Euro Crisis May Force Europeans To Bail Out Their Banks, Too
The bank bailouts of 2008 created a firestorm of public anger in the United States. Now European leaders are trying to avoid the same fate. It's not looking good.
European Central Bank President Mario Draghi on Thursday denied the possibility that the ECB would bail out European banks by buying large amounts of troubled government bonds. Yet many economists and observers believe the central bank ultimately will have to give in.
For a while it seemed like Europe was going to take a hard line against banks. In November 2010, at Germany's urging, European leaders agreed that they would pursue "haircuts" instead of bank bailouts, essentially forcing the banks holding troubled government debt to take a loss. This past October government leaders forced banks to swallow a 50 percent cut on the value of their Greek government bonds.
European leaders agreed to force a haircut on Greek government debt because it had become simply unsustainable, and some sort of partial default was necessary, said Michiel Bijlsma, program leader of financial markets at the CPB Netherlands Bureau for Economic Policy Analysis.
The move was a last-resort effort to rescue the Greek government from default, but it was also a victory for Germany. German Chancellor Angela Merkel had been insisting that banks take part of the loss. "Have politicians got the courage to make those who earn money share in the risk as well?" Merkel said in November 2010, according to Reuters.
Merkel's tough talk played well at home, particularly as the foil to the United States' bank bailouts. Many in the U.S. believe banks got off easy and blame the government for bailing them out.
"There's an electoral price to be paid for bailing out banks," said Bo Becker, assistant finance professor at Harvard Business School. "Merkel and her party have ridden somewhat high in the last few years on the claim that German responsibility and so on is better than the United States' easygoing financial system. So she especially has a lot to lose."
But recently Germany has been forced to change its stance. The country agreed earlier this week to eliminate the possibility of any more haircuts on government debt. European leaders are hesitant to force more haircuts since banks are now in a weak position, and more haircuts could trigger a collapse of the the European banking system, some economists say.
Back in 2008, when the United States banking system was similarly on the brink of collapse, the Treasury Department and Federal Reserve acted quickly and decisively. The federal government took ownership stakes in banks and the Fed loaned money to them. Meanwhile, the Fed also bought large amounts of mortgage-backed securities when no other investors would touch them.
"Americans are more pragmatic and less ideological when it comes to emergency action," said Harvard economist Richard Cooper. Though part of the eurozone's slow response to the crisis can be attributed to Europe's "exceptionally clumsy" decision-making apparatus, he said, the delay can be in part attributed to the German perception that they should cast blame for the crisis as it is being solved. In contrast, he said, "Americans say, 'Let's get the problem behind us, and we'll decide who goes to jail later.' "
A full U.S.-style bailout isn't necessarily an option for Europe, however. The European Central Bank can't buy government bonds directly, as the Fed does routinely. Since the European Central Bank legally cannot bail out governments, bailing out private banks seems less justifiable, Paris-based economist Gael Giraud said. "That's why the banks were partially convinced to accept to pay something," he said of the Greek haircut.
But more haircuts would not by themselves dig Europe out of this hole. Because if over-leveraged banks are forced to reduce the value of their assets, en masse, they could fail. That could either blow up the economy or force European countries to do what the United States did three years ago: Bail out their banks. It's just taking longer.
"Unless the Europeans can solve the sovereign debt crisis," Cooper said, "there will certainly have to be some form of support for the European banks."Scroll down for live updates:
Wall Street closed higher this week, after European Union leaders announced that they'd reached a deal aimed at solving the Eurozone's debt crisis, according to Reuters:
The Dow Jones industrial average <.DJI> ended up 186.56 points, or 1.55 percent, at 12,184.26. The Standard & Poor's 500 Index <.SPX> was up 20.84 points, or 1.69 percent, at 1,255.19. The Nasdaq Composite Index <.IXIC> rose 50.47 points, or 1.94 percent, at 2,646.85.
For the week, the Dow rose 1.4 percent, the S&P gained 0.9 percent and the Nasdaq was up 0.8 percent.
Banks, which have been pressured by the uncertainty over Europe, rallied after the EU summit. Bank of America Corp rose 2.3 percent to $5.72, while JPMorgan Chase & Co added 3 percent to $33.18. The Financial Select Sector SPDR rose 2 percent.
