Euro Area Grapples With ESM Rules as Legacy Assets Loom

Euro-area finance ministers staked out their turf in a brewing battle over bank rescues amid German and Austrian warnings that direct bailouts won’t be widely available.

Ministers seek an agreement in the first half of this year on how and when the 500 billion-euro ($668 billion) European Stability Mechanism can bypass governments and provide direct help to banks. Ireland and France led calls at a meeting of euro finance chiefs in Brussels yesterday for work to proceed quickly so the new tool can be ready as quickly as possible.

Some creditor nations countered that direct bank aid shouldn’t start until the European Central Bank takes up its new role as single supervisor within the currency zone, which isn’t expected until 2014. In the meantime, the ESM needs to leave its resources free to be a lender of last resort, German Finance Minister Wolfgang Schaeuble said.

“One has to damp further-reaching expectations because that would completely overburden the ESM,” Schaeuble told reporters after the meeting. He urged the euro area not to “repeat earlier mistakes” by raising hopes of aid that won’t materialize.

“We mustn’t relapse to create incentives that fall under the heading of moral hazard,” Schaeuble said. “We must keep decision-making power and liability close together.”

Bailout Payments

Bank bailout policy was the major open issue at yesterday’s meeting, which saw Dutch Finance Minister Jeroen Dijsselbloem take over from Luxembourg Prime Minister Jean-Claude Juncker as head of the so-called Eurogroup. The ministers welcomed progress in Greece, Spain and Portugal toward winning new bailout payouts and also said they didn’t expect to make a rescue deal with Cyprus until March.

With no do-or-die decisions to make, ministers instead were able to take a first run at sorting out who should benefit from the prospect of direct bank aid. French Finance Minister Pierre Moscovici said the new ESM tool is important and needed to safeguard the financial system.

“We can’t have a mechanism that is weak and unreadable,” Moscovici said. “Having that direct recap is part of this banking union. Priority means let’s go fast. Let’s be really ambitious.”

EU leaders dangled the prospect of direct bailouts as a way to assure investors that they would protect the euro from an onslaught of banking problems that threatened to overwhelm individual nations. Since then, they have relied on announcements from the European Central Bank to keep markets calm.

Bond Markets

Borrowing costs in bailed-out and debt-laden euro nations have plummeted since the ECB pledged to commit to backing their bond markets. Spain’s 10-year yield has declined more than 200 basis points. The cost of insuring Ireland against default has dropped 84 percent since July 2011.

The euro climbed 0.4 percent against the U.S. dollar today, trading at $1.3367 at 8:40 a.m. in Brussels.

With officials declaring the worst of the region’s three-year market emergency over, finance ministers debated whether the ESM should take over earlier bank bailouts that were routed through governments and what to do with so-called legacy assets. A European Union aide who briefed reporters last week defined those as loans already on a bank’s balance sheet that could cause problems in the future.

Noonan’s Call

Irish Finance Minister Michael Noonan called for some aid to be available “retrospectively” to banks that have received aid and are still doing business, like Bank of Ireland Plc, Allied Irish Banks Plc and Permanent TSB Group Holdings Plc.

“Banks that were still functioning, lending, trading banks would be eligible, even though insolvent banks on wind-downs mightn’t be,” Noonan said.

The actual amount of ESM funds available for direct aid to banks may be less than 100 billion euros because the fund needs to fulfill its main mission of lending to governments that lose market access, said Nicolas Veron, senior economist at the Brussels-based Bruegel research group. Bank aid may also require additional set-asides for the ESM to maintain a high credit rating.

Austrian Finance Minister Maria Fekter said the ESM shouldn’t lend to banks until the EU is closer to a more complete banking union.

Direct Recapitalizations

“You can’t say only because we have an agreement on a single supervisor, the way is clear for direct recapitalizations,” Fekter said going into the meeting. “All the burdens can’t be imposed on the net payers, even if the ailing countries want things to go faster.”

Incoming Eurogroup chief Dijsselbloem endorsed further progress on banking union, without taking a stand on the technical issues surrounding direct ESM aid.

“The completion of the banking union is essential in my view,” Dijsselbloem said. He called for the EU to press ahead with efforts to create a single resolution mechanism, along with harmonized deposit guarantee schemes and work toward a “single rulebook” for financial regulation across the region.

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