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January 06, 2012 • Tom Buerkle
Page 1 of 8
Tensions in financial markets were on the rise in early March when leaders of the 17 euro countries gathered for a special summit meeting in Brussels to consider new measures to address the bloc’s worsening debt crisis. Doubts about the efficacy of big bailout programs for Greece and Ireland were growing, driving up yields on government bonds of countries on the euro zone’s periphery, and speculation was swirling that Portugal too would soon need a rescue.
As Germany’s Angela Merkel, France’s Nicolas Sarkozy and other leaders sat around a giant oval meeting table at the European Union’s Justus Lipsius Building, John Lipsky, who was overseeing the Greek and Irish programs as the No. 2 official at the International Monetary Fund, appealed to the politicians to take bolder action to contain the crisis and save the euro. “Europe’s problems are manageable, but they have to be managed,” he said. “If they aren’t managed, they will fester. And if they are left to fester, they’ll become unmanageable.”
Over the next nine months, the euro zone leaders would hold seven more summits and countless bilateral meetings, and several of the key participants would caucus at the Group of Twenty summit in Cannes and at a farewell ceremony in Frankfurt for Jean-Claude Trichet, who stepped down in late October as president of the European Central Bank. Those meetings produced a string of initiatives designed to stem the crisis: a pact for the euro to enhance economic policy coordination and competitiveness; a so-called six-pack of measures to tighten the bloc’s rules on deficits and debt; a €78 billion ($104 billion) bailout for Portugal; a revised adjustment program for Greece that offered more money while imposing a 50 percent haircut on private bondholders; a €100 billion-plus recapitalization plan for European banks; and a plan to leverage the EU’s bailout fund, the European Financial Stability Facility, to provide a massive €1 trillion in firepower. Euro zone chiefs even orchestrated the replacement of elected governments in Greece and Italy with technocratic leaders committed to pursuing stringent austerity programs.
The efforts failed to impress financial markets, however. Bond yields climbed to record highs, and contagion spread from the periphery to Spain and Italy. Even Germany received a scare when investors shunned one of its bond auctions at the end of November. So when the leaders reconvened in Brussels in early December, they found themselves confronting a nightmare scenario: the possible breakup of the euro, an event that could plunge Europe into a depression, unravel decades of closer political cooperation in the EU and push the rest of the global economy into recession.
Weeks of frantic bargaining between Berlin and Paris had exposed the basic policy differences between the euro’s two linchpin members—the role of the ECB and the desirability of jointly issuing Eurobonds—even as they edged closer to a compromise. The escalation of the crisis had eroded business confidence, tightened credit conditions and left the euro area on the brink of recession, which would only aggravate the debt problem. On December 5, just three days before the summit opened, Standard & Poor’s put 15 of the 17 euro countries—including France, Germany and the Netherlands—on credit watch for a possible ratings downgrade, saying the bloc’s “defensive and piecemeal measures” had been inadequate to contain the systemic problems in the euro zone. And only hours before the leaders gathered, the European Banking Authority said that as a result of the latest round of stress tests, EU banks would need to raise an additional €114.7 billion in capital to meet new regulatory standards.
As Sarkozy told a gathering of center-right political leaders in Marseille just hours before the summit opened, “Never has the risk of Europe exploding been so big.”
The pressure had a galvanizing effect, at least in the short run. In an all-night negotiating session, European leaders agreed to a fiscal compact designed by the bloc’s largest economy and paymaster, Germany. The plan will enshrine tough new balanced-budget rules in each country’s constitution, subject violators to automatic sanctions and policy remedies from Brussels, and require governments to submit their economic policies to closer European oversight and coordination. The leaders also agreed to accelerate the introduction of a permanent bailout facility, the European Stability Mechanism, and to increase their crisis-fighting firepower by having national central banks lend as much as €200 billion to the IMF, an amount that could be recycled back to troubled countries. EU leaders hoped that move would attract contributions from surplus countries like China that to date have been reluctant to come to Europe’s aid.
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