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11/22/2010 11:30 AM
Europe's Neverending Crisis
Can the Euro Still Be Saved?

The countries of the euro zone are hopelessly divided over the
question of how to save the currency in the long term. Bailouts for
individual countries like Ireland and Greece can only be a temporary
solution. Meanwhile, an internal paper drawn up by the German
government has revealed Berlin's plans for forcing private-sector
investors to take their share of losses in future crises. By SPIEGEL
Staff

In the time since European leaders named the Belgian politician Herman
Van Rompuy president of the European Council a year ago, the public
has taken little notice of the reserved native of Belgium's Flanders
region. But that changed last Tuesday, when Van Rompuy made headlines
across Europe with a brief remark.

"We all have to work together in order to survive with the euro zone,
because if we don't survive with the euro zone we will not survive
with the European Union," Van Rompuy said during a panel discussion.
With his comments, he expressed what many people in Brussels had been
thinking but few had dared to say out loud.

As it happens, Van Rompuy would also have preferred not to say what he
said. Two days later, he claimed that he had been misunderstood. He
had apparently stuck his neck out too far. But that doesn't change the
fact that the statement itself was correct.

Euro-zone governments have spent months trying to end the crisis
facing their common currency, but the danger has not been averted. On
the contrary, the crisis meetings have returned and billions in
emergency funds are needed once again. And there is still no end in
sight to the crisis.

Merely Temporary Relief

European leaders have tried all kinds of measures in the bid to save
the euro. They approved a bailout program for Greece and a massive
rescue fund for the entire euro zone, they whipped legislation through
their parliaments and they expanded the articles of the Lisbon Treaty
to their legal limits (and beyond, many would argue). The European
Central Bank (ECB) has even violated an ironclad taboo by buying up
the bonds of ailing countries in an attempt to stabilize their prices.

But those steps only brought temporary relief, which only lasted until
the next piece of bad news emerged. Yesterday it was Greece, and now
it's the sorry state of Irish banks that poses a threat to the common
currency. Each new report fuels the suspicion that the problems may be
so pervasive that they can no longer be solved with conventional
methods and by taking on more and more debt. Fears are growing that
the crisis could lead to the default of individual countries or
possibly even the collapse of the euro zone.

A deep divide between two almost irreconcilable camps runs through
Europe. German Chancellor Angela Merkel heads one camp, consisting of
the northern European countries. Merkel sees herself as the defender
of a culture of stability of the sort that Germany has maintained
since the days of the deutschmark. Her goal is to prevent the monetary
union from becoming a kind of transfer union, with Germany as paymaster.

The second camp consists of the so-called PIIGS states, which have
accumulated too much debt in the past and are now hoping for help:
Portugal, Italy, Ireland, Greece and Spain. They want the thing that
Merkel wants to prevent: a union in which the strong pay for the weak.
Europe's institutions are now maneuvering between these two camps.

Causing a Stir

The first act of the current crisis began in the chic French beach
resort of Deauville in mid-October. To the consternation of their
allies, Merkel and French President Nicolas Sarkozy announced the end
of their ambitious goal to enforce a stricter stability pact with
automatic sanctions for nations that break the deficit rules. In
return, Sarkozy supported the German idea to assign some of the
liability for future financial crises to private-sector creditors like
banks and to accept the possibility of bankruptcy for an insolvent
country. The 27 heads of state and government approved the deal at the
European summit in late October.

The plans, and the horror stories about Irish banks, caused a stir in
the financial markets, pushing up risk premiums for the government
bonds of all the ailing countries. "Merkel and Sarkozy apparently
didn't think about the second act," comments Luxembourg Foreign
Minister Jean Asselborn.

The yields on Irish government bonds rose as high as 8.6 percent at
times -- 6.2 percentage points higher than the rate Germany pays to
borrow money. This prompted Irish Prime Minister Brian Cowen to
angrily note that Merkel's actions were "not helpful."

The German plan to automatically force bondholders to pay up when
financial aid packages are approved "might seem attractive from a
theoretical point of view," says ECB executive board member Lorenzo
Bini Smaghi, but it would "in practice destabilize markets and have
severe effects on economies in the euro area." It could ultimately
achieve the opposite of what was intended, says the central banker,
because "speculators would take advantage of the situation, while many
small investors would suffer losses."

