German Finance Minister Wolfgang Schaeuble says the euro area’s firewall isn’t there to be used. Portugal has taken the hint.
As the government in Lisbon came to the end of a 78 billion-euro ($106 billion) bailout, Prime Minister Pedro Passos Coelho decided to take his chances on financial markets rather than seek the safety net of a precautionary credit line. Then Portugal passed up the last payment of its rescue program. In both cases, the political cost of meeting the conditions attached to aid outweighed the benefit, even after three years of recession.
In the four and a half years since Greece sparked Europe’s debt crisis, five countries have been rescued. The region’s leaders have rolled out a series of fire-fighting tools, most recently direct bank aid from the European Stability Mechanism, the euro firewall, loaded with onerous conditions for use. This joins the firewall’s bond-purchase, precautionary and now-expired leveraging instruments on the shelf of unused tools, designed amid great political fanfare and never deployed.
This built-for-show arsenal was made possible by European Central Bank President Mario Draghi’s pledge to do “whatever it takes” to save the euro. The resultant market calm alleviated the need for urgent action and allowed politicians like Schaeuble, deeply suspicious of rescues from the start, to shape Europe’s preparations for the next crisis.
“Thanks to Draghi all the crisis response tools have become almost obsolete,” said Carsten Brzeski, chief economist at ING-DiBa AG. “Thanks to the ECB, the obvious -- be it on purpose or not -- strategy of lengthening the final development of crisis-response tools endlessly, so that there is no need to use them anymore, has worked perfectly.”
Schaeuble welcomed Portugal’s decisions. After all, the Germans have been working consistently to make sure that any public aid comes with tough conditions and that recipients surrender some sovereignty in exchange for rescue cash.
If that means countries try to sort out their own problems and the aid goes untapped, so much the better. As Schaeuble said of the 500 billion-euro ESM, “the point of the ESM is that it isn’t used. That’s what we call prevention.”
At the height of the financial crisis, U.S. Treasury Secretary Timothy F. Geithner urged Europe to step up its firepower and break the cycle of contagion between banks and sovereign borrowers. EU leaders at one point were spooked enough to amass $1 trillion -- on paper -- for their firewall funds.
Instead, the ECB stepped into the breach, starting with 2012’s as-yet-untested Outright Monetary Transactions program for buying government bonds.
Guided by their goal of taking taxpayers off the hook in future bank crises, EU policy makers have also built in tough new rules for imposing losses on shareholders and creditors at failing lenders.
“It has become almost impossible not to bail in,” said Karel Lannoo, chief executive officer of the Brussels-based Centre for European Policy Studies. In this case of Deutsche Bank AG, this could reach 160 billion euros, he said, a level that might be financially ruinous.
The most recent addition to the banking union toolbox is the the ESM’s capacity to recapitalize banks directly, conceived by euro-area leaders in June 2012 as a way to “break the vicious circle between banks and sovereigns.”
Dutch Finance Minister Jeroen Dijsselbloem, who leads meetings of his euro-zone counterparts, promised that the tool would be available when the ECB publishes the results of its Comprehensive Assessment prior to assuming oversight of euro lenders on Nov. 4.
Yet the hurdles to be cleared are daunting, starting with losses on a bank’s shareholders and creditors equivalent to 8 percent of most liabilities. Cash in the host country’s share of an industry-financed resolution fund must also be drained, and the government must contribute as well.
Asked July 2 if he thought banks were likely to seek direct aid from the ESM after the ECB’s assessment, Dijsselbloem said: “I expect the likelihood to be very, very limited.”
Furthermore, the low ceiling on direct aid -- 60 billion euros -- means it could only react to a small or medium-sized financial crisis, said Jacob Funk Kirkegaard, senior fellow at the Peterson Institute in Washington. This doesn’t mean ministers might not raise it in a more serious crisis, just that its market-calming availability is offset by a perception that its existence might lure risk.
“Berlin doesn’t want a situation where the French or Italians, e.g. epicenters of a potentially large crisis, might feel that it is easier to simply rely on the new European rules,” Kirkegaard said.
Some tools will be gradually phased in, making them politically more palatable now. This group includes the common fund, filled by bank levies over eight years, that will back up the euro area’s new bank resolution authority.
And others have been kicked down the road. A proposal for a public backstop that could lend to the common resolution fund nearly derailed work on the euro-area bank-failure authority, until EU finance ministers agreed to water it down, committing only to develop a common backstop during the “transitional phase” as the fund is filled.
The U.S. experience with its Troubled Asset Relief Program, which recapitalized a wide swath of American banks, shows that any systemic crisis requires a new round of political wrangling over how to handle the costs.
“That of course also makes it a lie, when politicians today say that taxpayers money will never again be used for a banking crisis in Europe,” Kirkegaard said. “They almost certainly will, but the threshold, and hopefully frequency, for their use has been raised substantially.”