German talk on euro is cheap

December 13, 2010, 4:36 PM UTC

Germany is changing its tune, but you can barely hear it above all the creaking and wheezing in the euro zone.

German finance minister Wolfgang Schauble this weekend ruled out ejecting a faltering country from the European common currency. He said the consequences would be “unforeseeable” and potentially as disruptive as the 2008 demise of Lehman Brothers.

Will 2011 bring more of the same?

That’s a welcome sign someone in Germany is coming to grips with reality. German leaders have spent recent months criticizing the profligate ways of their embattled euro zone neighbors Greece, Ireland, Portgual and Spain, though doing so now is pointless. Could a change of heart in Berlin point to a way out of the sovereign debt and banking crises consuming Europe’s periphery?

Perhaps the leaders of Europe’s strongest economy have concluded their earlier saber-rattling only unsettled the markets. That could mean a big shift as European officials meet this week to discuss how to get the Continent out of its bind.

But for now, the Germans are still opposing new policies that could help to bridge Europe’s yawning financing gap — which means all the talk is just a waste of time. And without serious action soon, a much bigger crisis could yet be upon us.

Next year “is going to be incredibly difficult,” said Desmond Lachman, a euro skeptic at the American Enterprise Institute in Washington. European policymakers want to persuade speculators to turn their attentions elsewhere, he said, but “the whole thing is already showing signs of fraying.”

The problem is manifold. Weak economies are being made to shrink their spending, deepening already serious recessions, because their euro membership prevents them from devaluing their currencies and exporting their way back to some semblance of health.

Investors have backed away from those heavily indebted nations’ debt, forcing bailouts of Greece and Ireland and raising fears of imminent crises in Portugal and Spain.

That seems to suggest letting weaker countries out of the euro would be best. But Europe’s banks would be crushed by such an outcome, as statistics released Sunday by the Bank of International Settlements confirm.

It said global banks have $2.28 trillion in exposure to the four weakest European states. German banks had $252 billion in exposure to Greece and Ireland alone at the end of the second quarter, BIS said; the comparable number for France was $170 billion. A default wouldn’t mean losses on those exposures dollar for dollar, but European banks are widely acknowledged to be undercapitalized and any big hit could send shockwaves.

“If you have a default in one of these peripheral countries, you could have a full-fledged banking crisis again on the Continent,” said Lachman. (See “Can the euro survive its ‘hair shirt’?“)

Accordingly, bond yields have risen even in Germany over the past month, on fears that taxpayers there will end up one way or another footing the tab for a peripheral bailout.

European ministers have responded by devising inventive responses to the weaker states’ financing problems. Under one plan, European Union members would be able to sell so-called e-bonds backed by the euro zone collective. This arrangement would bring down costs for weaker countries that have been locked out of the bond market.

Red ink everywhere

Under another plan, a credit line pledged jointly this summer by euro area members for the sake of funding bailouts of weaker states would be repurposed to purchase bonds issued by various struggling states.

The proposal would add to the bond purchases being made by the ECB and would give policymakers a bit more firepower in what promises to be a fight to the finish with investors dubious about the region’s finances and political will.

They could use all the help they can get. Euro zone countries will need to repay or refinance $750 billion in debt in 2011, according to one estimate.

And though outsiders like Lachman say the situation calls out for debt restructuring – slashing debt loads by forcing creditors to accept discounted repayment terms – the ever deepening bailout of the Irish banks suggests officialdom isn’t quite there yet, given potential consequences such as bond market lockout.

Admittedly, Germany and France did push in October for a plan to force private lenders to take haircuts in future sovereign debt restructurings. But as sensible as the idea is, it had the unpleasant effect of bringing the recent crisis to a head, which forced EU policymakers to put off implementation till 2013.

As for the e-bonds and the expansion of the European stability facility, Germany has opposed both proposals. Remarks this weekend by a top official at the ECB offer a reminder of the schism between the hard money crowd and those who desperately need a hand simply to keep their creditors at bay for another day.

“We are not in charge of fiscal policy,” said ECB executive board member Jurgen Stark. “Our mandate is not to make it easier for governments to refinance their debt.”

He’s right, of course, but saying that’s hardly the way to prevent Europe from reliving the Lehman Brothers nightmare.