The ratings agency Moody's has downgraded three major French banks because they have had difficulty raising capital.
Moody's slashed its rating of the long-term debt of BNP Paribas and Credit Agricole by one level to Aa3 and cut its rating of Societe Generale's long-term debt by one notch to A1.
"The probability that the banks will face further funding pressures has risen in line with the worsening European debt crisis," Moody's said.
British Prime Minister David Cameron's decision not to sign on to the deal reached by other European leaders raises worries that England may split from the EU, Bloomberg reports:
Dec. 9 (Bloomberg) -- David Cameron found himself left behind as the 26 other European Union leaders began negotiating the future of the region’s economy. Delivering on a veto threat his predecessors carried with them to Brussels for the past 30 years, Cameron strengthened the hand of members of his Conservative Party calling for Britain to pull out of the EU.
It was Conservative Prime Minister Edward Heath who took Britain into an embryonic EU, the European Economic Community, in 1973. His three Tory successors have each battled to maintain influence in Europe while refusing to sign up to the federal dreams of their neighbors.
The deal European leaders reached Thursday indicates that in the EU rift, French President Nicolas Sarkozy and European Central Bank President Mario Draghi came out winners, while British Prime Minister David Cameron came out losers, Reuters writes:
BRUSSELS (Reuters) - Napoleon dreamed of it, De Gaulle fought for it, but Nicolas Sarkozy may have achieved it -- a Europe of Nations with France in the cockpit and Britain on the sidelines.
The French president emerged as one of the big winners of a European Union summit on Friday which ended with up to 26 member states agreeing to move forward in economic integration around the euro zone, and Britain alone in staying out.
"Of course this is not just a long-standing desire, but a long-standing goal of French politics ... because in the French tradition Britain never really belonged to the European Union, dating back to De Gaulle," said a senior EU official who attended the summit, referring to the French president's veto of British entry in 1963 and again in 1967.
James Goundry, country analyst at IHS Global Insight, wrote in a report on Friday that unlike European government leaders, the European Central Bank ultimately holds "the key" to mitigating Europe's current liquidity crisis.
But he wrote that the importance of the agreement yesterday should not be discounted, since it "could well mark a significant moment in the creation of a so-called 'two-speed' Europe, which began with the creation of the single currency." Goundry added:
"The European Council statement makes clear that a new 'fiscal stability union' would seek to deepen the internal market and enhance competitiveness and social cohesion, in addition to creating stronger fiscal and economic rules. Outside this union, the UK is likely to become increasingly irrelevant and marginalised."
The New York Times is featuring a graphic that's tracking developments by country.
Charles Wyplosz, an international economics professor at the Graduate Institute in Geneva, wrote in a blog post for VoxEU that European leaders still need to accomplish two more large goals in order to address the sovereign debt crisis.
With regard to the crisis, the beginning of the end requires three steps: A backstopping of sovereign debts by the ECB; A credible commitment to fiscal discipline over the next 50 years or so in order to reduce existing debts to comfortable levels; Debt restructuring.
The summit has moved seriously on the second step, which makes the first step more plausible but, unfortunately, appears to have backtracked on the third.
Add The New Republic's Matt O'Brien to the chorus of commentary criticizing the European Central Bank for not doing more to stop the Euro crisis. O'Brien argues that the ECB is the only institution that can truly save the day:
It’s not yet certain whether European leaders will arrive at an agreement at today’s summit in Brussels, but what’s already clear is that Europe is running out of time. After two years of kicking the can down the road, contagion from the continent’s debt crisis has begun to infect Europe’s core. Indeed, the credit rating agency S&P recently threatened to downgrade the credit ratings of the entire Eurozone due to the increased risk of financial cataclysm. Increasingly, commentators are suggesting that only one European institution can possibly save the day: the European Central Bank.
The AP put together a list of the key players in the European financial crisis such as Angela Merkel, Nicolas Sarkozy, David Cameron and others.
Germany has laid out plans for rescuing its second largest bank from default if necessary, according to the German newspaper Der Spiegel.
German government sources told Der Spiegel that if Commerzbank does not raise enough capital by next summer, Germany will buy a majority stake in the bank. The European Union has mandated that European banks need to raise their capital ratio to nine percent, which Commerzbank may not be able to manage.
"Commerzbank is the clinical thermometer for the euro crisis," one source told Der Spiegel.
