Leaders at Meeting on Euro Move to Tighten Fiscal Union
By STEVEN ERLANGER and PAUL GEITNER
Published: June 29, 2012
BRUSSELS — European leaders went a surprising distance on Friday toward restoring confidence in the euro, taking a significant step toward economic integration and easing market pressure on Spain and Italy, as what appeared to be a new coalition of forces pushed Germany to bend.
Enlarge This Image
The European Council president, Herman Van Rompuy, called the agreement a “breakthrough that banks can be recapitalized directly,” which represents a concession by northern European countries, including Germany.
But questions quickly arose about what precisely the leaders had agreed to and whether they would deal with the most fundamental problems of the euro zone, its structural imbalances and lack of a lender of last resort. While Chancellor Angela Merkel of Germany ceded some ground by agreeing to direct refinancing of banks, she did not yield on the issue of sharing debt burdens, which is highly unpopular with German voters but is seen by many economists as a necessary step in saving the currency.
“In a nutshell, we think that the Europeans have cracked open more doors than we thought, but they still have a lot on their plate,” said Gilles Moëc, an economist at Deutsche Bank in London. “The discussion on fiscal integration and debt mutualization has not started in earnest.”
At the latest all-night summit since the beginning of the long euro crisis, the leaders made a breakthrough toward more central control over their banking system, a crucial aspect to the stability of the common currency. They also moved swiftly to grant their bailout funds more flexibility to come to the rescue of Spain and potentially Italy, the fourth and third-largest economies in the euro zone, respectively, because they are too big to fail.
But the meeting also marked an important shift in the foundation of the euro zone, with France, under the new Socialist president, François Hollande, breaking from the traditional lock step with Germany. Working more in partnership with Prime Minister Mario Monti of Italy than with Ms. Merkel, Mr. Hollande helped isolate Germany and broker the deal for Italy and Spain, which breaks a previous German taboo on direct recapitalization of ailing banks, and makes a beginning, however small, toward pooling of liabilities.
Financial markets rallied Friday, suggesting the measures had exceeded admittedly low expectations. The president of the European Central Bank, Mario Draghi, who has not shied from criticizing political inaction, called himself “quite pleased with the outcome.” He added, “It showed the long-term commitment to the euro by all member states of the euro area.”
In return for allowing the direct recapitalization of banks by the bailout funds, Germany won agreement on a single banking supervisory agency, with the European Central Bank playing a central role, a shift bringing it closer to the powers of the United States Federal Reserve.
Agreement on the bank authority was “the major breakthrough” of the night and a key step in breaking “the vicious circle between banks and sovereigns,” said the European Council president, Herman Van Rompuy. While the long euro crisis has been centered on excessive government debt, European banks have been weakened by their portfolios of government bonds, made worse in Spain, as in Ireland, by a property bubble that burst.
Spain has asked for a bailout of up to $125 billion for its banks, but objected to that new debt being added to its national debt, rather than directed to the banks themselves. Investors agreed, pushing Spanish and, in a ripple effect, Italian debt toward unsustainable levels. Italy’s total debt is about 120 percent of gross domestic product, second only to Greece in the euro zone.
The new deal will let the bailout funds lend directly to Spanish banks — although not until the new central bank supervisor is established — probably by the end of the year. Spain also would not get a lot of onerous new conditions because it, like Italy, is making serious strides to streamline its government and economy and cut its deficit. Also important to investors, in the case of Spain, the bailout fund will not be the first in line for repayment, in the event of default.
“We have taken decisions unthinkable just some months ago,” said José Manuel Barroso, the president of the European Commission.
Mr. Monti, who emerged a winner from the summit meeting, said that Italy had no immediate plans to seek help from the bailout funds, but might in the future.
He and the Spanish prime minister, Mariano Rajoy, held up agreement at the meeting until the early hours of Friday, when they got a deal on the use of the bailout funds. Some of the leaders resented what they felt was blackmail, but others saw it as a hard-nosed negotiating tactic by Mr. Monti, a former European commissioner and highly respected economist.
Prime Minister Enda Kenny of Ireland described the agreement as “a seismic shift in European policy,” after having won a promise that Ireland’s bailout for its collapsed banking sector could be adjusted as well.
In a research note, the bank BNP Paribas wrote that while the agreement on using bailout funds to purchase debt was a positive development, it also noted that “the details are rather lacking” and warned that this fact “could temper the initial market enthusiasm.” The uncertainty was underscored on Friday when Mr. Hollande said that future bank bailouts could be authorized without the unanimous consent of the euro zone members, making such rescues far easier. But that interpretation was immediately disputed by European Union officials, who could find no such stipulation in the fine print.
Mr. Hollande, while speaking Friday of “no winners and no losers,” clearly supported Italy and Spain, no doubt concerned that France, with its total debt now approaching 90 percent of gross domestic product, might be next in line if the markets tired of speculating on Spain and Italy.
It was bad enough that Germany should lose its semifinal soccer match to Italy on Thursday night, but some suggested that Ms. Merkel had also lost to Mr. Monti here.
Although the chancellor stuck by her argument that none of the basic principles demanded by Germany had been violated, the German news media were quick to call the deal a retreat from her previously tough position.
“Merkel caves in,” wrote the influential Bild, a mass-circulation daily newspaper. The online edition of the newsmagazine Der Spiegel titled its lead story on the negotiations “The night that Merkel lost.”
Ms. Merkel said that the new financing pact worked with existing mechanisms and that Germany had agreed only to more flexible use of the bailout funds in return for centralized banking supervision under the central bank, which should be in place by the end of the year.
“We have remained completely true to our existing model — performance, reward, conditionality and control,” she said Friday. “And so I believe we’ve done something important and remained true to our philosophy: no reward without performance.”
Yet she received criticism from some in her own party and from members of the opposition Social Democrats, who argued that allowing banks to tap directly into the bailout funds brought Germany closer to a common sharing of debt.
“It is not so easy for Ms. Merkel,” said Tanja Börzel, a political scientist from the Free University in Berlin. “She can’t simply charge ahead, but has to consider her domestic audience and the democratic and legal procedures we have in Germany.”
Still, her skill at diverting this meeting from discussing more sweeping issues like euro bonds should not be underestimated, said Holger Schmieding, a London-based economist at the Berenberg Bank of Germany.
“Merkel agreed to let common sense prevail by not asking Italy and Spain to potentially kill their economies through an overdose of austerity,” he said, while sticking to her guns on strict conditions for aid. “That Monti, Rajoy and Hollande are now happily selling this as a victory says a lot about the diplomatic skills of Ms. Merkel.