Geithner Urges End to European ‘Cascading Default’ Threat

By Ian Katz and Simon Kennedy - Sep 25, 2011 3:13 AM GMT+0700
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U.S. Treasury Secretary Timothy F. Geithner. Photographer: Joshua Roberts/Bloomberg

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Timothy Geithner, U.S. treasury secretary, stands after the the International Monetary Fund (IMF) Governors group photo at the IMF and World Bank annual fall meeting in Washington. Photographer: Joshua Roberts/Bloomberg

U.S. Treasury Secretary Timothy F. Geithner pressed European policy makers to intensify their efforts to end the 18-month sovereign debt crisis and avoid the “threat of cascading default, bank runs and catastrophic risk.”

In his strongest public push yet for Europe to step up its crisis-fighting, Geithner said strains in the euro-area’s budgets and banks are the “most serious risk now confronting the world economy.” He urged governments to unite with the European Central Bank to immediately “create a firewall against further contagion.”

Geithner’s call -- made today at the annual meeting of the International Monetary Fund in Washington and echoed by other finance chiefs -- came at the end of a week in which stocks entered their first bear market in two years. The slide partly reflected worries among investors that Greece is nearing default and Europe’s repeated failure to stop its woes from spreading may cause another global recession.

Bank of Canada Governor Mark Carney said Europe should make available about 1 trillion euros ($1.35 trillion) to “overwhelm” the crisis, more than double the current rescue package. U.K. Chancellor of the Exchequer George Osborne called for “credible” action to support European banks, some of which the IMF says need recapitalizing. The Washington-based lender said today it’s ready to “strongly support” Europe.

‘Resolved Promptly’

“The sovereign debt crisis in the euro area needs to be resolved promptly to stabilize market confidence,” People’s Bank of China Governor Zhou Xiaochuan told the IMF.

There are indications European governments are heeding the lobbying as they study working with the ECB to boost the firepower of their bailout fund through leverage. They may also accelerate the start of a permanent rescue program and the ECB could soon increase lending to banks.

The pressure is on them as billionaire investor George Soros said today that Greece may be unable to avoid default and its neighbors should prepare for that. Pacific Investment Management Co. Chief Executive Officer Mohamed El-Erian and former U.S. Treasury Secretary Lawrence Summers drew parallels this week between Europe’s troubles and the 2008 financial crisis.

Economists at Citigroup Inc. said yesterday they now expect Greece to begin restructuring its debt as soon as December, while those at JPMorgan Chase & Co. said the euro area will start contracting in the fourth quarter and that the ECB will cut interest rates next month.

Greek Default

Germany’s government has already begun debating how to shore up German banks in the event Greece defaults, while ECB Governing Council member Klaas Knot said this week he no longer excludes a Greek bankruptcy. One official from a G-20 country said an eventual Greek default is likely.

European finance officials will examine next week the cost advantages of setting up the fund, known as the European Stability Mechanism, a year earlier than its currently planned July 2013 start, according to a document prepared for the meetings and obtained by Bloomberg News.

Drawing on paid-in capital, the ESM will have a 500 billion-euro ($677 billion) war chest that could help shield countries like Italy. It also includes provisions for sharing costs with bondholders for countries with “unsustainable” debt.

Temporary Fund

Asked by Bloomberg Television about bringing forward the ESM’s start date, European Union Economic and Monetary Affairs Commissioner Olli Rehn said the focus for now is on upgrading the temporary fund, the 440 billion-euro European Financial Stability Facility. Spanish Economy Minister Elena Salgado said she would back early adoption of the fund.

Debate increased among EU officials this week over how to ratchet up the spending power of the EFSF through leverage once a revamp in about mid-October leaves it able to buy bonds in markets and aid banks.

One way of achieving that, proposed by economists Daniel Gros and Thomas Mayer, is for the EFSF to operate like a bank and borrow from the ECB, using the bonds it purchases as collateral. Other suggestions are for the EFSF to guarantee ECB bond purchases or help the central bank make loans to investors who buy stressed-country debt, with the facility absorbing initial losses.

Using leverage mimics the U.S. response to the 2008 crisis. While Geithner pitched the idea at a Sept. 16 meeting with euro- area finance chiefs in Poland, it met initial resistance from Germany, Europe’s dominant economy.

‘Cannot Wait’

“Decisions as to how to conclusively address the region’s problems cannot wait until the crisis gets more severe,” Geithner said today.

The ECB may also step up its own initiatives to support markets and growth, Governing Council members Luc Coene and Ewald Nowotny said in Washington. Potential measures include the revival of 12-month loans to banks and Coene didn’t rule out cutting the 1.5 percent benchmark interest rate.

ECB President Jean-Claude Trichet, attending his final IMF meetings before retiring Oct. 31, yesterday said European policy makers “are not blind and we are not hiding.”

Greek Prime Minister George Papandreou said yesterday his government was determined to proceed with the implementation of the July 21 decision for a second financing package. Osborne said no G-20 plan had been formed for a Greek default and Spain’s Salgado said there had been no discussion over such an event.

To contact the reporters on this story: Ian Katz in Washington at ikatz2@bloomberg.net; Simon Kennedy in Washington at skennedy4@bloomberg.net.