ANALYSIS:THE DEBT crisis in the euro zone is deepening rapidly. As global financial leaders gather in Washington this weekend for the IMF's annual meeting, Europe is set to come under fresh pressure to step up its ailing response, writes ARTHUR BEESLEY
In the latest ructions, Italy was downgraded by Standard & Poor’s (S&P) and Greece tried again to avert default by winning approval from the EU-ECB-IMF “troika” for a new wave of austerity measures.
In an ominous turn for the weakened bank sector, it also emerged that German industrial giant Siemens had transferred huge sums of money from a big French bank into the European Central Bank .
Markets dropped yesterday, then rose again. From Brussels came yet another warning to EU member states as competition commissioner Joaquin Almunia urged them to increase their bank recapitalisations. In Washington, meanwhile, the IMF sternly told Europe to snap out of its torpor.
This is the daily grid of crisis. In the face of a tidal wave threatening everything in its path, concern mounts that Europe’s leaders still don’t get the gravity of the task they face. They say they do, yet their incremental actions do not match the intensity of the challenge. Deeds count in a malaise like this, words much less so.
In Poland last Friday, US treasury secretary Timothy Geithner implored his European counterparts to escalate the battle and warned of “catastrophe” if they did not. Many fine words were uttered, but nothing happened.
By Monday night, US president Barack Obama was on the phone to German chancellor Angela Merkel. They agreed that “concerted action” would be required in the coming months to reassert control over the situation, but gave little away.
Still, waiting for months is a luxury not open to global leaders. The scene is too volatile for that. Hence the expectation that something new might come out of the IMF annual meeting in Washington this weekend and a gathering of the Group of 20 industrialised and developing countries.
At this point European leaders seem likely to come under fresh pressure from the US and its allies to expand the operations of the European Financial Stability Facility (EFSF) bailout fund by giving it the power to “leverage” its assets.
Such moves, still resisted in Europe, might involve the fund giving cross-guarantees to the European Central Bank to insure it against any losses on its interventions in sovereign bond markets. European leaders may also be asked to expand the fund’s top-line lending capacity – €440 billion, under current plans – but that is something that Merkel rejected only last month.
Also in question is the extent to which they respond to growing demands to reinforce vulnerable banks with new capital. The concern here centres on French banks, under siege amid fear of a Greek default, and on certain lenders in Germany and Spain.
While Europe has long insisted it was sufficient merely to recapitalise the banks that failed a stress test in mid-summer, the message yesterday from Almunia was unambiguous.
“The worsening of the sovereign debt crisis, its impact on a fragile banking system and the continuing tensions in funding markets, all point to the possible need for further recapitalisation of banks, on top of the nine that failed the stress tests earlier this year,” the commissioner said.
This mirrors the stance adopted by the IMF and underscores mounting frustration at the failure of political leaders to settle the emergency.
As the heat comes off the global economic recovery, all these knotty questions reflect growing anxiety about the potential for the euro crisis to ripple far beyond the frontiers of the single currency zone.
Chinese leaders are bellowing down their megaphones at Europe, while Brazil is talking about sending emergency aid via the IMF.
In the US, meanwhile, the Federal Reserve is expected to take exceptional measures today to lower long-term interest rates in a new effort to stimulate growth.
That the IMF pointedly told the ECB to cut rates and continue its contentious bond-buying campaign suggests a heightened concern about the divisions in the top echelon of the Frankfurt-based institution.
Until last week at least, the thrust of political debate in Europe centred on the execution of decisions made in July to reinforce the EFSF.
Parliamentary approval is still awaited in most euro countries for these reforms, which would give the EFSF powers to intervene in sovereign bond market like the ECB.
These moves are controversial in their own right. German Bundesbank chief Jens Weidmann said in a submission to a parliamentary committee in Berlin that the fund’s new powers would increase the burden on financially strong countries.
“These decisions are another big step toward a collective liability and reduce the disciplining function of capital markets without strengthening control and influence on national fiscal policies in return,” he said.
Still, Europe is now under serious pressure to give yet more powers to the fund. This flows directly from concern that further measures will be required to help ease doubt about Italy, the third-largest euro zone economy.
S&P’s downgrade yesterday serves to amplify such anxiety. Italy is under pressure from markets as never before and dependent on emergency ECB bond purchases to keep its borrowing costs in check.
Yet leaked phone transcripts show prime minister Silvio Berlusconi to be preoccupied with his carnal assignations, while boasting that official duties are a matter for his “spare time.” No wonder S&P doubts his government’s ability to “respond decisively” to the problems it faces.
This is the backdrop against which Geithner pushed last week for leveraging powers for the EFSF to support the ECB’s bond initiative.
These would mirror measures under which the US treasury gave credit protection to the Federal Reserve Bank of New York when it intervened in markets to keep consumer credit flowing.
Geithner was politely rebuffed in Poland, but told Bloomberg Television late on Monday night he was confident Europe would soon follow Washington’s lead.
“I think you’re going to see them draw on the lessons of our crisis, draw on the lessons of things that worked here in the United States,” he said.
It remains to be seen whether he is right, but there is no doubting that the turmoil has reached a new level. Some people in Brussels simply shake their heads when asked how bad it is.
Arthur Beesley is European Correspondent