Europeans Seek Bold Debt Deal, Despite Differences
By STEVEN ERLANGER
Published: October 21, 2011PARIS — European leaders were struggling on Friday to craft a bolder solution to the region’s financial crisis, despite clear signals from French and German officials that they have sharp differences heading into an important weekend summit meeting in Brussels.
As ever, the focus is on Chancellor Angela Merkelof Germany and President Nicolas Sarkozyof France, who have made a habit of cobbling together deals to present to their European Union colleagues. But forging an agreement now is harder than before, as Paris and Berlin face core differencesover how to maximize the euro zone’s financial rescue fund and how far the European Central Bank should intervene in the bond markets, either on its own or through the bailout fund.
Already the two leaders have announced that Sunday’s summit meeting, which had already been delayed to allow more time for negotiations, would be followed by another summit meeting as early as Wednesday. That announcement, paradoxically, seemed to buoy stock and bond markets, apparently because the Europeans at least appeared to be focusing intensely on resolving the crisis.
But the delay may have been because Mr. Sarkozy needs pressure from other nations to bring Mrs. Merkel around to a more flexible position on how to use the bailout fund, called the European Financial Stability Facility, and the central bank.
Mr. Sarkozy has now rushed twice to Germany for talks with Mrs. Merkel, the last time on Wednesday, as his wife was giving birth, to press for a deal. The meeting was testy, said German officials, who have complained that France is “not budging an inch.” Mr. Sarkozy, clearly the supplicant in the relationship, speaks openly of a “European rendezvous with history,” while Mrs. Merkel keeps repeating that “there is no magic wand” and that a long-term solution will take time.
Jean-Claude Juncker, who also leads the meetings of euro zone finance ministers, said that Thursday’s move to delay final decisions until the second summit meeting Wednesday looked “disastrous” to the outside world. He canceled a news conference scheduled for after Friday’s meeting of the finance ministers of the 17 countries that use the euro, suggesting that no breakthrough was imminent.
The “Franco-German couple” has been vital to each of the agreements reached by the European Union during this two-year crisis. But so far none of the deals have been sufficient to solve even the problem of Greek indebtedness, which is growing worse in an austerity-driven recession, let alone the problem of contagion spreading now to Italy and Spain. Nor has there been an agreement yet on how much capital needs to be injected into European banks so that they can reassure investors that they will remain solvent even as the sovereign debt of Greece, Italy, Spain and other hard-hit countries loses value.
These are the main issues on the agenda.
On Greece, Germany appears willing for a deal to restructure Greek debt to no more than half of its face value, to try to bring Greece’s debt burden to a sustainable level. But Germany wants private investors and banks to accept such losses voluntarily to avoid a formal default, which would be a first for the euro zone.
Big European banks had already agreed to what was billed as a 21 percent reduction in the value of their Greek debt in July, a deal not yet implemented, and they are reluctant to reopen the matter. Nor are they confident that enough private bondholders would agree to such a large cut.
France and the European Central Bank do not want to restructure Greek debt further, fearing market contagion and, for Paris, additional pressure on French banks that hold significant amounts of Greek, Spanish and Italian debt. A major recapitalization of French banks would put more strain on France’s budget and require new cuts elsewhere to meet deficit targets, and could thus jeopardize France’s coveted AAA credit rating. That would be bad politics with elections six months away and Mr. Sarkozy already unpopular.
There is also a fear that banks would cut back on lending rather than try to raise more capital while their stock prices are down, which could lead to a new credit crunch at a time when the entire euro zone is on the brink of a new recession.
France wants Europe to collaborate on recapitalizing banks, ideally by turning the bailout fund into a bank, which could then draw on loans from the European Central Bank, which has the authority to print euros as needed.
But Germany and the central bank itself have resisted that option. “The path is closed for using the E.C.B. to ease liquidity problems,” Mrs. Merkel told her parliamentary caucus in Berlin on Friday, Reuters reported.
Mrs. Merkel wants each country to be responsible for injecting funds into its own banks, and only then turn to the regional bailout fund in an emergency. Politically, it is easier for her to explain to Germans that German money is being used to recapitalize German banks than to concede that it is going to everybody’s banks. Mrs. Merkel is also compelled by German law to seek a mandate from Parliament’s budget committee before committing new funds. Mr. Sarkozy does not face such restrictions.
