EU Weighs Direct Aid to Banks as Antidote to Crisis

German Crisis Stance Challenged by EU Call for Direct Bank Aid
Jose Barroso, president of the European Commission, center, speaks with Angela Merkel, Germany's chancellor, ahead of a European Leaders summit in Brussels, on March 2, 2012. Photographer: Jock Fistick/Bloomberg

The European Commission challenged Germany’s remedies for the financial crisis, calling for direct euro-area aid for troubled banks and demanding a path to common bond issuance.

The commission, the European Union’s central regulator, sided with Spain in proposing that the planned permanent rescue fund, the European Stability Mechanism, inject cash to banks instead of channeling the money via national governments.

“Flexibility and speed of action will be of the essence,” Jose Barroso, the commission’s president, said in Brussels yesterday. He sought “not only flexibility in terms of instruments, but also in terms of speed of reaction of the so-called firewalls, in this case of the ESM.”

Proposals for more liberal use of European bailout money face resistance in creditor countries such as Germany, Finland and the Netherlands, the scenes of growing taxpayer opposition to adding to the 386 billion euros ($479 billion) already pledged to fight the crisis.

Germany showed no signs of easing its stance, as Steffen Seibert, Chancellor Angela Merkel’s chief spokesman, told reporters in Berlin that “the German position on the direct recapitalization of banks out of the European rescue funds is known.”

Signs of stress multiplied in financial markets. Investors relinquished returns for security, sending the yield on German two-year notes to zero yesterday. Italy’s 10-year yields declined for the first time since May 24 after rising above 6 percent yesterday for the first time since January. Spain’s 10-year yields fell 3 basis points to 6.58 percent.

The euro rose 0.2 percent to $1.2395 at 9:55 a.m. in Berlin.

Leaders’ Call

President Barack Obama held a videoconference with Merkel, French President Francois Hollande and Italian Prime Minister Mario Monti to discuss “developments in Europe,” the White House said in a statement late yesterday. Merkel faced calls by those three leaders at the Group of Eight summit this month to do more to spur growth and stem the debt crisis.

The commission packaged the bank-aid ideas along with a call for a European deposit-insurance program, designed to break the spiral of faltering governments and failing banks. It said it will make concrete proposals for common bond issuance -- also opposed by northern European donor countries -- and singled Spain out as the only country entitled to more time to cut its budget deficit.

Spain, the 17-nation euro area’s fourth-largest economy, is trying to simultaneously plug holes in regional budgets and detoxify its banks, all while struggling to lift the economy out of a recession.

‘Sever the Link’

Current EU plans call for the 500 billion-euro ESM to funnel bank-aid money through national governments and, ultimately, require those governments to pay it back. Direct recapitalizations by the fund “might be envisaged” and would “sever the link between banks and the sovereigns,” the commission said in a staff working paper.

Any discussion of creating that power would come once the permanent fund gets going in July, the commission said. A makeover of the fund’s aid tools requires a unanimous vote of the euro area’s 17 finance ministers, though ratification by national parliaments wouldn’t be needed.

Germany is spearheading resistance to direct European financing for banks because that would let governments bypass the conditions set for full aid programs, such as deeper budget cuts and more European intrusion into economic management. Finland is in Germany’s camp, Martti Salmi, a Finance Ministry official, said in a telephone interview.

Banking Union

The commission appealed for a “banking union” that would more tightly integrate supervision and create a pool of European funds to clean up banks with cross-border exposure and segregate their underperforming assets.

“It’s hard enough to bail out local banks let alone non-domestic banks,” said Harvinder Sian, a London-based fixed-income strategist at Royal Bank of Scotland Group Plc. “A crisis lesson so far is that big ideas coming from Brussels or the guys taking the money are noise up until the point that the Germans get on the same page.”

Part of the solution lies in “correct and transparent risk recognition” instead of putting off the reckoning, the commission said. In the wake of the European Central Bank’s unprecedented 1 trillion euros in long-term loans, some banks are still using the funds to buy sovereign bonds, binding them more closely to financially shaky governments, the commission said.

Watchful ECB

The central bank’s “accommodative” monetary policy with interest rates at 1 percent limits its scope for spurring the economy, the commission said. It estimated on May 11 that the euro economy will contract 0.3 percent in 2012.

In an assessment by staff economists, the commission said there is little room for deficit-plagued countries to push back planned savings to a later date. Such an easing-up would be punished by markets, it said.

“Member states which face high and potentially rising risk premia do not have much room for maneuver to deviate from their nominal fiscal targets, even if macroeconomic conditions turn out worse than expected,” according to the document.

Still, Economic and Monetary Commissioner Olli Rehn said Spain might be granted an extra year, until 2014, to bring its deficit down to the limit of 3 percent of gross domestic product.

Spanish Plan

Spain deserves that mercy -- denied to France and the Netherlands -- because it is the only euro-area country likely to still be in recession in 2013, Rehn said. The concession will only come if Spanish Prime Minister Mariano Rajoy’s government delivers a “solid, two-year budget plan for 2013 and 2014,” he said.

The commission, which gained new powers to police national budgets in response to the crisis, is trying to crack down on deficits without imposing policies that crimp the economy.

“Credibility of consolidation is one of the key factors,” the staff paper said.

The commission kept alive the debate over common borrowing by euro-area governments, already rejected by Merkel as at best a goal for the long term and not a way out of the current turmoil.

Debate over euro bonds flared at last week’s summit of European leaders, the first for Hollande after he took office vowing to challenge the German-dominated budget-cutting creed that has marked the crisis response.

Debt Fund

Ideas include a debt-redemption fund proposed by Germany’s council of economic advisers and different types of “stability bonds” sketched out by the commission last year. The commission is now working on more concrete proposals.

Passage of a deficit-limitation treaty and the adoption of two laws that further enhance central oversight of national budgets will help pave the way toward common bond sales, the commission said.

The commission is only asking for “a roadmap and a timetable, but an early confirmation of the steps to be taken will underscore the irreversibility and the solidity of the euro,” Barroso said.

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