Europe Officials Move to Carry Out Rescue Package

Europe Officials Move to Carry Out Rescue Package
By JACK EWING and JAMES KANTER
Copyright by Reuters
Published: May 10, 2010
http://www.nytimes.com/2010/05/11/business/global/11euro.html?th&emc=th


FRANKFURT — European officials on Monday took steps to tackle the widening sovereign debt crisis that has destabilized the Continent.

Just hours after leaders agreed to provide nearly $1 trillion as part of a huge rescue package, central banks began buying euro-zone government bonds directly on Monday — an unprecedented move to inject cash into the financial system.

Officials were hoping the size of the rescue package — a total of $957 billion — would signal a “shock and awe” commitment to such troubled countries as Greece, Portugal and Spain, in the same vein as the $700 billion package the United States government provided to help its own ailing financial institutions in 2008.

In response, the euro has rallied against the dollar, markets surged and the risk premium on Greek and other government bonds plunged. But analysts pointed out that the package did little to reduce overall debt, and that the uncertainty that has plagued the markets could return if European nations do not take bold steps to reduce their borrowing.

“If the will for fiscal discipline in the E.U. is plainly evident, long-term confidence in the euro will be restored,” Michael Heise, chief economist of German insurer Allianz, said in a note to investors.

After hours of meetings that lasted into early Monday morning, finance ministers from the European Union agreed on a deal that would provide $560 billion in new loans and $76 billion under an existing lending program to countries facing instability. Elena Salgado, the Spanish finance minister, who announced the deal, also said the International Monetary Fund was prepared to give up to $321 billion separately.

On top of the huge sum, the European Central Bank reversed its position of just a few days ago and began buying government and corporate debt. And the world’s leading central banks, including the Federal Reserve, announced a joint intervention to make more dollars available for interbank lending.

“The channels of normal monetary policy were not functioning,” Jean-Claude Trichet, president of the European Central Bank, said at a news conference in Basel on Monday.

Central bank purchases of euro-zone government bonds began Monday, although the European Central Bank did not immediately release details.

The initial market reaction was ecstatic. The euro jumped back above the $1.30 mark for the first time in a week before falling back slightly. Greece’s 10-year borrowing costs plunged by almost half.

In afternoon trading, the Euro Stoxx 50 index, a barometer of euro zone blue chips, rose more than 8 percent, following on modest gains in Asia.

The package was much larger than expected, and represented an audacious step for a bloc that had been criticized for acting tentatively, and without unity, in the face of a mounting crisis.

Philippe Gijsels, head of research at BNP Paribas Fortis Global Markets in Brussels, said the central bank action was in some ways the most crucial, because the European Central Bank would be in effect funding government budget deficits by monetizing their debt.

The trick now, he said, would be to ensure that Greece and other countries in similar straits are held to their promises to straighten out their finances.

“The debt is still in the system,” Mr. Gijsels said. “Eventually all these problems will rise again.”

Mr. Trichet also warned governments that they must attack the debt problem vigorously. “For us what is absolutely decisive is the commitment of governments of the euro area to take all measures needed to meet their fiscal targets this year and in the years ahead,” Mr. Trichet said in Basel.

The central bank, which had said buying bonds was not even on the agenda at its regular meeting last Thursday, announced the reversal early Monday after an emergency telephone conference by members of its Governing Council. The purchases began Monday, but the central bank did not immediately say which government bonds the banks are buying or what amounts. A Bundesbank spokesman also declined to provide details.

Michael Schubert, an analyst at Commerzbank in Frankfurt, said the central bank might initially buy Portuguese bonds as a signal that the Greece crisis will not be allowed to infect other euro-zone countries. “This could be a successful means of putting a halt to the domino effect,’ ’Mr. Schubert said in a research note.

The bank’s bond-buying program, which will be conducted via the central banks in nations that belong to the euro, could amount to about 110 billion euros, or about 5 percent of the total volume outstanding. The Fed has spent about the same amount in percentage terms buying bonds to stabilize U.S. financial markets.

In its statement, the European Central Bank said that the liquidity that the bond purchases will pump into the European financial system will be “sterilized,” or offset with other monetary operations to drain liquidity from the system. In doing so, the bank seemed to be trying to answer criticism that buying bonds is the same as printing money and could lead to inflation.

According to Commerzbank, the expiration of 442 billion euros in one-year loans in June will automatically drain cash from the financial system.

However, the European Central Bank also announced new lending to prevent a repeat of late 2008, when banks’ doubts about each other’s solvency caused interbank lending to seize up.

