European leaders met in Brussels late last week following a $112 billion bailout of Ireland and amid escalating financial market concerns about both Portugal and Spain. Despite calls by some European officials for bold new initiatives to stem the spreading euro crisis, the leaders essentially kicked the can down the road.
“They are inviting the markets to test them,” said Desmond Lachman, a resident fellow at the American Enterprise Institute in Washington.
And this testing could come early next year. Within a few months, Lisbon and Madrid will need to roll over tens of billions of euros in government debt – meaning issuing new bonds to pay for the redemption of maturing securities. Ireland holds a parliamentary election Feb. 25. Heated rhetoric in the run-up to that vote is likely to raise new doubts about Dublin’s willingness to go through with promised belt-tightening. And by March a new European bank stress test could create new doubts about the health of European financial institutions.
“We are going to live in very dangerous and uncertain times in 2011,” predicted Uri Dadush, director of the international economics program at the Carnegie Endowment for International Peace in Washington.
Seeking to prevent the mounting debt crisis from engulfing Portugal and Spain, Europe’s finance ministers approved a $112 billion bailout package for Ireland in late November that requires stringent spending cuts and that would include bondholders in any future debt restructuring.
When European leaders met in Brussels Dec. 16 and 17, they faced calls for renewed action in the face of Europe’s worst sustained financial crisis since the Great Depression. They agreed to make permanent the pool of money first established to bail out Greece earlier this year. But they did not enlarge the fund – or take any other significant steps to deal with the spreading debt crisis.
right now, deepening and spreading, and what these people
are doing is talking about a resolution mechanism in 2013.”
These leaders said that bondholders might one day have to bear some of the cost of sovereign restructuring, but not until 2013 and then only on a case-by-case basis. And they took no action on the creation of a euro bond or a common European fiscal policy.
“While it was not the kind of paradigm-shifting changes some had been hoping for,” observed Jacob Funk Kirkegaard, a research fellow at the Peterson Institute for International Economics in Washington, “they did what they said they were going to do.”
Moreover, Kirkegaard noted, the leaders promised to ensure adequate financial support for beleaguered euro-area countries, signaling they stood ready to add to their 440 billion euro bailout fund if necessary.
“They have adopted the same constructive ambiguity as the European Central Bank,” said Kirkegaard. “I think that is very sensible. If you did otherwise, you would be giving a green light to the markets to go after Spain.”
Meanwhile, ambiguity ensures market pressure on Portugal and Spain to pursue further budget-tightening and structural reform. But critics contend what was accomplished in Brussels was not nearly enough.
“This is just a joke,” complained Lachman of the AEI. “There is a total disconnect. You have a real crisis right now, deepening and spreading, and what these people are doing is talking about a resolution mechanism in 2013. What the markets are looking for is a very firm commitment from the Europeans that they are going to be providing the money right now to keep things together. It is another confirmation that, for whatever reason, the Europeans are in a reactive mode in this crisis.”
Whatever the rationale for minimalist decisions at the Brussels meeting, the outcome exposes Europe to further turmoil. “In the foreseeable future,” said Dadush, “they will be very exposed.”
the Portuguese come under pressure
to ask for a bailout.”
Making the bailout fund permanent requires amending the Lisbon treaty that governs the European Union. This creates the opportunity for any one of the parliaments of the EU’s 27 member nations to object.
In the upcoming Irish parliamentary election campaign, the opposition Fine Gael and Labor parties are likely to promise to renegotiate terms of Ireland’s bailout if they win, forcing the holders of Irish bonds to share the burden of adjustment. While there may be more smoke than fire to their rhetoric, market jitters are almost inevitable.
Portugal has a presidential election in late January. Faced with the need to roll over its debt soon thereafter, Kirkegaard said, “I would not be too surprised if after the election the Portuguese come under pressure to ask for a bailout.”
New European bank stress tests could trigger market perturbations as early as February, when the methodology for such examination of the banks’ books is expected to be announced. Ireland demonstrated that previous tests were a whitewash. The new inquiries need to be tough to be credible. But if they are tough, they are likely to paint a bleak picture of many European institutions, creating new anxiety among investors.
The timid reform proposals ratified at the Brussels’ leadership meeting suggest Europe is still in denial about its slow motion economic train wreck.
But Germany is the greatest imponderable in the New Year. Germans have long been reluctant to underwrite bailouts. But sentiment there is changing. “German public opinion has traveled 1,000 miles in the last six months,” claimed Dadush. Nevertheless, he said, “if they don’t wake up soon and do something major, the Germans will face something they abhor, which is disorder and possibly that their own currency will come under threat.”
leadership meeting suggest Europe is still in denial about
its slow motion economic train wreck.
“My expectation is that things will get worse,” said Lachman, “but they will continue to kick the can down the road. They will ride to the rescue when countries are on the ropes and provide huge amounts of money because they understand that if they let any countries default or get out of the euro, they will have a major banking crisis. They are still a few crises away from fundamental change.”