By James G. Neuger and Stephanie Bodoni - Dec 9, 2011 7:11 AM GMT+0700
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Angela Merkel, Germany's chancellor, arrives to attend a working dinner as part of a two-day summit of European Leaders at the European Council headquarters in Brussels. Merkel damped expectations, saying the euros' credibility has suffered. Photographer: Jock Fistick/Bloomberg
Dec. 9 (Bloomberg) -- Kent Smetters, a professor at the University of Pennsylvania’s Wharton School and a former Treasury Department economic policy official, talks about Europe's sovereign debt crisis. He speaks with Susan Li on Bloomberg Television's "First Up." (Source: Bloomberg)
European leaders battled into the night to halt two years of debt-driven turmoil in financial markets and dispel concerns that the 17-nation euro currency is on the brink of unraveling.
Leaders worked on a “fiscal compact” at a Brussels summit to restore bondholders’ confidence and make it possible for the European Central Bank and International Monetary Fund to step up contributions to the rescue effort. No agreement has yet been reached, said two government officials familiar with the talks.
Chancellor Angela Merkel of Germany, Europe’s dominant economy, damped expectations, saying the euro’s credibility has suffered and calling the 15th summit in 23 months part of a “step-by-step” solution to the crisis that has cast doubt on the currency’s survival. Italian and Spanish bonds tumbled and the U.S. Standard & Poor’s Index fell the most in two weeks as some investors reined in optimism about the summit’s outcome.
European leaders are navigating a labyrinth of political, legal and economic constraints amid unrelenting pressure from financial markets to craft a fifth “comprehensive” package to stamp out the crisis that began with the Greek government discovering an unexpected budget hole in October 2009.
Talks that started at 7:30 p.m. yesterday dragged past midnight, with the leaders yet to tackle how to anchor tougher budget rules in European treaties. The debate focused on a proposal to cap structural deficits at 0.5 percent of gross domestic product and require each country to establish an “automatic correction mechanism” when budgets stray from the target.
‘More Intrusive’
The proposal, laid out by European Union President Herman Van Rompuy, also foresaw a near-automatic disciplinary procedure for high-deficit countries and “more intrusive control” of taxing and spending by governments that flout the rules.
Whether the meeting wraps up on schedule today or runs into the weekend, the leaders are likely to leave Brussels with much business unfinished. Planned treaty amendments won’t be penned until March and may take several more months to enshrine in law.
In addition, the independent ECB signaled yesterday that a Brussels deal to strengthen fiscal discipline wouldn’t prompt it to rush to the rescue of Spain or Italy, the two countries now seen as most vulnerable.
ECB President Mario Draghi said he was “kind of surprised” by a view that took hold in markets last week that the central bank would rapidly supplement its 207 billion-euro ($276 billion) bond-buying operations in response to a summit announcement of steps toward a closer fiscal union. Draghi is taking part in the summit.
Bond Slide
Italian 10-year bonds slid the most in almost a month, pushing up yields by 44 basis points to 6.43 percent. Bonds of other high-yielding countries also fell as investors sought the relative safety of German debt. The yield on 10-year bunds declined 9 basis points to 2.01 percent.
The euro slipped 0.5 percent yesterday and was little changed at $1.3344 at 9:02 a.m. in Tokyo. In the U.S., where President Barack Obama has been pushing European leaders to find a solution to the crisis, the S&P 500 lost 2.1 percent to 1,234.35 points.
Still, Draghi didn’t rule out a proposal up for discussion at the summit that would channel about 150 billion euros from national central banks into the IMF’s crisis-fighting war chest. Euro-area governments expect central banks of non-euro EU countries to chip in 50 billion euros more.
The ECB provided breathing space yesterday, trimming its main interest rate by a quarter-point to 1 percent and pledging to offer commercial banks unlimited cash for three years to tide them through the crisis.
Treaty Change
ECB measures sought to alleviate the impact of the debt crisis on the banking system, now in need of 114.7 billion euros in fresh capital, according to a European Banking Authority announcement yesterday. European lenders will have to raise a total of 8 billion euros more than estimated by the EBA in October.
With Greece, Ireland and Portugal drawing on a combined 256 billion euros in European and IMF loans and Greece counting on 130 billion euros more, the government leaders’ focus shifted to preventing future budgetary crackups. That would happen by reinforcing a “stability pact” that Germany conceived in the 1990s and watered down in 2005.
“What’s important for me is that the euro can only win back its credibility if we change the treaties a way that develops toward a stability union,” Merkel said before the summit. “That’s what at the core here for me.”
Draft Proposal
Van Rompuy’s draft proposal contained elements that are taboo for Germany, including the “possibility of moving toward common debt issuance” and enabling a planned permanent rescue fund to act as a bank that could borrow from the ECB.
Looming over the crisis management was a decision by Standard and Poor’s decision to issue a downgrade warning for 15 euro-area governments pending the summit outcome.
“We need more solidarity in the euro zone and more discipline,” French President Nicolas Sarkozy said at a pre- summit meeting of conservative leaders in Marseille. Europe is in an “extraordinarily dangerous situation.”
In a joint pre-summit letter to European leaders, Merkel and Sarkozy set a March 2012 deadline for an agreement on treaty amendments, calling on euro states to set up their own fiscal- enforcement system in the absence of an accord among all 27 EU governments.
That go-it-alone threat plus a call for a financial transaction tax set up a showdown with U.K. Prime Minister David Cameron, head of the biggest EU country still using its own currency. Cameron comes to Brussels vowing to defend London’s status as Europe’s premier financial market.
British Interests
“We need obviously to get that stability in the euro zone that’s good for European countries, good for Britain as well,” Cameron said on his way into the summit. “But also we need to protect Britain’s interests.”
Merkel and Sarkozy pushed back against the U.K. demands, regarding Cameron’s plea as a distraction from efforts to shore up the euro zone, a German government official said on condition of anonymity.
Van Rompuy’s draft called for the permanent rescue fund, the 500 billion-euro European Stability Mechanism, to be set up in July 2012, a year ahead of schedule. He proposed letting it lend the full amount, instead of lowering its lending limit by the roughly 170 billion euros already committed by the temporary rescue fund, the European Financial Stability Facility.
In a concession by Germany, the revamped permanent fund will follow IMF practices on imposing potential losses on holders of bonds of debt-ridden states. Merkel agreed in the pre-summit letter that the two writedowns imposed on Greek bondholders this year were “unique and exceptional.”
Finnish Sensitivity
National sensitivities pervade the negotiations, such as Finland’s objection to scrapping the unanimity rule for decisions by the fund to grant aid packages. Van Rompuy proposed that an 85 percent supermajority could vote to release aid funds only when an “urgent decision” is required.
European leaders “now recognize the urgency of doing something serious and bold,” Obama said at a White House news conference yesterday. “The question is whether they can muster the political will to get it done.”
To contact the reporters on this story: James G. Neuger in Brussels at jneuger@bloomberg.net; Stephanie Bodoni in Brussels at
To contact the editor responsible for this story: James Hertling at jhertling@bloomberg.net
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