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Shocked and awed?

In creating a massive financial rescue package, the EU has done what was needed.

Any lingering sense of superiority that European Union politicians may have harboured about the origins of the global financial crisis in the US ‘sub-prime’ housing market must surely have been blown away over the past week.

The EU’s sovereign debt crisis has been escalating since the turn of the year. It is homemade. It was widely foreseen. That it has also, like the US sub-prime crisis, brought the transatlantic economy to the brink of disaster is almost entirely down to European misjudgements.

Europe’s €750 billion rescue package, announced in the early hours of Monday morning (10 May), was, at last, an acknowledgement that its debt crisis posed a threat to world financial stability.

Greece’s troubles were showing signs of spreading, not only to Portugal and Spain, but also to already weakened banks in France and Germany, and so threatening to infect the global banking system. The European Central Bank (ECB), announcing its intervention plans on Monday (10 May), said that some markets were becoming “dysfunctional” again.

A week earlier (2 May), the Eurogroup of eurozone finance ministers and Jean-Claude Trichet, the president of the European Central Bank (ECB), had agreed with the International Monetary Fund (IMF), the nation states’ lender of last resort, to put in place a monster €110bn three-year bail-out package for Greece.

This figure was more than five times larger than the sum (€20bn) that many EU officials thought would do the job at the time of the EU summit on Greece in late March and, because these negotiations were so mishandled, more than twice the €50bn doing the rounds more recently.

Firewall

Experts in fighting sovereign-debt crises were saying weeks ago that any Greek “firewall” would need to be put together swiftly and that ready cash, ideally in the form of an emergency bridging loan, needed to be on the table.

Outrageously large sums of money would be needed to scare off speculators. Thinking in terms of just the minimum that eurozone member states could get away with would not do the job.

Crucially, these experts insisted, the bail-out would only work if private-sector lenders (especially leading French and German banks with multi-billion euro loans to Greece) agreed to roll over their existing commitments. These were the already well-established lessons of financial-crisis history.

The adverse reaction from the financial markets because the Eurogroup/IMF commitment to Greece of 2 May did not meet these conditions meant that the situation became critical last week as Europe’s sovereign-debt crisis began to go global.

On 7 May, ahead of an emergency eurozone summit to endorse the Greek bail-out plan, rumours began spreading in the markets about a new, more comprehensive rescue package. Finance ministers of the Group of Seven leading industrial countries held an emergency conference call and US President Barack Obama discussed the burgeoning crisis with German Chancellor Angela Merkel.

The €750bn package announced on Monday morning, on top of the Greek bail-out, is, finally, the outrageously large sum needed to face down speculators and stabilise the markets. So most of it will probably never be needed. Critically, it was accompanied by a momentous decision from the ECB to intervene to buy government bonds.

The package is designed to turn the crisis into an opportunity by creating time to put in place contingency plans for the longer term. This should include a bail-in component for private-sector banks, which, apart from in Germany, still seems to be missing. It must also improve the EU’s misfiring mechanisms of co-ordination which have allowed the Greek virus to mutate and spread across the continent.

The details of the broader plan are reported elsewhere in European Voice (see Pages 6-7). It will not raise Europe’s growth rate in the next couple of years. It should, however, serve to prevent the renewed, double-dip, slump which was looming because of the burgeoning crisis.

Some private economists have recently been becoming more optimistic about the economic outlook in Europe. They note, for example, that the weaker euro has been helping German exports. Nevertheless, the European Commission, like the IMF in its recent World Economic Outlook, rightly took a cautious line in the spring economic forecast (see table) that it released last week (5 May).

Damaged confidence

Even if the crisis is now being contained, confidence has been damaged. It is highly unlikely that medium- to long-term interest rates in Europe, sovereign or corporate, will all fall back to the levels that prevailed for much of last year. Securing new finance will remain difficult. What happens in the US, China (where trouble is brewing) and Asia will also have a big impact on the EU economy.

But perhaps it is Europe’s global status that has suffered most this year. Sitting in Beijing, Washington, DC, Brasilia or even Moscow (hardly a paragon of good governance), leaders and senior officials whose job it is to assess the EU’s capacity for action on the world stage, might well indulge in the occasional snigger. The events of the past four months suggest that the EU, despite the brave post-Lisbon rhetoric, is barely able to manage its own affairs efficiently.

EU governments must now build on this near-disaster and learn the lesson that mutual fiscal support and discipline is a necessary and inevitable part of monetary union. The world will be watching to see what steps are taken in order to improve EU and eurozone economic and political governance.

Stewart Fleming is a freelance journalist based in London.