Philip Stephens, associate editor at The Financial Times, wrote in a column that Germany needs to learn how to be a leader, since it is decidedly the strongest power in Europe, and France needs to learn how to be a follower.
He wrote that the many photo ops of German Chancellor Angela Merkel and French President Nicolas Sarkozy -- designed to portray Europe as being led by the duo -- amounts to simply "keeping up appearances."
"The Franco-German relationship will always be a pivotal one, but it is now unequivocally unequal," Stephens wrote. "Paris needs friends beyond Berlin – in Warsaw, Rome and Madrid."
This is the picture taken by the Press Association's Chief Political Photographer Stefan Rousseau featuring Cameron and his wife Samantha during a street party to celebrate the royal wedding in Downing Street.
It will appear on the prime minister's Christmas card for 2011.
Even optimists have begun to concede that the end of the Euro may become a reality, HuffPost UK reports:
Battle-weary traders in Europe are readying themselves for yet another fraught deadline.
The consensus view is that Friday's EU summit - where major changes to the fiscal rules in the eurozone are being debated - will provide another crutch for the wounded monetary union to limp on towards its eventual goal of solvency. However, beyond the strong rhetoric designed to calm markets' fears, even optimists have been forced to concede that understanding the unthinkable - the end of the euro - is now more than just an academic exercise.It is a marginal risk, but it is a real risk.
French President Nicolas Sarkozy came out of a European summit today smiling, the Financial Times reports, indicating he got everything he wanted:
The one person who emerged from the European summit in Brussels with a big smile on his face was Nicolas Sarkozy, the French president, who appeared, at least from his body language, to have got everything he came for.
"This was a summit that will go down in history," he declared at an extraordinary press conference in the early hours of the morning, after the leaders of the European Union abandoned their efforts to agree on changes to the EU treaties in the face of a British veto. Far from bewailing the split, he seemed quite content.
Wolfgang Munchau, associate editor of The Financial Times, wrote in a column that the only way to save the eurozone may be to destroy the European Union.
He wrote that British Prime Minister David Cameron's refusal to sign on to an agreement for tighter European control of countries' budgets -- as well as the eurozone's decision to pursue a treaty anyway -- demonstrated the currency union has decided not to let the larger European Union get in the way of its will.
"These latest developments have reaffirmed my conviction that the only way to save the eurozone is to destroy the EU," Munchau wrote. "But European governments may, of course, end up destroying both."
Floyd Norris, The New York Times' chief financial correspondent, writes in the NYT Economix blog that the European Central Bank "threw cold water" on IMF involvement, resulting in a disappointing deal:
This week some smart people thought they knew what was going to happen in Europe.
European and American officials thought there was a deal that would be worked out to provide the needed funding by printing money. There would be concessions to German demands for fiscal purity, but it would accept the need for drastic action.
Daniel Gros, director of the Centre for European Policy Studies in Brussels, said in an interview with Reuters that the new agreement for fiscal integration of the eurozone "is a great leap sideways."
"The German view is that this is all that is needed to convince markets to buy Spanish and Italian debt. I have my doubts that it will be enough," Gros said. "I think the tensions continue."
David Mackie, an economist at JPMorgan Chase in London, had a similarly bleak take. "It's not the grand bargain some people had been hoping for," he told Reuters.
-- Bonnie Kavoussi
Ordinary Britons say they're wary of Prime Minister David Cameron, but they support his decision to be one of the few leaders to reject a deal aimed at solving the Eurozone debt crisis, according to Reuters:
Some Britons may suspect his motives but they also believe Prime Minister David Cameron did the right thing in saying "no" to closer European integration.
Many suspect he may have been swayed by a desire to placate angry Conservative party right-wingers, but outright hostility towards Europe crosses the party divide.
"We should go the whole hog and get out (of Europe) looking at what the euro has done to Europe," said Tim Banks, a 42-year-old IT worker, who has traditionally voted for Labour.
"It was supposed to have been better for trade, but it has destroyed countries. Good on Cameron."
Peter Praet, a member of the executive board of the European Central Bank, hinted in a speech on Friday that the ECB does not plan to print money to buy large amounts of troubled government debt -- a move that many economists view as essential for saving the eurozone -- because a larger money supply would eventually cause inflation.
