The detailed plan to be agreed on by European officials next weekend “will be decisive,” French Finance Minister Francois Baroin said Saturday as he concluded a two-day session with finance ministers from the Group of 20 major economic powers.
But the plan excludes the open-ended use of the European Central Bank as a guarantor of government debt and the swift infusion of public capital into banks that U.S. and IMF officials say could be critical to restoring confidence in the euro region. Both were central elements of the effort to shore up the U.S. financial system three years ago.
“They clearly have more work to do,” U.S. Treasury Secretary Timothy F. Geithner said after the meetings adjourned, withholding judgment on whether the European plan will prove convincing.
“It’s all in the details,” he said. “In financial crises, it is more risky to act gradually and incrementally than to act with bold force.”
At the peak of the U.S. crisis, then-Treasury Secretary Henry M. Paulson Jr. summoned major bank executives to an October 2008 meeting in Washington and ordered them to immediately accept billions of dollars in government money. Paulson argued that the infusion of funds was vital for saving the financial system and that all the banks had to take the money, regardless of whether they needed it, so none would be singled out for accepting a bailout.
European leaders have rejected a similarly swift and dramatic response.
Their planned effort to prepare banks for a possible default by Greece or another heavily indebted European nation could take until June to complete. Banks first will be asked to raise extra capital from private sources — such as their own profits or a new sale of stock — and then, if necessary, to appeal to their governments for public help. If a government cannot afford it, officials could ask to borrow the money from the new bailout program, the European Financial Stability Facility.
Funding: Public vs. private
The step-by-step process is a concession to European politics. Officials in Germany, the most influential voice in the euro zone, are insisting that new bank capital should come from private investors before public sources. Taxpayers in many nations are weary of footing the bill for bailouts already underway in Greece, Portugal and Ireland.
But some analysts say the plan means months more uncertainty while potentially weakening banks that have to turn to public sources for help and admit they cannot raise money on their own.
It “is going to be very tricky and very long,” said Anne-Charlotte Com, a bank analyst with the Aurel BGC investment firm.
The approach also runs counter to the recommendations of the IMF, which has urged a fast, conclusive and mandatory infusion of new money into the European financial system.
“We would recommend a mandatory approach in the sense that no bank can say, ‘I don’t need this,’ ” IMF Europe division director Antonio Borges said at a recent conference.
European banks hold hundreds of billions of dollars in bonds issued by Greece and other highly indebted European nations. After initial months skirting the issue, officials now want banks to have set aside enough capital to withstand a Greek default, as well as any problems that would occur in the aftermath.
In the worst-case scenario, a Greek default on its bonds could catch banks unprepared, prompting the kind of global credit meltdown caused by the failure of the Wall Street investment bank Lehman Brothers in 2008.
Baroin said European leaders are likely to agree within days on a way to cancel some of Greece’s debts. Such a step represents a recognition that Greece cannot return to financial health unless some of its $300 billion in outstanding bonds are reduced in value.
Over the summer, Josef Ackermann, chairman of Deutsche Bank and then-chairman of the Institute of International Finance (IIF) trade group, developed a proposal under which banks would agree to swap existing Greek bonds for new ones to be repaid over a longer period, lightening Greece’s burden. The proposal was accepted by European leaders and the IMF at the time. The deal was heralded as a breakthrough, with banks and other private investors voluntarily accepting losses that would do little damage to their financial health. But the IIF proposal included no actual reduction in the face value of Greece’s bonds.
The European Central Bank does not want private investors to face forced losses in Greece, arguing that this could undermine the financial health of the euro area even further. But some analysts said Greece cannot be made solvent without more substantial debt relief, which would hit banks harder.
The new capital requirements being developed could help banks absorb losses on Greek bonds. But calculating precisely how high capital levels should be depends on what could happen to bonds issued by a range of countries beyond Greece. Market analysts now expect at least some losses on bonds issued by Portugal, Ireland, Spain and Italy. Yet it is difficult for European officials to factor those possible losses into capital standards, because each of the countries insists that it will pay its obligations in full.