Meeting in Brussels on Tuesday to work out a way to keep the euro from collapse, finance ministers from across the European Union struggled to keep ahead of the curve, with events in Rome and Athens unfolding at a giddy pace.
Yields on Italian 10-year bonds rose to a new record of 6.7 per cent, while an embattled Prime Minister Silvio Berlusconi lost his parliamentary majority. And, the European Central Bank (ECB) reported that Italian banks needed euro111.3 billion in funding from their central bank in October, up from euro104.7 billion in September and a mere euro41.3 billion in June, a sign that they are increasingly being cut out of money markets.
In Greece, the main political parties continued to wrangle over formation of an interim government after Prime Minister George Papandreou stepped down on Sunday. Faced with the imminent prospect of bankruptcy unless a second international bailout plan was passed, the ruling socialists and conservative opposition struggled to agree on naming a new Prime Minister to lead the proposed ‘unity’ government.
The political instability in both countries made it tough for euro zone ministers to announce any clear results at the Brussels meet. Until the situation in Italy and Greece resolves, it is difficult to know how much money is required to anchor the euro.
The ministers attempted to work out details of a plan to leverage the EFSF (European Financial Stability Facility), the euro zone’s bailout fund, to euro1 trillion. However the spectre of an Italian bailout makes that amount woefully inadequate, though it had seemed reassuringly substantial only a few weeks earlier. Italy’s debt alone is euro1.9 trillion.
Issues
The events in Greece and Italy are making it clear that the crisis facing Europe is not merely fiscal, but also political. The question in the spotlight is the ability of democracies to take tough, unpopular decisions. Given their high levels of debt and lopsided demographics, with more pensioners than workers, few disagree that Greece and Italy require serious structural reform. But, with all the main political actors in both countries enmeshed with the vested interests and patronage networks that benefit from the current structures, it is difficult to see how this could be done, even were the current governments to be replaced by opposition parties.
The EU is cranking up the pressure. The finance ministers in Brussels made it clear that the next tranche of euro8 billion in bailout money to Greece would not be released until the two leading political parties signed a letter affirming their commitment to meeting the conditions of the loan deal reached on October 26.
The ministers did announce that they intended to complete “legal and operational work” on bulking up the EFSF by the end of November, with “implementation” set for December. Meantime, European officials are to continue to consult investors and credit-rating companies over two ways to translate the rescue fund’s euro440 billion in guarantees into euro1 trillion of spending power.
Choices
The first idea is to bring down troubled countries’ borrowing costs by issuing ‘partial protection certificates’, a form of insurance for bond sales. The option is to create one or more special investment vehicles, that would court outside investment for the bonds of weaker European states, potentially from sovereign wealth funds, private investors or cash-rich emerging markets such as China.
The problem is that potential investors do not appear to find the idea of investing in peripheral Europe tempting, under the current circumstances. Even the EFSF itself had difficulty finding buyers for its top-notch AAA-rated bond sale yesterday, drawing barely enough bids for euro3 bn of 10-year bonds issued to support Ireland.
Increasingly, analysts are saying the only certain way to protect the euro zone against being ravaged by contagion is to allow the ECB to print money, a role that Germany in particular remains dead against.
The finance ministers also debated the best way to recapitalise Europe’s shaky banks to cope with a potential default from Greece. Options included offering state guarantees to borrower banks or injecting cash into the European Investment Bank, the EU’s soft-loan project finance arm, so that it could lend them more.