European governments sought to quell the market turmoil menacing the euro, handing Ireland an 85 billion-euro ($113 billion) aid package and diluting proposals to force bondholders to bear some cost of future bailouts.
European finance chiefs ended crisis talks in Brussels yesterday by endorsing a Franco-German compromise on post-2013 rescues that means investors won’t automatically take losses to share the cost with taxpayers as German Chancellor Angela Merkel initially proposed to the consternation of bond traders.
The twin decisions were not enough to placate investors today that the crisis is now contained. Irish 10-year bonds erased an early advance, European stocks and the euro declined and the cost of insuring the debt of Spain and Portugal against default soared to record highs.
“The notion that a rescue package for Ireland would create a firewall and stop the fear of contagion is clearly discredited,” said Preston Keat, director of research at Eurasia Group, a political consultancy, in London. “Portugal and Spain are already facing pressures in the markets.”
Six months after the Greek rescue exposed flaws in the euro’s makeup and fueled doubts whether 16 countries belong in the same currency union, policy makers again found themselves meeting on a Sunday racing to calm markets. In a third move yesterday, Greece was told it could have an extra four-and-a-half years to repay emergency loans totaling 110 billion euros to match the seven-year term under Ireland’s deal.
The euro depreciated against all but one of its 16 major counterparts after sliding 3.2 percent against the dollar last week. The Stoxx Europe 600 Index retreated 0.8 percent to 264.54 at 12:52 p.m. in London.
The yield on Spanish 10-year bonds rose 14 basis points to 5.35 percent, the highest since 2002. That pushed the premium over German bunds to 261 basis points, within 4 basis points of the euro-era record. Portuguese 10-year yields climbed 9 basis points to 7.23 percent and similar-maturity Italian bond yields rose 11 basis points to 4.54 percent. The return on Irish bonds increased 6 basis points to 9.42 percent.
Germany, which built the euro on the principle of budgetary rigor, unleashed the latest phase of the crisis by demanding a “permanent” system as of 2013 that would enable fiscally troubled countries to restructure their debts and cut the value of bond holdings.
The German push ran into criticism from policy makers elsewhere, who called it mistimed, and from European Central Bank President Jean-Claude Trichet, who warned it would unsettle bondholders. Merkel, who has faced domestic criticism for aiding EU neighbors, yesterday backed away from the pitch for an automatic penalty, agreeing to give the International Monetary Fund a role in determining losses on a case-by-case basis.
The new proposal, fast-tracked from a debate set for December, would introduce “collective action clauses” for debt sold as of 2013, enabling fiscally hard-hit governments to renegotiate bond contracts. EU governments aim to enshrine it in the bloc’s treaties by mid-2013 and pair it with a new emergency liquidity fund to replace the one expiring then.
Trichet yesterday called the compromise a “useful clarification” and the ECB’s Governing Council said that the Irish program will “contribute to restoring confidence and safeguarding financial stability in the euro area.”
“There’s plenty of herd behavior in the market,” EU Economic and Monetary Affairs Commissioner Olli Rehn said. “We want to clarify any possible confusion.”
Germany’s export-led economy has powered through the euro crisis, with business confidence at a record high in November and the government projecting expansion of 3.7 percent this year, the fastest pace in more than a decade. That resilience contrasts with recession in Greece and Ireland, splitting the euro region between better-off countries in Germany’s economic slipstream and poorer ones on the continent’s fringes.
Yesterday’s decisions bring “hope of preventing contagion spreading to other countries but do not address long-term solvency issues,” said Andrew Bosomworth, a Munich-based fund manager at Pacific Investment Management Co. “It’s a kick-the-can-down-the-road solution as opposed to acknowledging and confronting the here-and-now insolvency problems.”
Ireland said it will pay average interest of 5.8 percent on the loans, which break down into 45 billion euros from European governments, 22.5 billion euros from the IMF and 17.5 billion euros from Ireland’s cash reserves and national pension fund.
“I don’t believe there were any other real options,” Irish Prime Minister Brian Cowen told reporters in Dublin.
A day after more than 50,000 protesters marched through Dublin to denounce Cowen’s budget cuts to stave off financial ruin, the EU gave Ireland an extra year, until 2015, to get its budget deficit to the euro limit of 3 percent of gross domestic product.
Including the bill for propping up Irish banks, the deficit is set to reach 32 percent of GDP this year, the highest in the euro’s 12-year history.
Cowen has overseen the collapse of Ireland’s banking system and public finances, leading to recession and unemployment near 14 percent. Cowen’s government is also unraveling. The Green Party, a junior coalition partner, wants elections in January, his party last week lost a special election for a vacant parliamentary seat and some of his own colleagues are slamming his leadership.
Close banking links led Britain, a non-euro user that didn’t contribute to Greece’s 110 billion-euro rescue in May, to contribute 3.8 billion euros to Ireland’s package.
“That is money we fully expect to get back,” Chancellor of the Exchequer George Osborne told reporters in Brussels. “It’s in everyone’s national interest and it’s in Britain’s national interest that we get some economic stability in Ireland and indeed across the euro zone.”
The deal for Ireland shifts attention to Portugal, which last week passed the deepest spending cuts in more than three decades with the goal of getting back under the EU’s deficit limits by 2012. HSBC Holdings Plc estimates it needs to find 51.5 billion euros over the next three years to meet its likely budget and bond redemption needs.
While Greece let the budget get out of hand and Ireland fell prey to a housing bust, Portugal suffers from a lack of competitiveness that kept average economic growth below 1 percent in the past decade. Its government has also been slower to cut its deficit than others, with the central government’s shortfall widening 1.8 percent in the first ten months of the year as Spain’s fell 47 percent.
Like Ireland, Portugal doesn’t immediately need money to run the government. It has completed this year’s bond sales and doesn’t face a redemption until April. The government debt agency plans to hold an auction of 12-month bills on Dec. 1.
“Portugal doesn’t see a need to ask for help,” German Finance Minister Wolfgang Schaeuble said yesterday.
Spanish Economy Minister Elena Salgado also reiterated that her economy -- the euro zone’s fourth-largest and almost twice the size of Portugal, Ireland and Greece combined -- won’t need aid either. As well as slashing its budget gap, the country has brought regional spending under greater control and half of its debt is held at home, limiting the threat of a withdrawal by foreign investors. It too doesn’t face the first of its 45 billion euros in bond redemptions next year until April.
Investors have nevertheless expressed worry that the EU’s bailout pot may be smaller than advertised and so not large enough to save Spain. HSBC’s sums show the country needs 351 billion euros over the next three years.
In practice, the EU may only be able to deploy 255 billion euros of the 440 billion-euro European Financial Stability Facility, according to Nomura International Plc. That’s because the rescue fund is financed by issuing bonds and to secure a AAA rating, governments agreed to set aside cash and to link lending to the creditworthiness of donors.
The rest of the bailout pool consists of 60 billion euros from the European Commission and 250 billion euro pledged by the IMF.
The reigniting of the crisis means the ECB may again postpone its exit from emergency measures just as it did at the height of the Greek turmoil. It’s likely to also provide more help to banks in Spain and Portugal and could ultimately extend its bond-purchase program to Spanish securities and maybe even conduct broader asset purchases, said Janet Henry, chief European economist at HSBC in London.
“We removed doubts and uncertainty and we must keep removing reasons to panic; we aim to take away speculators’ tools,” Finnish Finance Minister Jyrki Katainen told reporters in Helsinki today. Still, “there is no guarantee the crisis won’t continue, or even spread, despite the Irish loans.”