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Eurozone rescue

March 26, 2012

German resistance to a larger bailout fund for the eurozone might be weakening, but forces within Berlin's coalition government are still resisting a planned boost to the European Stability Mechanism.

The euro symbol painted on a wall
Image: Fotolia/K.F.L.

The European Stability Mechanism (ESM), the permanent rescue fund meant to stop the spread of the debt crisis, is to take effect in the summer.

But just how high this "firewall" will be has been a topic of discussion in the European Union for months. German Chancellor Angela Merkel at first insisted that the upper limit should not exceed 500 billion euros ($663.2 billion).

But on Monday, the chancellor announced a change of course. The ESM and part of the current temporary rescue fund known as the European Financial Stability Facility (EFSF) will now run parallel to one another, generating a combined lending volume of 692 billion euros.

Merkel had hesitated to issue a decision, saying the final decision on the ESM's limit would only be reached in time for the meeting of EU finance ministers in Copenhagen at the end of the month.

Double the rescue fund?

Nearly all the finance ministers in the 17 eurozone member states now think that the 500-billion-euro limit is insufficient. Olli Rehn, EU Commissioner for Monetary Affairs, has recently suggested that the fund be increased to nearly twice that amount.

European Economic and Monetary Affairs Commissioner Olli Rehn
Rehn has suggested combining the EFSF and the ESM to boost the firewallImage: Reuters

Rehn has suggested combining the 440-billion-euro EFSF with the permanent ESM, amounting to a potential financial heft of 940 billion euros. According to the European Commission, this is the only way to protect the financial markets from speculation against Spain and other ailing eurozone economies.

But Rehn's scenario means that Germany would need to increase its contribution beyond its current threshold of 211 billion euros.

Berlin seeks compromise

Doubling the fund was a step too far for the chancellor. Her governing partner, the Free Democrats, and parts of her own conservative Christian Democratic Union, have openly opposed such an increase.

Horst Seehofer, head of coalition party CSU, declared in Munich that distribution of the emergency funds will occur in packages just as in Greece.

"We will treat them just like we have in the past - always with the approval of parliament on each specific decision," Seehofer said.

German credits would not be issued all at once, particularly since it will take years for the permanent ESM to reach its actual volume. The shareholders, in this case EU states, have to pay their own money into funds in Luxembourg, which occurs in instalments.

Klaus Regling, head of the EFSF in Luxembourg, told the magazine "Focus" that the need for more money at the moment is difficult to prove in light of the relatively calm situation. But money calms the markets, he added, saying, "Putting big numbers in the window creates calmness."

Changing course

Finance Minister Wolfgang Schäuble developed the plan to increase the rescue fund. Schäuble, who in November abruptly dismissed any talk of an increase, came to favor a model in which the old EFSF and the new ESM would run in parallel for a time. This would allow the lending volume to increase to 600 billion euros, without drastically increasing the German share of the bailout risk.

Schäuble's plan seems to have made the idea of an increase more palatable to the coalition partners. Michael Meister, deputy chief of Merkel's CDU, has said it's clear that the rescue fund must be increased; now it's just a question of what form it will take.

The German parliament is to consider the new laws concerning the ESM in May. Already, the opposition Social Democrats have accused Merkel of being in "breach of promise."

International pressure

Angela Merkel and Wolfgang Schaeuble
Schäuble has been working on a new variation for the rescue fundImage: dapd

Meanwhile, the International Monetary Fund is to decide mid-April whether to establish a special fund for Europe. IMF head Christine Lagarde has emphasized repeatedly that this would only be done if the Europeans make more of a contribution.

And at the last meeting of the G20 finance ministers, US Treasury Secretary Timothy Geithner said Europe couldn't count on more IMF money as long as their firewall protection was too low. EU heads of state decided in December to provide 300 billion euros in fresh loans to the IMF, intended for Europe, but this plan has not been pursued further.

Fire chief Draghi

The largest European firewall so far was set up by Mario Draghi, the head of the European Central Bank. He lent European banks around 1 trillion euros at the lowest interest rates to prevent a credit crunch and boost the purchase of government bonds.

"We had to act," said Draghi in an interview with German tabloid Bild. "The worst is over, but risks still remain." Draghi, given a Prussian spiked helmet by Bild's picture editors, said Germany's economic growth and stability served as a "role model" for the rest of the eurozone.

But Jens Weidmann, head of Germany's Federal Bank, has criticized the move to flood banks with cheap money, calling it a secret financing of government debt by printing money. He said that could lead to inflation, the opposite of stability. "There can be no compromises in achieving the goal of price stability," Weidmann said at a recent conference in Frankfurt.

The Organization for Economic Cooperation and Development (OECD) has warned Europe to bolster its defenses against possible speculation on the financial markets. "We must build the mother of all firewalls," OECD Secretary-General Angel Gurria told the business daily Handelsblatt. "The thicker and more impressive it is, the less likely it is that we will need it."

The risk that Spain and Portugal could become the next victims of the financial crisis has by no means been averted, added Gurria.

Author: Bernd Riegert / cmk
Editor: Ben Knight