Crucial EU Summits on Eurozone. Bid to Convince Markets Now and in Future. (3/9)     Print Email

This month is supposed to mark a turning point for the euro.  Two EU summit meetings on bolstering the euro and the eurozone will happen in Brussels -- the first this Friday March 11 and the second, more important one on March 25. This week, fresh urgency was added to the crisis and the EU’s ability to restore confidence when the markets raised the interest rates being charged Portugal for its government bonds on March 9 to an all-time high that Lisbon admits is “unsustainable” as the price of rolling over its sovereign debt.

 

The summit this week will provide an initial read-out on the degree of consensus on the challenges and their solution.  The second will be a litmus test – among financial officials and in world markets – on the chances of seeing EU leaders actually push through whatever plans they adopt.  At stake is whether they manage to produce a credible “comprehensive solution” to the crisis that has engulfed the single market.

The main symptom is the staggering amount of sovereign debt – meaning international borrowing – owed by weak euro economies, notably Greece and Ireland and also Portugal and Spain.  In recent days, debates about this problem have taken a new twist, with some officials and analysts now calling for more emphasis on the faults of European banks -- in over-lending -- and more leeway for troubled borrowing countries in the terms and timing of their efforts to work their way back to sustainable fiscal balances.

This new tack emerged powerfully from a speech March 7 by John Bruton, a former Irish prime minister and then the EU’s ambassador in Washington.  He said in a speech in London that the Irish taxpayers were now being forced to assume the full burden of paying off mistakes that were shared by the big European banks, and even the European Central Bank: the banks ignored the risks of Ireland’s real-estate bubble as they continued to lend more and more to Dublin -- a situation that the ECB could (and should) have sought to curb, he said. Mr. Bruton’s high-profile attack coincides with an effort by Ireland’s new government to negotiate easier terms for repaying its bail-out, but it nonetheless underlined the often neglected fact that the current EU crisis involves mismanagement by banks, including big German institutions -- a problem on top of the sovereign debt overhang accumulated by some EU governments’ excessive borrowing and misleading accounting. Some critics charge that the problem is “too big to tackle,” noting that some of the bank debts in some EU nations could amount to as much as 20 percent or more of their gross domestic product. (Part of the uncertainty is the amount of these banks’ hidden liabilities that have not been disclosed.)

The fresh focus on major EU banks’ current and coming problems was highlighted days before the EU summit, when it was reported March 9 that Europe seems about to “blink” on the terms of the imminent new round of stress tests slated for its banks. These tests have been widely touted as a way of restoring confidence in Europe’s 88 biggest banks’ ability to ride out a future financial storm without needing tax-paper bailouts. The tests are intended to overcome market doubts after a previous round of stress tests last year, widely derided for giving passing grades to most banks, without details about different national situations.

Now, it is being reported that the new tests may be watered down again the same way, by repeating the key weakenesses in last year’s test – letting each country set its own local standards for the required capital ratio of reserves to loans. That ratio is a measure of a bank’s ability to withstand unexpected losses, and the weakness of national standards was confirmed in recent months when some banks that passed last year’s flawed tests subsequently did have to take taxpayer bailouts.

The tests are intended to set a standard across Europe that would dissipate fears that some banks are under-capitalized and restore confidence in the credibility of the tests and of the banking system. The tests are being designed and administered by the new European Banking Authority, a London-based agency set up as part of the EU’s new financial regulatory structure. It may be technically impossible to impose Europe-wide standards in time for the tests (the terms are due to be set this week and the results to be released in June), but EBA Chairman Andrew Enria has said that he is introducing a “peer review” process in which groups of regulators will double check the work of other regulators. The Wall Street Journal reported that he has written bank executives, promising to establish a task force “to ensure the credibility and consistency of the exercise using both statistical benchmarks and expert judgment.”

At the summits, observers will be watching for signs of EU determination on three major areas for reform in order to stabilize the outlook for eurozone economies under attack and bolster the reputation of the EU and the euro in future. These key areas of reform include:

  • A stronger but tougher  “bail-out” facility to cope with the current and future crises threatening economic stability in EU states.
  • Changes in the collective economic governance of the eurozone and EU countries to prevent such future crises
  • Tougher rules about the future responsibilities and performance of banks to ensure that they pay part of the price in any future melt-down – in contrast to the recent crisis in which the brunt has fallen on tax-payers and working people, with the banks enjoying strong financial protection from governments.

