Q+A – Why is the euro zone failing to contain the crisis?

By Andrew Torchia

LONDON, May 7 (BestGrowthStock) – Here are factors behind the
failure of euro zone policy makers to contain the spread of the
Greek debt crisis through financial markets, drawing on the
lessons of past financial crises.

LACK OF PREEMPTIVE ACTION. An International Monetary Fund
study of the Asian financial crisis of the late 1990s, published
in 1998, said early action by policy makers was crucial in
preventing crises from building.

In 1998, when a Russian debt default caused global jitters
about sovereign credit risk and hit hedge fund Long-Term Capital
Management, which had assets of over $120 billion, quick action
by the U.S. Federal Reserve appeared to prevent a wider crisis.
Within several weeks, the Fed organised a bailout of LTCM; it
cut interest rates three times in three months. Another IMF
study found, “The Federal Reserve actions may have staved off a
far more dramatic crisis.”

Because of the reluctance of Germany and some other euro
zone governments to participate, this week’s 120 billion euro
($140 billion) bailout of Greece was assembled about six months
after the crisis began building. By that time Greece’s 10-year
bond yield had soared above 10 percent, effectively shutting it
out of the debt market.

The European Central Bank took one preemptive action this
week, suspending its minimum credit rating standards for Greek
government bonds used as collateral in its money market
operations; this will allow continued use of the bonds if Greece
is downgraded by more rating agencies. But the ECB, seeking to
protect its reputation for conservative monetary management,
said on Thursday it had not even discussed taking the one
radical step that some analysts believe is necessary to calm the
markets: buying government bonds from the market.

The delay in taking action has narrowed policy makers’
options. Some analysts think restructuring Greece’s 300 billion
euro debt is inevitable to cut the problem to a manageable size,
but the markets now seem too unstable to negotiate that without
causing fresh panic. German Finance Minister Wolfgang Schaeuble
said on Thursday any restructuring of Greek debt would cause
“exactly the kind of conflagration that we could no longer

snowballed over five months in 1997 as first Thailand, then
Indonesia and South Korea requested and obtained IMF aid.
Markets began a broad-based recovery only after the IMF had
dealt with all the major weak spots in the region.
Stephen S Roach, chairman of Morgan Stanley Asia, said of
the Greek crisis this week: “In some respects what is going on
in southern Europe right now feels a lot like what went on in
south eastern Asia in summer 1997 with the crisis in Thailand.
It then spread.

“You can’t stop pan-regional vulnerabilities by addressing
the weakest link if there are lots of weak links. It’s difficult
to stop the bleeding with a package directed at only one

So far, euro zone policy makers have insisted there is no
question of any need for bailouts of Portugal, Ireland and
Spain, widely seen as the next potential “dominoes” in the
crisis. More bailouts would be controversial among euro zone
taxpayers; officials may also fear talk of more bailouts would
scare markets. But if policy makers do not admit the
possibility, they risk seeming blind to the scale of the danger.

turning around during the global financial crisis of 2007-2009
after policy makers promised sums of emergency aid that seemed
more than sufficient for almost any scenario.

For example, the U.S. Troubled Asset Relief Program, which
was used to aid banks, the auto industry, insurer AIG and many
other recipients, totalled $700 billion when it was approved by
Congress in 2008. The Treasury has since said it does not expect
to deploy more than $550 billion, and has actually disbursed
less than $400 billion.

The 110 billion euro ($140 billion) package of emergency
loans for Greece is billed as a three-year bailout but may not
be large enough to cover the full three years. Economists at
several European financial firms estimate Greece’s borrowing
needs through end-2012 at 120 billion euros; Germany’s Bild
daily cited a government estimate of 150 billion euros given to
the parliamentary finance committee.

Greece will therefore need to resume borrowing from the
markets some time in the next three years. Analysts fear that
given the scale of Greece’s debt problem, this may not be
possible. After the Russian default of 1998, it took two years
for the first Russian entity, a bank, to return to the
international debt market; Argentina has still not done so after
defaulting in 2002.

DISAGREEMENTS AMONG DONORS. The U.S.-led bailout of Mexico
in 1995 was complex and controversial, including contributions
from the IMF, the Bank for International Settlements and the
Bank of Canada. It faced public opposition within the United
States, where Congress balked at passing it, and some European
creditors expressed concern that their interests could be hurt.
However, Washington took unchallenged leadership of the bailout,
which convinced markets that Mexico would be rescued. President
Bill Clinton bypassed Congress by invoking emergency powers to
provide $20 billion.

The Greek bailout has been marked from the start by
difficult negotiations among euro zone governments on the
language of the aid pledge, the structure of the deal, and
whether and how to involve the IMF. ECB policymakers opposed the
role of the IMF before expressing approval of it when the
bailout was announced. These disagreements have left markets
wondering whether the commitment of key donor countries such as
Germany to the bailout could fade over time, especially if
Greece does not hit fiscal conditions in the deal.

Since the announcement of the bailout, policy makers have
continued to sound at odds on some issues. Germany has asked its
commercial banks to contribute to the bailout and said other
European banks are likely to contribute too, but French and
Italian officials have said banks in their countries are not
being asked to do so.

Euro zone governments have stressed the Greek bailout is a
one-off deal and they do not have an explicit, permanent
mechanism for bailouts, meaning the rescue of another weak
country such as Portugal could require additional months of
negotiations. The European Commission is to propose a permanent
mechanism for handling crises on Wednesday, possibly drawing on
a German proposal for a European Monetary Fund, but its creation
may require controversial changes to the European Union Treaty
that would require many months.

BLAMING THE MARKETS. Euro zone policymakers and officials
have repeatedly blamed excessive speculation, rather than
countries’ fiscal weaknesses, for much of the markets’
volatility. They have demanded a “crackdown” on speculators and
on Friday, the Committee of European Securities Regulators
launched a consultation process to introduce mandatory
transparency rules for derivatives linked to foreign exchange,
equities, interest rates and commodities.

“To some degree this is a battle between the politicians and
the markets,” German Chancellor Angela Merkel said on Thursday.
“But I am firmly resolved — and I think all of my colleagues
are too — to win this battle.”

Many analysts view such rhetoric as counter-productive, by
suggesting policy makers are more concerned with scoring
political points than in addressing root causes of the crisis.

(Editing by Jason Webb

Q+A – Why is the euro zone failing to contain the crisis?