Europe Financial Defense Package: Agreement Reached On Massive Preemptive Bailout
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BRUSSELS — A bold $1 trillion rescue by the European Union halted the slide of the euro on Monday and sent markets soaring worldwide in a gambit that may ultimately be seen as the moment Europe truly became a union.
The sweeping cash injection was greeted with euphoria on Wall Street, where stocks rocketed to their biggest gain in more than a year.
Still, the package did not resolve the basic dysfunction at the heart of Europe's monetary union: Governments can still spend recklessly and saddle their partners with the bill.
The approval of a "shock and awe" level rescue package followed weeks of indecision that hammered the euro and sent world markets plunging on fears Europe's debt contagion could spread well beyond Greece, where the crisis began several months ago.
"For once the scope of actions unveiled dwarfed previous leaks and speculation. This is shock and awe Part II and in 3-D," said Marco Annunziata, the chief economist at UniCredit Group.
"Europe has unequivocally said, 'We will defend the euro's integrity,'" said Oliver Pursche, executive vice president at Gary Goldberg Financial Services in Suffern, N.Y.
After frantic talks lasting into the early hours of Monday, European officials agreed the 16 euro nations would put up $572 billion (euro440 billion) in new loans and $78 billion (euro60 billion) under an existing lending program. The International Monetary Fund will pump in another $325 billion (euro250 billion), for a total package of nearly $1 trillion.
The European Commission is to raise the money in capital markets, using guarantees from member governments, and lend it to crisis-stricken countries so they can pay their bills.
Many questions were left unanswered, such as how the money would be dispensed and on what terms.
Still, the move supplied the decisiveness – and the big headline – the markets had been craving. The Dow Jones industrial average rose 405 points to close at 10,785 – its biggest gain since March 2009 – and recouped two-thirds of last week's losses. At its peak Monday, the Dow was up nearly 455 points.
Broader U.S. indexes outpaced the Dow's 3.9 percent rise, while gains in several European markets topped 9 percent.
The Standard & Poor's 500 index rose 48.85, or 4.4 percent, to 1,159.73. The Nasdaq composite index rose 109.03, or 4.8 percent, to 2,374.67.
The euro bounced back from 14-month lows around $1.25 on Friday to over $1.30 on Monday, reversing the ominous slides and sense of panic from last week.
The crisis had raised fears of a panic like the one following the collapse of U.S. investment bank Lehman Brothers in 2008 and prompted nervous banks to cut back on lending to businesses and hammered stock markets.
A weaker euro and financial and economic disaster in Europe would hurt U.S. exports, and the U.S. Federal Reserve pitched in by agreeing to make dollars available to the European Central Bank in exchange for euros. The ECB will then loan those dollars at fixed rates to banks in Europe; the interest eventually goes to the Fed when it swaps the euros back for dollars at the same exchange rate as the original transaction.
European banks need dollars to lend to companies across the continent. European companies with operations in the U.S. pay their employees in dollars and buy raw materials with the U.S. currency. Also, oil and other commodities are priced in dollars around the world.
But because of the debt crisis, private banks in the U.S. have been leery of making loans to banks in Europe. Hence the need for the currency swaps between the central banks.
Analysts warned, however, that the emergency bailout fund would do nothing to reverse Europe's soaring public debt – and could even worsen it.
"The last thing you give a drunk is another drink," said Jeremy Batstone-Carr of Charles Stanley stockbrokers.
"The process of providing a bridging facility for Greece and possibly other indebted nations will add significantly to regional debt and deficit ratios without actually solving the underlying problem."
EU officials said the next step was to more closely coordinate member nations' economies, including tougher rules to keep them from running up too much debt. The eurozone has a limit on deficits of 3 percent of gross domestic product, but that was widely ignored.
"The key missing pieces ... are steps to strengthen fiscal discipline and structural reforms," said economist Annunziata. "I remain skeptical on this front, as greater fiscal integration at this stage requires deeper political integration."
Still, he noted, some experts argue the "current crisis is exactly what was needed to trigger a new quantum leap in European integration. I hope that turns out to be the case."
European Union President Herman Van Rompuy said European governments need to consider pooling their national powers and create a joint economic government.
"We can't have a monetary union without some form of economic and political union and that is our big task for the coming weeks and the coming months," he said.
He said he would draft tougher rules for EU leaders to discuss in October that go beyond current EU limits on debt and deficit.
The core problem is near-zero economic growth, high unemployment and governments unwilling to take painful steps to get people to work more and longer.
Simon Tilford, an economist at the Center for European Reform think tank, warned that EU governments so far haven't come up with anything "game changing."
"What Europe needs is a growth pact because without growth, public finances aren't going to be sustainable," Tilford said. "The bond markets are going to be forcing them to make those kind of changes."
Even EU president Van Rompuy warned that the bloc risks irrelevance and the end of its expensive welfare programs if it can't speed up economic growth, forecast to expand by just 1 percent this year.
"With 1 percent growth we can't finance our social model any more. With 1 percent structural growth we can't play a role in the world," he told the World Economic Forum in Brussels. "We need to double the economic growth potential that we now have."
Many are skeptical that can be achieved.
Jennifer McKeown, senior European economist at Capital Economics, said the rescue package won't stop euro economies like Greece, Portugal and Spain from suffering "a long period of extreme economic weakness" and won't erase fears of a default or collapse of the euro.
"We still see the euro weakening further to around $1.20 by the end of this year," she said.
Others worried over the prospect of EU policymakers stepping away from the strict rules that underpin the euro.
Marc Ostwald, a market strategist at Monument Securities, said Monday's rewriting of the rule book "in just a couple of hours" could foreshadow "a lot more in the way of absolute risk priced into government bond yields."
The European Central Bank's agreement to buy government bonds also spurred concern that it had caved in to political pressure, ironically weakening a key euro institution in order to save the currency.
"It will be hard not to see this as a loss of credibility and independence for the ECB," Annunziata said.
Commerzbank economist Michael Schubert said the rescue could spur irresponsible behavior by other eurozone nations if they know there's a bailout when they overspend.
Dutch bank NIBC said in a research note that the only long-term solution for countries like Greece was an eventual debt restructuring – the polite term for a technical default, with lenders unlikely to receive anywhere close to the full value of their loans to the government.
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AP Business writers Pan Pylas in London and Christopher S. Rugaber in Washington and Associated Press writers Frank Jordans in Basel and Matt Moore in Frankfurt contributed to this report.
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AOIFE WHITE 05/10/10 07:27 PM ET Associated Press