The easiest to solve may be an expansion of the EU’s standing bail-out fund. Currently called the European Financial Stability Facility (EFSF), this temporary fund could be quickly strengthened by allowing it to lend its full 440 billion euro line of credit. This move would consolidate confidence that the worst-hit countries (Ireland, Greece and Portugal) can be kept solvent. Ireland’s new government wants a cut in the interest rates it is paying for its bail-out. But the summit seems likely to concede only that the deal can be “re-evaluated,” probably next year.

On the question of EU-wide economic governance, there are signs of convergence – but the degree of final consensus will be the litmus test for markets. In demanding tougher fiscal discipline, the leader has been Germany, as the EU’s lender of last resort, with support from France, which sees prestige for itself in standing with Berlin and distancing itself from its old role as a spokesman for the more laxist-inclined southern Europe. For Chancellor Angela Merkel, success on this issue is crucial as part of any package she has to sell at home. German domestic opinion has turned steadily more strongly to opposition for Germany’s strategy of helping bail out weaker member states – even though German interests, too, would be hard hit by a failure of the eurozone.

Merkel and France’s President Nicolas Sarkozy announced their plan as a “competitiveness pact” that would require eurozone states to accept a set of new disciplinary rules that would be a core of EU-wide financial governance and fiscal integration. The list includes more restrictive retirement conditions and other entitlement cuts, an end to the old “inflationary ladder” of tying salaries and wages to any increases in the cost of living and other “brakes on national debt.”  This core idea, in some form, seems set to become the centerpiece of the EU summits.

Initially resisted as a Franco-German “diktat,” this approach has also been publicly criticized by Europe’s center-left political leaders, including two prominent former European Commission heads – France’s Jacques Delors and Italy’s Romano Prodi.  Both challenged the “pact” as a plan for productivity, financial stability and therefore profits – not, they said, what Europe needs. Instead, they recommended a stimulus–oriented approach sustaining workers’ buying power and job-creation measures that could help Europe “grow its way” out of its present quandary – partly thanks to a proposal for financial transactions tax (the so-called Tobin tax) that could be channeled into major investment for green technologies and job-producing infrastructure. “We propose austerity plus investment, not just austerity,” according to a spokesman, who said he was representing labor unions and the European in pushing a “growth pact.”

In practice, a version of the competitiveness pact seems bound to come into effect. In the EU at this juncture, center-right governments seem to hold political sway (and have the financial clout) gain ground in imposing governance, which can only come at some cost in sovereignty to small (and often more profligate) member states. In an incidental confidence vote in favor of this approach, fiscally-conservative Estonia proceeded to join the eurozone on January 1, 2011.  Meanwhile Iceland, which has always thought there were advantages in staying out of the euro and its accountability, is mired in financial-abuse scandals that compromise its future: this week, there were criminal arrests among the financiers at the top of the country’s short-lived international credit pyramid.

In the summit’s decisions, some version of the Franco-German initiative seems likely to prevail. Its initial measures have been softened in proposals circulated in recent days by the Commission President Jose Manuel Barroso and President Herman Achille Van Rompuy. Their formulation would leave governments with only vague commitments to set limits to national deficits, and cut pension entitlements to make these programs more sustainable.

Big question marks also exist about perhaps the most contentious issue of all for the summit – the shape of the European Stability fund, which is set to become the permanent replacement of the EFSE. From 2013, it is supposed to become the bail-out mechanism, and Merkel’s camp stressed that it should require that bond-holders (and banks) also suffer financial losses in any future write-downs of their assets. In other words, bank and their investors will have to take a “hair-cut” of their own wealth whenever a nation has to call for support from the EU or the International Monetary Fund. So far, help from these quarters has imposed steep costs on taxpayers, but not on the financiers who oversaw the boom and bust of the great recession. While Merkel is arousing opposition for the “hair-cuts” in the German financial community (including her junior coalition partners, the business-minded Liberals), she is also firing fierce opposition on the right against any idea of seeing the ECB being allowed – in the future ESM -- to engage in direct buying of sovereign bonds to help governments react with more latitude in trying to cope with future volatility in their credit-ratings.

With so much on the table at the Brussels summits, smart voices tend to say that the world will not get a clear “no” to firm reforms, but also will probably not get a clear “yes” either.  If a compromise non-agreement emerges from Brussels on March 11, the markets’ reaction may deliver a powerful message that the traditional “fudge” of this sort will no longer be enough to convince and satisfy global investors.  A financial crisis may then loom. Bad as that sounds, some analysts see it as a hope, arguing that the EU only takes significant action under the threat of disaster.

 

European Affairs

 

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