Responding to the accusation that it triggered the Ireland crisis, the
government in Berlin said that the German proposal to involve private-
sector investors has no effect on current market behavior because it
focuses on the period after 2013. It insists that even government
bonds purchased today would remain unaffected by any new rules. "In
fact, this has nothing at all to do with the current debate over
Ireland," says German Finance Minister Wolfgang Schäuble.

Misjudging Reactions

None of this has reassured the players in the financial markets. Once
again, the German government was confronted with the realization that
it cannot take action relating to the euro crisis without taking the
reactions of investors into account. It misjudged this reaction once
before, when it opposed financial aid for Greece for so long. In those
weeks of uncertainty, the risk premiums for Greek government bonds
continued to rise, while speculators began setting their sights on the
bonds of the other PIIGS countries.

In the end, the euro-zone countries approved a comprehensive bailout
package, leaving Chancellor Merkel in a losing position -- and looking
like she was to blame. Her many adversaries in Europe argued that by
taking such an uncooperative approach, Merkel made the crisis worse
and drove up the costs of the bailout. The chancellor justified her
actions by arguing that if it hadn't been for her tough stance, the
Greeks would not have agreed to a strict austerity program and the
involvement of the International Monetary Fund (IMF).

Merkel's reputation in Europe has been battered since then. Many see
her as a betrayer of European ideals who stubbornly pursues German
national interests. These critics feel vindicated by recent
developments.

There is a rising tide of anger directed at the chancellor. Greek
Prime Minister George Papandreou has criticized Merkel, saying that
her reform plans could break the backbone of entire countries, while
the Portuguese finance minister likens her plans to a foul in the game
of soccer.

Wait-and-See Approach

All this criticism prompted the Germans to avoid taking a leading role
in the current crisis talks in Brussels. They took a wait-and-see
approach, even when they were put under pressure, especially by
Portugal and Spain. Both countries are afraid of being sucked into the
Irish crisis.

Unlike the Greeks, who implored their fellow Europeans to come to
their aid, the Irish needed more persuasion. They didn't want the
Europeans' money, because they fear it could weaken their sovereignty.
And they argued they didn't need it either, because they won't need to
borrow money on capital markets until the middle of next year.

This is true in theory. Ireland's problems are not its government
finances but the balance sheets of its banks. However, the two things
are closely related, because the country issued a comprehensive
government guarantee for its banks after the financial crisis --
without suspecting how big the problem could turn out to be.

There has been a quiet exodus of billions from Ireland in recent
weeks. Most international investors were no longer willing to lend
Irish banks as much as a cent. The Irish banks repaid €55 billion ($75
billion) to their international creditors, mainly German, French and
British banks, because the corresponding bonds had matured. But those
creditors took the money and fled from the country. Only government-
owned banks were still willing to lend money.

By the end of October, the Central Bank of Ireland had extended
"extraordinary liquidity assistance" in the amount of €20 billion
without the Irish banks providing the corresponding collateral. Also
by the end of October, Irish banks had borrowed €130 billion from the
ECB, which is more than the Greek banks borrowed. ECB experts have
been hard at work at the Irish Department of Finance since September.

Even though the government has already taken a considerable portion of
their risks off their hands, Irish banks are still dragging around
property loans valued at €200 billion, which have not yet been
adequately written down. Even the reserves of the better financial
institutions have been used up, and the entire Irish banking system is
on the verge of collapse.

In internal talks early last week, ECB President Jean-Claude Trichet
made a far-reaching proposal. To solve the problem once and for all,
he said, both Ireland and Portugal, which is also in financial
trouble, ought to be provided with sufficient funds. These ideas went
over well, especially with smaller member states.

Multi-Billion Bailout for Ireland Announced

A delegation of representatives of the EU, the IMF and the ECB arrived
in Dublin on Thursday of last week to investigate how big the Irish
problem really is. At that time, the draft version of a bailout plan
had already been written.
It included two options. Under the "minor solution," the euro-zone
stabilization fund would only cover the acute new shortfalls of the
Irish banks. Under this scenario, the rescue fund would have to
provide about €45 billion-50 billion, according to estimates made
before the experts arrived in Dublin. London market insiders even
feared that the sum could be as high as €60 billion-80 billion.

