(From THE WALL STREET JOURNAL)
By Stephen Fidler and Matina Stevis
Once again, a summit of European leaders raised hopes that the euro
zone's debt and banking crisis could be about to turn the corner. And
once again, those hopes were soon dashed.
The leaders' late-June summit followed the usual template. Since the
start of the crisis in early 2010, summits have been greeted by
bond-market rallies lasting anywhere from a few hours to a few days --
followed by abrupt reversals.
Political fixes are proving unconvincing to markets, says Paul De
Grauwe, an economics professor at the London School of Economics.
Leaders "have stopped thinking about economic implications: They look
at this process from a political point of view," he says.
Time and again, leaders claim they have reached agreement on issues
that are then revealed not to be settled at all.
In June, the leaders said they agreed on "short-term measures" to
build confidence, including a commitment that private bondholders
wouldn't be pushed down in the creditor pecking order by loans to help
Spain rescue struggling banks. They said finance ministers would
elaborate on the measures on Monday.
Monday has passed, and no elaboration has emerged. One key measure
that had initially helped to reassure markets turns out to be a
subject of fierce disagreement among governments and in Brussels: the
decision that the bailout funds could -- once a euro-zone banking
supervisor was in place -- directly bolster the capital of struggling
Spanish banks.
The leaders claimed that this would help "break the vicious circle
between banks and sovereigns." That was because Spain wouldn't further
swell its already fast-growing government debt by having to borrow to
help its weak banks.
But Wolfgang Schauble, Germany's finance minister, after Monday's
meeting said he "expects" governments will retain liability if the
bailout funds suffer losses on those investments. That appeared to
contradict the statements of other officials, such as European
economics commissioner Olli Rehn -- suggesting the issue is far from
settled.
This is typical of a dynamic in evidence since the start of the crisis
in early 2010. The markets seek signs that Germany and the other
strong euro economies are willing to commit their financial muscle to
aiding their weaker brethren, while Germany and its allies resist
doing that until they are absolutely sure they are not writing blank
checks.
A further market concern is the small size of the euro-zone's bailout
funds, which have already committed some 200 billion euros ($246
billion) to Greece, Ireland and Portugal. The European Stability
Mechanism, the permanent bailout fund due to come into operation in
the next few months, will have a total capacity, by July 2014, of 500
billion euros. Until then, under current plans, the maximum spare
lending capacity of all the bailout funds will be 420 billion euros.
Euro-zone officials say that, apart from the sum of up to 100 billion
euros Spain will need for its banks, the bailout funds are likely to
face calls soon for a further 25 billion euros from Ireland to pay off
debt it issued to rescue its troubled banks, plus as much as 12
billion euros for Cyprus, a further 9 billion euros to 10 billion
euros for Portugal, and perhaps 16 billion euros to 20 billion euros
more for Greece.
More significantly, Italy and Spain could be knocking on the door, too
-- if not for full-fledged bailouts, possibly for the funds' help in
buying bonds to keep borrowing costs down. "It wouldn't be prudent to
say that Italy will never need to use this or that fund," Italian
Prime Minister Mario Monti said at a news conference Tuesday in
Brussels.
The funds are just not big enough, says economist Nouriel Roubini.
"The more the better. The numbers could be 2, 3 trillion, or as little
as 1.5 trillion," he says.
Some European officials are also skeptical about the adequacy of the
bailout funds, particularly if countries such as Portugal and Ireland
don't return to market borrowing as soon as hoped. Unless the
firewalls are boosted, some countries may have to be turned away, they
say.
Mr. De Grauwe argues that if Italy does ask for help in its bond
markets now, the request would backfire. Because the bailout funds'
resources are relatively small, investors will expect them to run out
of cash quickly, he says. That would mean rational bondholders would
dump bonds immediately, rather than waiting for the funds to run out
of money.
Keeping Italian bond yields down to affordable levels would cost 26
billion euros a week, estimates Patrick Artus, an economist at asset
management group Natixis. That would use up the euro zone's remaining
bailout resources in three months.
Bondholders are thus not convinced that the bailout funds can prevent
restructurings for Spain and Italy, and that means they demand high
yields to compensate for risks.
The only institution that can convince investors they won't suffer
losses, says Mr. De Grauwe, is the European Central Bank, which has an
unlimited capacity to buy bonds. If it views Italy and Spain as
suffering from liquidity -- rather than solvency -- problems, the ECB
should intervene to keep borrowing costs down. The ECB, though,
remains fiercely resistant to funding governments. Asked if he sees
signs of the central bank taking his advice, Mr. De Grauwe says: "No
sign whatsoever."
---
Christopher Emsden, Giada Zampano and William Horobin contributed to
this article.
(END) Dow Jones Newswires
July 10, 2012 20:02 ET (00:02 GMT)
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