Still, some progress has been made on the amount of new funds needed to shore up banks. Partly that is because the Europeans have decided that the amount required is half of what the International Monetary Fund and some other experts have suggested. And partly because European officials have used new ways of valuing sovereign debt that offset markdowns on the bonds of weaker countries with paper gains on sovereign holdings of less indebted countries.
Even so, France is asking for a period of nine months for banks to meet recapitalization targets.
France and Germany also disagree on how to leverage or maximize the $590 billion bailout fund to create a “wall of money” to discourage the markets from speculating further on Spain and Italy. The fund has already committed about $200 billion to Greece, Portugal and Ireland, and the German government has promised taxpayers that its own share, as the largest contributor, will not be more than $305 billion.
There are a variety of ideas on how to leverage the fund, but so far they have run into problems with existing treaties, and the European Central Bank has opposed the idea that it should guarantee loans made by the fund. Germany has discussed using the fund as “insurance” to guarantee a portion of any potential losses on future bond auctions for Italy and Spain, but France would still prefer that the bailout fund be allowed to borrow from the central bank. France might agree to the German idea if the insurance ratio is higher.
And there are reports that the International Monetary Fund might also provide some cheaper credit to European countries facing severe market pressure on their bonds.
The Europeans will also be discussing longer-term measures to provide more “economic governance” to the euro zone nations, but those changes are also likely to require treaty changes.
While the markets are focused on Brussels on Sunday and Wednesday, a firmer deadline is probably Nov. 3-4, when Mr. Sarkozy presides over the meeting of the Group of 20 leading economies in Cannes. President Obama, who has been in regular contact by telephone with Mr. Sarkozy and Mrs. Merkel, wants a solution by then, at least, to stop the drag the crisis is having on global markets, economic growth and his own prospects for re-election.
a) On Greece sovereign debt
Restucture or Not ?
Merkel's position seems to be a willingness to restructure Greek debt to 50% (vs the 21% haircut earlier negotiated). Reason- Greece mired in recession cannot find the "growth" to create the "surplus" needed to pay her sovereign debts andw/o the further haircuts, the high level of debt makes a default a certainty.
Sarkozy & ECB does not want the further haircuts becos of the likely effects on the B/S of banks exposed to the Greek debt; of which French banks are the most highly exposed. Further haircuts meant higher recap needs and France's AAA rating is on the line when the state gets involved in guaranteeing the debt of the banks.
b) On recaps
How to ringfence banks/FIs against Greek default?
i) National efforts vs Common Pool efforts?
A Common Pool effort will mean a common fund like the EFSF involved to guarantee Euro wide banks.
A National effort means each nation is responsible for her own banks recap needs.
Merkel wants Option 1, so that German voters will not be enraged that they are paying for the profligacy of the peripheral nations. It is politically easier to sell the idea that Germans are paying for recaping German banks than for "others" banks. Germans also don't want ECB involved becos they will foot the biggest portion of the bill there.
Sarkozy wants to use the EFSF ( i.e turn it into a quasi bank) and leverage on the ECB which can print infinite money as the solution will deter the "shorts' and vigilantes who are eyeing contagion to Italy and Spain should Greece default/fall. The big "bazooka" effect has worked in the US with TARP & TALF and sounds like a great solution (IMHO).
IMHO, a hybrid solution could be that nations guarantee the 1st portion of banks losses in a Greek default followed by the EFSF guaranteeing the 2nd tier , followed by the ECB. That way U have 3 tiers of insurance. The task reduces to negotiating the levels of capital limits in each tier.
ii) Amount of Recap needed ?
200b Euros or 100b Euros ?----- the IMF and the Eurozone countries have different opinion on the amount needed. More rigorous and credible "Stress tests" should solve this.
c) On the Role of EFSF ?
Is it to be used only as a last resort for bailouts?
Should EFSF be buying Spanish & Italian sovereign debt issues to lower the spreads over German bunds and lower their cost of debt so as to reduce contagion risks?
Should IMF act as a backstop to EFSF and buy sovereign bonds as some suggested?