Many experts in the EU and a few finance ministries recommended a
"bigger solution," which would involve taking Ireland "completely off
the market," at least for some time. Otherwise, the proponents of this
solution argued, the problems could begin all over again in the
spring, when the government of Prime Minister Cowen will have to
obtain new money to extend expiring loans. That plan would however
cost "about €100 billion," said one official, "maybe even a bit more."

The British also indicated they wanted to contribute to the rescue
package for Ireland. They may not be part of the euro club, but they
are "good neighbors," said a British government spokesman.

Then, on Sunday, the Irish government announced it had officially
asked the EU and IMF for help. Europe's finance ministers quickly
agreed to the aid in a hastily convened telephone conference on Sunday
evening. It is not yet clear exactly how big the bailout will be, but
Prime Minister Cowen said it would be less that €100 billion.

On Monday, the British Chancellor George Osborne confirmed that
Britain had also offered a bilateral loan to Ireland totaling around 7
billion pounds (€8.2 billion or $11 billion). "Ireland is our very
closest economic neighbor so I judged it to be in our national
interest to be part of the international efforts to help the Irish,"
he told BBC radio.

Reserved Approach

The German government has taken a reserved approach to providing
financial help for the euro-zone's troubled members. Chancellor Merkel
is under particularly intense pressure. In addition to public opinion
in Germany, she has to take the views of the judges on the
constitutional court and the coalition parties' parliamentary groups
into account. The Karlsruhe-based constitutional court is currently
reviewing several constitutional complaints against the billions in
aid for Greece and the establishment of the European stabilization
fund, and the number of such complaints could soon rise.

"In the event that Ireland also applies for assistance from the EU
stabilization fund, we will immediately file a motion for a temporary
injunction with the constitutional court to prevent the funds from
being disbursed," said Berlin legal scholar and economics professor
Markus Kerber ahead of Sunday's announcement.

He is one of the appellants filing a suit against the EU stabilization
fund in Karlsruhe. If billions are made available for highly indebted
countries with financial difficulties, the monetary union will turn
into a transfer union, Kerber argues. In addition, he says, the
government's approval of the fund violates the property guarantee
under Germany's constitution, which is known as the Basic Law.
"Article 14 of the constitution guarantees a secure, stable currency,"
says Kerber.

Peter Gauweiler, a member of parliament for the conservative Christian
Social Union (CSU), also has constitutional concerns about aid for
Ireland, and he believes that the prospects of his suit against the EU
rescue fund are improving. "If Ireland asks for help from the EU now,
this will confirm the basic assumption of my constitutional complaint,
namely that the basis for a secure euro in the Treaty of Maastricht
has become obsolete," he said recently.

Criticism of Low Corporate Tax Rate

Politicians from the conservative Christian Democrats (CDU/CSU) and
their coalition partner, the pro-business Free Democratic Party (FDP),
are also closely watching each step the German government takes in
Brussels. Markus Ferber, the chairman of the CSU group in the European
Parliament, wants to tie aid for Ireland to strict conditions. "We
also managed to obtain tax increases in the case of Greece. The same
thing has to happen in Ireland," says Ferber. "It is unacceptable if a
country relies on the solidarity of the community while continuing to
secure competitive advantages over its benefactors through the use of
tax dumping."

He is referring to Ireland's low tax policy. Corporations in Ireland
pay a low corporate tax of 12.5 percent. "If they had our system, they
would be swimming in money," says economist Hans-Werner Sinn,
president of the Munich-based Ifo Institute for Economic Research.

The tax question had been the sticking point in the bailout
negotiations. The tax question is non-negotiable, said the Irish
government. Without concessions there will be no money, responded
officials in Brussels.

Tense Situation

Nevertheless, it was clear that there would be a compromise in the
end, and that Ireland would get help. It is hoped that the bailout
will bring calm to the financial markets, at least for the time being.
But what happens after that? Won't the markets' attention turn to
Portugal next? Not even Portuguese Finance Minister Fernando Teixeira
dos Santos is willing to rule out that his country could find itself
in a situation in which it would need the protection of the rescue
fund. His counterpart at the Foreign Ministry can even imagine
Portugal being ejected from the euro zone.