The bank said it would lend unlimited dollars to banks that can provide collateral in return. The action appeared to be an attempt to take pressure off the euro. While many analysts still consider the euro to be overvalued against the dollar, the central bank may want to avoid a sudden drop in the currency, which would be disruptive for businesses and boost the price of oil and other commodities in euro terms.

Underscoring the urgency of the situation, President Barack Obama spoke to the German chancellor, Angela Merkel, and the French president, Nicolas Sarkozy, on Sunday about the need for decisive action to restore investor confidence. The actions by the United States represented significant concern that the European crisis could spill over and hinder the American recovery.

New political complications in two of Europe’s most important countries added to the challenge. In Germany, voter anger at the effort to save Greece cost Mrs. Merkel an important regional election Sunday, undermining her leadership, and in Britain the government remained in a state of suspended animation because of the inconclusive parliamentary elections last week.

Financial unease has been mounting. Riots in Greece, ever-tightening terms of credit and the unexplained free fall in the American stock market last Thursday have compounded the sense that the European Union’s inability to address its sovereign debt crisis might lead to the type of systemic collapse that followed the fall of Lehman Brothers.

The debt crisis began with Greece teetering toward default, and fear quickly spread about other weak economies like Portugal, Spain and even Italy. Previous efforts by the European Union to shore up investor confidence were viewed as too little, too late, with the markets making clear that they were looking for a bolder plan.

Olli Rehn, the European commissioner for monetary policy, described the arrangement as “a consolidation pact” that would be “particularly crucial for countries under speculative attacks in recent weeks.” He specifically mentioned Portugal and Spain.

Mr. Rehn said the I.M.F. would provide “half as much as the European Union” following lengthy talks with fund officials.

“We shall defend the euro whatever it takes,” Mr. Rehn said.

What emerged from the discussions, which covered more than 10 hours, represented a partial retreat from a system discussed earlier in the day that would have radically expanded the powers of the European Commission to raise funds.

Instead the ministers devised a system that would speed up the pace at which states that use the euro could lend to one another, but on a bilateral and voluntary basis.

One of the crucial decisions that ministers made was to create a so-called special purpose vehicle to disburse the $560 billion in new loans, should that support be required by member states in economic difficulties.

The use of such a financial instrument reflected the difficulties that individual European governments — and Germany’s in particular — had in committing huge sums to a central authority. Having a body like the European Commission, Europe’s executive body, oversee the economic management of the bloc was seen by some countries as a clash with national sovereignty.

The Bank of Japan joined in the global response, saying after an emergency board meeting Monday that it would pump 2 trillion yen, or $21.6 billion, into financial markets for a second consecutive trading day in a bid to ease credit.

In a statement after their meeting, the ministers emphasized that the special purpose vehicle would expire after three years and that its use would be strictly dependent on “national constitutional requirements.”

The language most likely reflected the reservations of some governments to providing even more money than is available in bailout packages already approved.

Ministers said their first line of defense against financial turmoil was to employ an existing loan program, which they expanded by $76 billion, and to use the further loans approved Monday as a “complement” as required.

While the sums being discussed are eye-catching, some bankers questioned whether they would be enough to calm the markets over the long term. One banker said that, with more European economies coping with rising deficits, raising, guaranteeing or backing such a large sum would not be an easy task.

But that concern may be addressed by a more forceful posture by the European Central Bank. The bank has rebuffed calls to inject liquidity into the markets by buying back European bonds, but in a statement Monday morning it said it would take whatever steps were necessary to smooth out the secondary markets for public and private debt, suggesting it would have the flexibility to intervene in the markets as needed.

There were many complications in trying to forge a consensus. They included defining the role of Britain, which lies outside the euro zone and had said it would not help in propping up the euro, as well as the European Central Bank. The fractiousness underscores the frailty of a monetary union in which the richest member, Germany, is also the most opposed to a financial rescue.

Since it became clear that Greece would not be able to meet its financial obligations and fears spread that other indebted nations like Spain, Portugal and Ireland would have similar troubles, Europe has responded fitfully.

The meetings on Sunday represented an extraordinary convergence of diplomatic activity, crammed into a tight time frame. Political leaders including Mr. Sarkozy of France said early Saturday, at the end of an earlier summit meeting, that a loan mechanism intended to restore confidence should be ready by Monday morning. That effectively left the European Commission and finance ministers a single weekend to change the way the European Union operates its finances.


James Kanter reported from Brussels. Landon Thomas Jr. contributed from London, David Jolly from Paris, Jack Ewing from Frankfurt, Sewell Chan from Washington and Bettina Wassener from Hong Kong.