"Monetary policy in the euro area will remain dedicated to our mandate, which is to maintain price stability over the medium term," Praet said in Vienna.
Praet expressed support for European leaders' recent agreement for more central oversight of European countries' budgets. He claimed that reduced budget deficits and economic structural reforms would increase the "longer-term growth potential" of struggling European countries.
-- Bonnie Kavoussi
The European debt crisis has brought Germany and Poland -- two countries that have historically been foes -- closer together, The New York Times reports:
BERLIN — In the battle over how to save the euro, Germany has plenty of leverage but not many friends. Among its staunchest supporters is also one of the most surprising, its historic enemy, Poland.
For all the damage wrought by the sovereign debt crisis in Europe, it has brought even greater harmony to the fraught and often bloody historical relationship between Poland and Germany. In the midst of discord, the former foes find themselves closer than ever, perhaps paving the way to a new axis of Paris, Berlin and Warsaw that could eventually form the core of a more deeply integrated Europe.
The European Banking Authority said the EU needs to raise $153 billion in extra capital as part of the deal to respond to the eurozone debt crisis, Bloomberg reports:
European Union banks must raise 114.7 billion euros ($152.8 billion) in fresh capital as part of measures introduced to respond to the euro area’s sovereign-debt crisis.
German banks need to raise an additional 13.1 billion euros, Italian banks 15.4 billion euros, and Spanish lenders 26.2 billion euros in core tier 1 capital, the European Banking Authority in London said yesterday. The capital shortfalls include 15.3 billion euros for Spain’s Banco Santander SA (SAN) and 7.97 billion euros for Italy’s UniCredit SpA. (UCG)
European leaders are demanding the region’s banks bolster capital to withstand writedowns after they agreed to take losses on Greek bonds. The EBA estimated two months ago that the region’s financial institutions needed 106 billion euros to increase their core Tier 1 capital to a target of 9 percent of risk-weighted assets by mid-2012, after marking their sovereign bonds to match market prices.
Ezra Klein, a columnist for The Washington Post, wrote in a Bloomberg View column that the eurozone crisis is a crisis of slow economic growth, not government debt, and that the summit deal today could unravel because European policymakers continue to focus on driving down debt levels at the expense of supporting economic growth.
The euro is making economic growth in struggling southern European countries even worse because the euro makes their goods expensive, while benefiting Germany by making its exports cheaper than they would be otherwise, Klein wrote. He added that struggling countries cannot simply leave the eurozone because then there would be a run on their banks, which would make their financial system collapse.
"Normally, countries in their situation would devalue their currency and try to grow through exports. But they can’t," Klein wrote. "And to make matters worse, they share a currency with Germany. Just as they drag the euro down, Germany pulls it up. So while Germany’s exports are cheaper than they should be, those of southern Europe are more expensive. The euro is making those countries less competitive, and less able to grow."
Graeme Leach, chief economist at the Institute of Directors, an organization made up of 43,000 business leaders mostly in England, but also around the world, told CNNMoney that a Euro collapse is inevitable unless the European Central Bank offers its support.
ECB President Mario Draghi has firmly said, time and time again, that the central bank's only mandate is to prevent inflation.
"It's the ECB or bust," Leach said. "Unless the ECB begins to operate as a sovereign lender of last resort function, with massive purchases of eurozone public debt, the inexorable logic is that the eurozone will break up."
The latest moves are steps in the right direction, but much more is needed, say experts.
"All of the harebrained schemes invented so far to resolve the crisis in euroland remain half thought out, unfunded and unimplemented...and therefore, still harebrained," said Carl Weinberg, chief economist at High Frequency Economics.
Michael Hudson, an economics professor at the University of Missouri at Kansas City, recently wrote a long piece arguing that a forced weakening of labor power in Europe amounts to a policy choice, not a necessity, that will benefit bankers at the expense of the European people.
"There is no technological or economic need for Europe’s financial managers to impose depression on much of its population," he wrote. "A debt crisis enables the domestic financial elite and foreign bankers to indebt the rest of society, using their privilege of credit (or savings built up as a result of less progressive tax policies) as a lever to grab assets and reduce populations to a state of debt dependency."
Hudson added that today's eurozone crisis "threatens to become a historic dividing line between the past half-century’s epoch of hope and technological potential to a new era of polarization as a financial oligarchy replaces democratic governments and reduces populations to debt peonage."
