her coalition threatens to spread beyond a hard core.

It also did not help that the Berlusconi paper Il Giornale put a photo of Merkel waving in a way that looks a bit like a Nazi salute with the headline, “Fourth Reich” on its front page.

Yanis Varofakis, correctly recognizing that there is no “unlimited” ECB bond buying program in the wings, explains why the widely heralded Draghi plan won’t deliver the goods even if the other hoped-for device for extending the firepower of the rescue facilities, that of giving the ESM a banking license, is put in effect:

Put simply, the policy of having the EFSF-ESM use its severely circumscribed fire power, in conjunction with a limited bond purchasing program by the ECB, to push Spanish and Italian yields down, will fail as miserably as the combined efforts of the EFSF and the ECB failed in 2010/11 to prevent Portugal and Ireland from following Greece into the mire.

The question now becomes (even if it is an academic one): What would it take to convince investors that the proposed measures will annul the ‘convertibility risk’ that Mr Draghi now acknowledges to be “not insignificant”. Everyone, including Gavyn Davies and Tim Geithner, seems to believe that the answer lies in giving the ESM a banking licence, thus allowing it to use the ECB’s balance sheet as a means of levering up whatever monies it has available (from less than 200 billion to the required 2 trillion!).

I have no doubt that an announcement along these lines would cause a frenzy of enthusiasm in the money markets, and that spreads throughout the Eurozone will collapse. But I also have no doubt that this would be another temporary measure. The reason? The toxicity of the EFSF-ESM funding structure. Toxicity? Yes, toxicity. As I have explained a long time ago, the bonds issued by the EFSF (which will have the same structure with those that the ESM will issue, assuming the German constitutional court gives the green light in September) are structured very much like the awful CDOs that brought the house of cards down in 2008. If this analysis was correct last summer, then levering the EFSF-ESM up, by granting it a banking licence, would be tantamount to creating a CDO mountain on steroids and planting it in the heart of the Eurozone. It may work for a while (just like the CDO market was buoyant for a while) but in the end that new, Eurozone-constructed, house of cards will come crashing down. And if investors have learnt anything from the recent past, they should see thins coming fairly early on, which means that the half life of a new ba king-licence-carrying ESM will cause more problems than it will solve very, very soon.

So? What policy can address ‘convertibility risk” effectively? The answer is: Nothing short of proper mutualisation of the Maastricht Compliant Debt. And since we do not have a Federal Treasury to do this (and won’t get one before the ‘convertibility risk’ turns into ‘convertibility reality’), the only tool that I think can do the trick is ECB-bonds as per Policy 2 of our Modest Proposal. That this is not on the cards is as evident as it is indicative of the low probability that the Eurozone will survive.