E.U. agrees on rescue plan for future financial crises

Friday, December 17, 2010

BRUSSELS -- European Union leaders agreed Thursday to change the bloc's main treaty to allow a permanent rescue plan for countries that run into financial trouble, but the region still faces rising pressure to solve its immediate debt woes.

Ratings agencies revealed new worries about Greece, where protests against debt-driven austerity measures turned violent Thursday. The far-larger Spanish economy is also facing worryingly higher borrowing costs.

The EU set up a temporary bailout fund this year but investors have been demanding stronger assurances that the bloc's divided leaders will protect their shared currency.

The treaty change contains no details but is a necessary legal step toward establishing a permanent mechanism for dealing with countries that can no longer pay off their debts.

It will by necessity include a permanent pot of money to bail out over-indebted countries. Officials also have said that it may contain language allowing the EU to force private creditors to assume some losses when a country can no longer pay off its bonds.

Finance ministers of the 27 EU nations will now begin working out details of the new mechanism, including how much money eurozone nations are willing to chip in and when exactly private creditors would be involved.

The treaty change will allow "member states whose currency is the euro" to "establish a stability mechanism to be activated if indispensable to safeguard the stability of the euro as a whole," a German official said. The official spoke on condition of anonymity.

Any aid to heavily indebted countries under the new mechanism would be "subject to strict conditionality," the official said. Such conditions would be similar to those imposed on Ireland and Greece in their bailouts, to cut their deficits and make their economies more competitive.

EU leaders had agreed to set up the so-called European Stability Facility at their previous summit in October and finance ministers outlined its broad features at the end of November.

"This is the best signal that we can make to show the absolute determination of the European leaders to do whatever is necessary to protect the euro, to protect financial stability and also to protect the European Union," European Commission President Jose Manuel Barroso said before the talks began Thursday.

Officials have stressed that the ESF won't apply to countries' existing debt loads and that it won't come into force until 2013.

In the meantime, those debt loads are worrying bond markets now.

European heads of state and government remained divided on whether bolder moves are necessary to reassure investors about the stability of the common euro currency. Analysts warn that weak growth, paired with worries over the health of the banks, will make it difficult for Portugal and Spain to pay off their debts, possibly forcing them to follow Greece and Ireland in seeking bailouts.

Further measures -- such as boosting the size of the region's 750 billion ($992.85 billion) bailout fund or introducing pan-European bonds -- have so far been blocked by Germany, Europe's biggest economy.

As leaders were meeting in Brussels, more questions arose over their current strategy to tackle the crisis, namely pushing highly indebted countries to get their finances in order and having the ECB buy up vulnerable bonds to stabilize borrowing costs.

Moody's Investors Service warned that "a multi-notch downgrade" of Greece's bonds was possible, since the country's debt turned out to be even bigger than expected. Greece was only saved from default in May by a 110 billion rescue loan from other eurozone nations and the International Monetary Fund.

The rating agency warned that support for the struggling nation might be less strong in the future than it had previously assumed, since it depended on Athens's ability to implement painful austerity programs and in how far bondholders would have to share the burden of any bailouts after 2013.

Many economists say that it will be impossible for Greece to garner sufficient economic strength by 2013 to pay off its debt load -- expected by then to reach 156 percent of gross domestic product.

The government in Athens is facing growing discontent from its citizens over the measures it has taken to cut the country's gaping budget deficit and improve its economic competitiveness. A general strike escalated into violence Wednesday, as unions and other demonstrators protested salary cuts and weakened collective bargaining powers.

Richer EU members are resentful at having to bail out overspending partners.

"Everybody has to stick to the rules and avoid that suddenly the Dutch taxpayer has to suffer for the abuse in Greece. Up to now, countries could get away with it," Dutch Prime Minister Mark Rutte said.

The European Central Bank also sent a strong political signal to EU leaders that they need to do more to salvage their joint currency, saying it needed to almost double the size of its capital coffers, which have been strained by its investments in vulnerable government bonds.

The ECB, which directs monetary policy for the 16 countries that use the euro, said the increase will take its capital base to 10.76 billion ($14.3 billion), from 5.76 billion currently.

It is the first time in its almost 12-year history that the ECB has asked national central banks for a capital injection. The move comes after the Frankfurt-based bank splashed out about 72 billion buying bonds from governments with shaky finances such as Greece, Ireland and Portugal.

The bond purchases have stabilized market turmoil, but the ECB has been under pressure from politicians to do more.

In its statement, the ECB didn't specifically mention the bond-buying program. It said the increase "was deemed appropriate in view of increased volatility in foreign exchange rates, interest rates and gold prices as well as credit risk." The funds will come from eurozone national central banks.

Michael Schubert, an economist at Commerzbank in Frankfurt, said, "I think the signal from the ECB is political, and it shows that the ECB in general will be rather reluctant to buy strong amounts of bonds," Schubert said. In the U.S., the Federal Reserve has embarked on a much larger-scale program.

"With this, the ECB gives a clear signal that purchasing bonds isn't, so to say, a free lunch, but it creates a lot of risks and therefore it decided to increase the subscribed capital," Schubert said.

Meanwhile, Spain -- the eurozone economy many view as too big to bail out -- had to pay significantly higher interest rates to borrow 2.4 billion ($3.21 billion) from bond markets Thursday.

The bond auction came a day after Moody's warned it may downgrade Madrid's credit rating in light of the billion of euros in debt the country has to refinance next year.

Geir Moulson in Berlin, Raf Casert in Brussels, Ciaran Giles in Madrid and Derek Gatopoulos in Athens contributed to this report.

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