Europe Pushed to Bolster Defenses to Lock in Crisis Respite

U.S. Treasury Secretary Timothy Geithner
U.S. Treasury Secretary Timothy Geithner said, The only way Europes going to be successful in holding this together, making monetary union work, is to build a stronger firewall. Photographer: Scott Eells/Bloomberg

European governments were warned against complacency as U.S. and International Monetary Fund officials told leaders at the World Economic Forum to strengthen their crisis defenses.

With policy makers dominating the third day of the meeting in the Swiss resort of Davos, U.S. Treasury Secretary Timothy F. Geithner yesterday urged the euro area to boost its cache of bailout cash and protect Italy and Spain against the threat of a market rout. IMF Managing Director Christine Lagarde pressed Greece and its creditors to strike an agreement on cutting its debt burden. European Union officials say an accord may be imminent.

“The only way Europe’s going to be successful in holding this together, making monetary union work, is to build a stronger firewall,” Geithner told delegates in Davos.

The pressure reflects concern that Europe must still do more to defeat its debt crisis even after money market lending rates eased, Italian and Spanish bonds rebounded and stocks jumped. With European leaders meeting in Brussels on Jan. 30 to discuss their next steps, Fitch Ratings underscored the threat facing the region by downgrading Spain, Italy and three other euro countries yesterday.

“The sense of despair and inevitable failure in Europe has receded, but leaders now have only a short period to work through reforms or the crisis will be back,” said Barry Eichengreen, a professor of economics at the University of California, Berkeley.

Economists Nouriel Roubini and Robert Shiller today warned the conference that the euro-zone will suffer a deeper recession than the IMF forecasts with Roubini predicting Greece may leave the single currency bloc within a year.

“The euro zone is a slow-motion train wreck,” Roubini said.

Europe’s Woes

Europe’s woes topped the agenda of the Alpine meeting two years after Greek officials first toured Davos’s conference hall in an ultimately futile bid to rally confidence in their bonds. Billionaire investor George Soros told Bloomberg Television yesterday that Greece remains the region’s weakest link as talks continue over reducing the nation’s debt burden.

“If Greece defaults it should not be the end of the world,” Soros said. “But the rest of Europe needs to be sufficiently ring-fenced, and not enough has been done.”

That was also the message of Geithner, who used his sixth trip to the continent since September to call for more resources to be committed. While the IMF can help, its resources can’t be used as a “substitute for a more effective” domestic response, he said.

Weekend Agreement?

Separately, IMF chief Lagarde said she was pleased to see Greece and bondholders going “back to the drawing board” as they try to narrow differences three months after investors agreed to cut by 50 percent the value of more than 200 billion euros ($264 billion) of debt.

The swap “has to be significant,” Lagarde said. “You don’t do this every now and then, so you have to do it right.”

EU Economic and Monetary Affairs Commissioner Olli Rehn said in Davos that an agreement may come over the weekend.

The size of Europe’s rescue funds will be discussed in March when leaders reassess a planned combined aid limit of 500 billion euros which kicks in when a permanent fund runs alongside a temporary bailout program from July. They can also use leverage to boost that amount toward a level the IMF and U.S. may deem more satisfactory.

“The higher the firewall, the less it will have to be used,” French Finance Minister Francois Baroin said yesterday. Spanish Economy Minister Luis de Guindos, said it “has to be big enough and flexible enough to avoid using it.”

ECB Caution

German Finance Minister Wolfgang Schaeuble nevertheless said that no amount of money would compensate for failure by cash-strapped countries to regain control of their debts and increase competitiveness. “It will not work if the real problems were not solved,” he said on a panel discussion.

As Davos delegates headed out to dinners and parties on last night, Fitch cut Italy two notches to A-. The rating on Spain was downgraded two levels to A. Belgium, Slovenia and Cyprus were also lowered.

“The gradualist approach adopted by politicians to systemic reform will continue to be punctuated by episodes of severe financial volatility, entailing a significant economic and financial cost that erodes sovereign creditworthiness,” Fitch said in an e-mailed statement.

Underlining the sense that Europe isn’t safe yet, European Central Bank President Mario Draghi said he doesn’t yet have evidence that the cash released by the bank’s long-term market operations is reaching households and businesses.

The ECB lent euro-area banks a record 489 billion euros for three years in December to ward off a funding squeeze. That has won plaudits throughout the week from Davos delegates.

Draghi “deserves great respect,” former U.S. Treasury Secretary Lawrence Summers told Bloomberg News. “It’s a mistake to lose sight of the fact that substantial time has been bought.”

Stocks Rebound

The gap between the overnight indexed swap rate and the cost of borrowing for three months in euros has declined 22 basis points to 78 basis points after last month touching the highest since March 2009. The euro headed for a second weekly gain versus the dollar and the Stoxx Europe 600 Index this week entered a bull market by climbing 20 percent from its September low.

With Draghi saying the financial system will have normalized when banks lend to each other again, some in Davos suggested that may be starting to happen.

“There is evidence Europe is starting to turn a bit of a corner,” John Phizackerley, Nomura’s chief executive officer for Europe, Middle East and Africa, said in an interview. “If we can free up European markets and access non-government money, it’s the beginning of the end.”

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