European officials again consider measures to save the euro

July 30, 2012

Europe was buzzing Monday with reports of yet another plan to save the euro by convincing skeptical financial markets that the continent’s debt-ridden governments are creditworthy enough to merit new loans.

Under the proposal, according to European officials and other experts, the European Union’s financial bailout funds would be used to buy sovereign government debt, particularly from hard-pressed Spain. At the same time, they said, the European Central Bank would make a coordinated round of multibillion-dollar loans to European banks, making cash available not only for business loans but also for government bond issues.

The proposal to use E.U. bailout funds to absorb sovereign debt is not new. It was agreed on, for a second time, at the latest E.U. summit June 29 in Brussels. What is new, the officials and specialists said, is the resolve by E.U. leaders to actually do what they had promised to do, seeking to convince financial markets that this time they mean what they say.

Lack of faith in a long list of E.U. summit declarations over the last several years has been a growing problem in banks and other financial institutions, which make loans to E.U. governments based on hard economic assessments that often vary with the lofty language of E.U. communiques, according to a European economic official assigned to follow E.U. proceedings.

“You can see the markets getting wiser all the time,” he said, speaking on the condition of anonymity to avoid offending E.U. governments. “At first it took them several weeks to realize the words would not lead to action. Now within days they realize nothing is being done.”

Luxemburg Prime Minister Jean-Claude Juncker, head of the 17-nation group that uses the common E.U. currency, said that this time euro-zone leaders are ready to act swiftly to reassure lenders if the markets require it and that the European Central Bank is ready to play a role.

“The euro zone is at a point where it must by all means prove its determination to guarantee stability,” Juncker said in a Q&A with Le Figaro newspaper in Paris. “As far as moving into action goes, we will decide based on an examination of the markets within a few days. There is no time to lose.”

But Juncker chafed at the need to move so fast, saying financial markets and the E.U. do not run with the same gait. European leaders often feel pressured to put on a display of action that is not always well thought out, he added, in order to gain lenders’ confidence from one week to the next.

“We live under the dictatorship of the short term,” he said. “Leaders are pushed to react all the time, in a fireworks that has nothing to do with the thickness of the real questions. We do not give ourselves the time to think.”

Mario Draghi, president of the European Central Bank, gave the first indication of the proposed steps last week with a declaration that his financial institution would do everything possible within its mandate to save the euro. “And believe me, it will be sufficient,” he added, without defining what he meant.

In its most direct intervention so far in the European debt crisis, the European Central Bank made loans of more than $600 billion to European banks in December 2011 at only one percent interest, loosening pressure on the euro for several months.

Draghi, who seldom speaks out, issued his statement after the Spanish government was forced to pay up to 7.4 percent in interest to place its latest bond issue, a sign that investing institutions had little faith in the euro’s staying power. The rate dropped to around 6.6 percent after his pledge, still difficult to sustain.

The two most influential EU leaders, French President Francois Hollande and German Chancellor Angela Merkel, sang from the same sheet of music after a telephone conversation Friday, also vowing to do “whatever it takes” to keep the E.U.’s common currency working properly. Merkel repeated her pledge over the weekend after a similar conversation with Italian Prime Minister Mario Monti.

In a display of U.S. interest, Treasury Secretary Timothy Geithner said after a meeting Monday with German Finance Minister Wolfgang Schauble that he was confident European leaders are on the right path to keep the euro stable.

Merkel did not say specifically she would support having the E.U. bailout funds — the European Financial Stability Fund, to be replaced in September by the European Stability Mechanism — get into the business of buying up sovereign debt. Merkel has long been leery of such attempts to soak up debt with common E.U. funds. Doing so, in effect, would allow bad credit risks, such as Spain, to use good credit risks, such as Germany, as a guarantee to get more loans.

In addition, Spain has not made a formal request for such loans, as required by E.U. regulations. The government in Madrid is reluctant to accept E.U. fiscal monitoring such as that imposed on Greece in return for its E.U. and International Monetary Fund bailout package.

“In order for this grand plan to kick off, you need Spain to make a formal request,” explained Vincenzo Scarpetta, a researcher at the Open Europe institute in London.

Draghi is expected to address the situation of the euro again Thursday, after a board meeting of the European Central Bank in Frankfurt. His comments will be closely watched and are likely to have an impact on financial markets.

E.U. leaders announced after the June 29 summit that the bailout funds also could be used to make loans directly to banks, without passing through their respective governments. This, it was decided, would avoid the trap of having governments pile up loans to save their endangered banks and sidestep the need for humiliating international fiscal controls.

The decision was regarded as a major concession by Merkel, who feared such loans would absolve governments of their responsibility for fiscal discipline. But she insisted that they would be possible only after creation of a more integrated E.U. banking system, such as European deposit insurance and a bank governing mechanism similar to the U.S. Federal Reserve.

The European Commission suggested recently that such changes would be possible by the end of 2013.

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