The weekend ended without any dramatic announcement about a multi-trillion euro bailout for the banking sector. But the elements of the bailout are being prepped. European officials are working on bolstering their bailout fund, known as the European Financial Stability Fund (EFSF).
After a weekend of being told by the United States, China and other countries that they must get more aggressive in their crisis response, European officials focused on ways to beef up their existing 440 billion-euro rescue fund.
Deep differences remained over whether the European Central Bank should commit more of its massive resources to shoring up Europe’s banks and help struggling euro zone member countries [...]
Markets fear that European banks could be dragged down by their exposure to Greece and other debt-strapped euro zone nations, and analysts say a bailout fund of around 2 trillion euros would be needed if the crisis spread to Italy and Spain.
A senior European official hinted that kind of firepower was being contemplated.
“We need to find a mechanism where we can turn one euro in the EFSF into five, but there is no decision on how we could do that yet,” the official said.
More anti-austerity protests raged in Greece, meanwhile, though the perspective of the people that have to suffer the consequences of protecting the banks doesn’t seem germane to European policymakers. Why Greece is bothering to knuckle under to such demands for another tranche of bailout money, when everyone believes they will go into default, doesn’t make a lot of sense to me.
With Greek government debt trading on the open market below 40 cents on the dollar, it is quickly approaching what debt experts call the recovery rate — the price investors would get for their bonds if the country officially defaulted.
In effect, that means investors have given up.
The Greek economy today is in depression, and the leadership there remains committed to acting as a pass-through for European bank funds. The German finance minister, Wolfgang Schäuble, said the first bit of common sense I’ve seen from a European official in a long time, telling the Institute for International Finance that the financial industry contributed to the sovereign debt crisis by making the bad loans in the first place, and that they had to pay a share of the cleanup costs. “Without a substantial contribution from financial institutions, the legitimacy of our Westernized capitalized systems will suffer.”
As Paul Krugman writes, all of these bailout options are destined for failure if the economic policies are the reverse of what’s needed in a time of recession.
Think of it this way: private demand in the debtor countries has plunged with the end of the debt-financed boom. Meanwhile, public-sector spending is also being sharply reduced by austerity programs. So where are jobs and growth supposed to come from? The answer has to be exports, mainly to other European countries.
But exports can’t boom if creditor countries are also implementing austerity policies, quite possibly pushing Europe as a whole back into recession.
Also, the debtor nations need to cut prices and costs relative to creditor countries like Germany, which wouldn’t be too hard if Germany had 3 or 4 percent inflation, allowing the debtors to gain ground simply by having low or zero inflation. But the European Central Bank has a deflationary bias — it made a terrible mistake by raising interest rates in 2008 just as the financial crisis was gathering strength, and showed that it has learned nothing by repeating that mistake this year.
As a result, the market now expects very low inflation in Germany — around 1 percent over the next five years — which implies significant deflation in the debtor nations. This will both deepen their slumps and increase the real burden of their debts, more or less ensuring that all rescue efforts will fail.
So Europe can protect its banks as much as they want, but the loans they gave to Eurozone nations will not be paid back unless those countries return to some manner of recovery. And the policies of the currency union are preventing that.
UPDATE: Rachel Donadio dares to actually describe the consequences for the Greek people of the actions of the government to desperately cling to the eurozone. Sample quote: “The government is increasingly at war with the citizens.”