The rescue fund was approved to calm the financial markets. Its mere
existence was expected to reduce tensions to the point that no country
would actually have to make use of it. Instead, the situation has
become more and more tense for many countries in the interim.

The European Union and the IMF envisioned a fund comprising €750
billion to protect their weaker members. This money would be
sufficient for Ireland and Portugal. But things would become more
difficult if Spain needed help. This is a situation Europe's
governments did not anticipate, who reasoned that what should not be
allowed to happen could not happen.

Apparently they assumed that the problems would be largely resolved by
the time the rescue fund expires in 2013. It was expected that by then
the PIIGS countries would have cleaned up their finances and be able
to borrow money at reasonable rates again. Now the European
governments must face a different reality, coupled with the question
of what happens in 2013.

Internal Government Document Outlines Planned Crisis Mechanism

Chancellor Merkel is determined to prevent the rescue fund, in its
current form, from becoming a permanent solution. She envisions that
the construct will be replaced with a "permanent crisis management
mechanism" when it expires in 2013. A plan developed by the German
Finance Ministry has already been coordinated with the Chancellery,
the Foreign Ministry and the Economics Ministry. German Finance
Minister Wolfgang Schäuble intends to present the plans in detail at
the next meeting of the Euro Group and the council of finance
ministers in Brussels in early December.
According to a "non-paper" drawn up by the Finance Ministry, "the
crisis mechanism is designed to allow for a fair balancing of
interests between the debtor country and bond creditors," so that
"systemic effects" on financial markets and the monetary union are
avoided. A non-paper is a document that is so confidential that it
doesn't really exist.

Change in Payment Terms

According to the Germans' plans, the conditions for all new bonds in
the euro zone would include a debt restructuring clause as of 2013.
The goal of the clause is to "make it possible to achieve a legally
binding change in the payment terms through majority decisions of the
creditors in the event of the debtor's inability to perform." The
document lists maturity data extensions, rate reductions and debt
waivers as measures.

A neutral chief negotiator would mediate between bankrupt countries
and investors. "This task should be assigned to an inter-governmental
institution that can also be a provider of financing at the same
time," the document reads.

The new facility could also provide ailing countries with liquidity
assistance. The money for the program would come from two sources.
First, there would be the revenue from the penalties euro-zone
countries would pay for repeatedly violating the upper deficit limit.
Second, the euro-zone countries would pay into the fund, with their
contributions possibly being based on their shares in the ECB.

A condition for the procedure is an analysis of a country's "debt
capacity" prepared by the European Commission, the ECB and the IMF.
German government experts are convinced that their plan will be
successful. "The affected country gets a realistic prospect of quickly
regaining its reputation and trust," they write, while the creditors
would receive the chance of "securing a portion of the value of their
bond."

The drawback of the plan is that it cannot go into full force in 2013,
because not enough bonds with restructuring clauses will be on the
market right away. Recognizing this weakness, the government experts
concede that there would be a transitional period. This would amount
to a "period of six to eight years, for which transitional solutions
will have to be found."

Euro Bonds Suggested

The document does not describe what this could look like. In bilateral
talks, Schäuble is already seeking allies for the plan, such as his
French counterpart Christine Lagarde. But many countries have
completely different ideas. Luxembourg Prime Minister Jean-Claude
Juncker supports the idea of issuing euro bonds. These are government
bonds whose repayment is not guaranteed by the issuing country but by
the entire monetary union.

The southern euro-zone countries think this is an excellent idea. The
Germans and the Austrians are against it. This sort of project would
penalize those "who are dutifully sorting out their national finances"
and benefits those "who haven't done their homework," says Austrian
Finance Minister Josef Pröll.

"When everyone is liable for everyone else, there is very little
incentive for individual countries to keep their own house in order,"
warns Christoph Rieger, a bond expert at Germany's Commerzbank. This,
says Rieger, jeopardizes the currency as a whole.

Indeed, all of the proposals to solve the euro crisis share the same
problem: They have the potential to make things even worse.

ARMIN MAHLER, PETER MÜLLER, CHRISTOPH PAULY, CHRISTIAN REIERMANN, HANS-
JÜRGEN SCHLAMP, CHRISTOPH SCHULT, ANNE SEITH

Translated from the German by Christopher Sultan


URL:
http://www.spiegel.de/international/europe/0,1518,730375,00.html
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