A Show of Force in Europe, but Worries Linger
FRANKFURT — European leaders orchestrated a huge show of financial force Monday to halt a spreading debt crisis, drawing applause from investors but also questions about whether the nearly $1 trillion rescue package merely postponed a reckoning with the euro area's underlying problems.
Markets rallied around the world in response to the extraordinary show of solidarity in defending the euro, which topped even the U.S. government's support for its collapsing financial system in 2008. A broad index of European blue chips closed up more than 10 percent and Wall Street was up more than 3 percent in afternoon trading.
The risk premium on Greek bonds nearly halved as the European Central Bank said it would buy government bonds directly for the first time ever.
But analysts pointed out that the package did nothing to reduce overall debt — it just spread it onto more shoulders.
There will also be a risk that, by in effect shielding Greece, Portugal, Spain and other over-indebted countries from the harsh verdict of the open market, the measures will make it harder for political leaders to overcome public resistance to the deep budget cuts needed to get spending and borrowing under control.
In what could be a sign of continued jitters, the euro gave up much of its early gains on Monday and interbank lending rates remained elevated. Moody's Investors Service also announced that it might cut Greece's credit rating to junk within the next month, citing the country's "dismal" economic prospects.
"Lending more money to already over-borrowed governments does not solve their problems," Carl Weinberg, chief economist of High Frequency Economics in Valhalla, New York, said in a research note. "Had we any Greek bonds in our portfolio, we would not feel rescued this morning."
Robert Barrie, head of European economics at Credit Suisse, paraphrased Winston Churchill: "It's not the end, I'm not even sure it's the beginning of the end." But, he added, "it takes us away from the threat of a crisis."
Jean-Claude Trichet, president of the E.C.B., said the central bank's governing council decided to prop up the bond market and inject cash into the European banking system because "the channels of normal monetary policy were not functioning." Only four days earlier, Mr. Trichet had insisted that the council had not even discussed bond purchases.
The E.C.B. action Monday also included measures, together with the U.S. Federal Reserve and other major central banks, to provide banks with dollars through the use of currency swaps.
The swaps are intended to make it easier for European companies, institutions and governments to borrow dollars when they need them, "and to prevent the spread of strains to other markets and financial centers," the Fed said in a statement from Washington.
The scale of the E.U. rescue program — €750 billion, or $957 billion — recalled the $700 billion package the U.S. government provided to help its ailing financial institutions in late 2008. That package, known as the Troubled Asset Relief Program, or TARP, also cheered markets at the time, but the uplift proved temporary until much later, after the broader economy, and U.S. banks, began to recover.
The E.U. package, reached after hours of meetings that lasted until early Monday, includes €440 billion in loan guarantees and €60 billion under an existing lending program. Elena Salgado, the Spanish finance minister who announced the deal, also said that the International Monetary Fund was prepared to provide up to €250 billion separately.
One major difference between the European bailout and the TARP plan, however, is that Europe is hoping that the fund will not be activated. After the Lehman collapse, there was always a certainty that the TARP would be deployed as soon as it was approved by the U.S. Congress.
Indeed, for all the excitement about the numbers, it is important to remember that the headline €440 billion number does not now exist. It is a commitment by E.U. governments to borrow such an amount if a large economy like Spain, which represents 12 percent of euro-zone gross domestic product, asks for it — and then have the I.M.F. contribute about half of what Europe lends.
By definition, if it came to such a point, interest rates would climb and the billions of euros that the special purpose vehicle would have to raise from the markets would not only come at a high cost, but would increase the debt levels of the likes of Portugal, France, Italy and Britain, thus compounding the region's heavy debt woes.
In the months ahead, investors are likely to closely scrutinize monthly budget figures from European governments, which previously went almost unnoticed.
"You definitely would want to see these additional austerity measures, especially Spain and Portugal," said Elga Bartsch, an economist at Morgan Stanley in London. "They all seem to be moving and getting more serious in addressing the underlying problem."
On Monday, Mr. Trichet warned European governments, all of whom are likely to miss the budget deficit targets they agreed to when they formed the euro, that they must continue to cut government spending.
"For us what is absolutely decisive is the commitment of governments of the euro area to take all measures needed to meet their fiscal targets this year and in the years ahead," Mr. Trichet said at a press conference in Basel, Switzerland.
He declined to say how much money the bank would spend buying government bonds on open markets, via the euro-zone's national central banks — a process that began Monday.
The E.C.B. also said that it would resume offering unlimited cash for up to six months at the benchmark interest rate of 1 percent for banks that post the necessary collateral.
The Bank of Japan joined in the global response, saying after an emergency board meeting Monday that it would pump ¥2 trillion, or $21.6 billion, into financial markets for a second consecutive trading day.
The overall package was much larger than expected, and represented an audacious step for a bloc that had been criticized for acting tentatively, and without unity, in the face of a mounting crisis.
At the same time, the sheer size of the package will strain the unity of Europe's fractious governments, especially when leaders like Nicolas Sarkozy of France or Angela Merkel of Germany are losing ground politically. Ms. Merkel's Christian Democrats lost power in North Rhine-Westphalia, Germany's most populous state, in elections Sunday.
In effect, Germany and other wealthier European countries are assuming responsibility for the creditworthiness of Greece, Portugal and the other debt delinquents, as if the U.S. government were bailing out California.
But the European central government is weak and must invent new structures to administer the promised aid.
"The debt crisis will change the nature of European monetary union," Jörg Krämer, chief economist at Commerzbank, argued in a note Monday. "The euro zone has moved away from a monetary union and towards a transfer union."
Mr. Krämer warned that the shift "can undermine political support for the euro zone in the long run. After all, it is unlikely that the countries receiving support will let others permanently dictate their economic policies. Moreover, voters in the countries giving support will not be willing to permanently give financial support to other countries."