Read the whole article here.
The European currency union has become like a bad marriage whose deep-seated problems have burst embarrassingly into public view, while the beleaguered partners stay together for the sake of the children. Maybe it's finally time for the unhappy couple to own up to the fact that they were never meant to be together. They bring too much historical baggage (a couple of World Wars, disagreements about whether it's okay for pork products to hang in shop windows). It often seem as if they are speaking different languages! The children -- Greece, Italy, Spain, Portugal and Ireland, for openers -- might actually be better off living by themselves. (Because, really, if your parents were Germany and France, with each decision in your life requiring their peaceful concurrence, how long ago would you have run away from home?)
The latest arrangement aimed at perpetuating this unhappy marriage is now emerging from the therapist's couch in Brussels, where most of Europe's member states were on Friday preparing to pledge that their finances should be tied together collectively in the name of fiscal discipline. Only one nation was holding out: Great Britain.
The S&P 500 rose 1.45 percent as of 11:20 a.m., and the Dow Jones Industrial Average rose 164 points, according to Thomson Reuters. The FTSE 100 in Britain rose 0.82 percent, the DAX in Germany rose 1.78 percent, and the CAC 40 in France rose 2.21 percent. The euro's value also stayed stable.
"European stocks are up today, and I have no idea why," Nobel Prize-winning economist Paul Krugman wrote on his blog.
European Central Bank President Mario Draghi denied the possibility on Thursday that the ECB would step in to rescue the eurozone by buying large amounts of troubled government debt to drive down borrowing costs. But he said he is supportive of European leaders' agreement on Thursday night to put European countries on a tighter budget leash.
"It's a very good outcome for the euro area, very good," Draghi said in Brussels. "It is going to be the basis for much more disciplined economic policy for euro-area members. And certainly it is going to be helpful in the present situation."
-- Bonnie Kavoussi
On the WSJ's Euro live blog, Thomas Catan points out that Southern European countries like Spain have unfairly shouldered a lot of the blame for this mess. While Spain's been accused of profligate spending and running up the country's debt, it's worth noting that Germany actually run up a much higher public debt in the years ahead of the 2008 credit crunch.
In 2007, before the crisis struck, Spain had a modest debt load representing just 36% of its economy, according to European Union figures. And those responsible Germans? They had 65%.Read the full story on WSJ.com
During the past decade, Germany repeatedly breached the euro rules by running too large a budget deficit. Spain actually ran a modest budget surplus in the years before the crisis hit.
But haven't things changed since then? The German economy has powered through the crisis while the Spanish economy has languished, so you would think the two would have traded places.
You'd be wrong. Last year, Spain's public debt load represented 61% of its economy. Germany's rose to 83%. In fact, Spain's debt burden last year remained below that of the Netherlands (63%), France (83%) and, for comparison, the U.S. (93%).
So if public debt is your yardstick, then the Spaniards were paragons of virtue. They borrowed lightly despite the fact that their euro-zone membership gave them an all-you-can-eat buffet of financing at bargain-basement rates.
Felix Salmon, Reuters' finance blogger, wrote on his blog that he fears that because the results of Thursday's European summit were "half-baked," the collapse of the eurozone "is now not a matter of if but rather of when."
"A continent which has risen to multiple occasions over the past 66 years has, in 2011, decided to implode in a spectacle of pathetic ignominy," Salmon wrote. "Europe’s leaders have set a course which leads directly to a gruesome global recession, before we’ve even recovered from the last one. Europe can’t afford that; America can’t afford that; the world can’t afford that. But the hopes of arriving anywhere else have never been dimmer."
Nobel Prize-winning economist Paul Krugman, an economics professor at Princeton and columnist for The New York Times, wrote on his blog that the eurozone summit was "a disastrous meeting," since it ensures that southern Europe will be stuck in a prolonged economic downturn and does little to address rising borrowing costs for indebted southern European countries.
"More austerity, more posing of the crisis, wrongly, as being all about fiscal deficits; no mechanism for ECB funding," Krugman wrote, denouncing the budget cuts that will be enforced by European leaders. "Somehow southern Europe is supposed to deflate its way to prosperity, while everyone runs a trade surplus, presumably against that potentially habitable planet we’ve discovered 600 light-years away."