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Assessing the Risks of a Euro Zone Bailout for Greece
Jon Levy explains why Germany's idea faces an uphill political battle.
The European Monetary Fund would probably be modeled on an existing balance of payments support facility, which the EU currently uses for eastern European countries. The idea is to smooth over financing risks while these countries move toward euro membership. This is a classical lender of last resort model, and it is consistent with EU and euro zone interests; loan conditions are structured to help countries meet limits on debt and annual deficits. In fact, this same facility was used to loan money to Greece as it prepared to join the euro zone.
However, once a country adopts the common currency, it is no longer eligible for this support, meaning that the euro zone has no tools to prevent a sovereign financing emergency. If Greece were to get an emergency loan today, it would be arranged on a purely ad hoc basis. The absence of a formal mechanism would compromise the effectiveness of financial support because uncertainty about both borrower and lender intentions would persist. While the IMF is another option, Euro zone policymakers are deeply concerned that IMF involvement in the euro zone could prompt irreconcilable institutional conflicts at some point.
Schaeubles concept would fill this institutional void by setting up a fund to ease euro zone countries through rough financing patches in exchange for policy adjustment intended to meet EU debt and deficit rules. Funded by all euro zone members and able to issue bonds, the facility would dramatically lessen uncertainty about political will among the lenders a vital element of bolstering credibility in financial markets, and among potential recipients.
However, the concept as it is currently envisioned would do nothing to deal with what might prove to be a much more significant problem in the euro zone and the EU a banking crisis that exceeds the capacity of a single government to manage, or which affects a bank with operations in multiple countries, thus obfuscating the lines of responsibility for crisis management and recapitalization.
The intellectual roots of the European Union are formed of a view that economic integration and interdependence can prevent the emergence of conflict a powerful and enduringly urgent requirement in Europe. This tradition has been enshrined through the development of a single market and open capital flows, which in turn fostered the development of an extensive cross-border banking market.
The lessons of the inter-war period, which are so vital to the ideas of political and economic union in Europe, also recall the dramatic risks of banking failure and of how an institutional failure can precipitate the transmission of economic strains across borders.
Over the last two years, several EU governments have nationalized, recapitalized or otherwise supported banks. The ECB and other EU central banks have extended enormous liquidity facilities to banks. Yet, any attempt to build a lasting, credible and adequately financed pan-national banking sector support facility has been a complete non-starter a French proposal in 2008 to set up a 300 billion fund was quickly shot down. In the absence of such an institution, a banking crisis of the sort described above will bring to light all of the uncertainties now evident with regard to financing for Greece.
These problems will even be worse because the opacity of the banking sector. The extent and diversity of inter-bank links will hinder efforts by governments to adequately assess the nature of the problem. By comparison, Greek public finances will look straightforward.
Schaeubles European Monetary Fund idea faces an uphill political battle, but it can at least prompt a new debate and it could end up forcing EU policymakers to negotiate a new economic policy treaty. Such a process would provide an optimal opportunity to finally deal with the glaring absence of a true European crisis containment capability.
Jon Levy is a Europe analyst at Eurasia Group.