Angela's amateur hour: after nearly wrecking monetary union through inaction, bumbling German Chancellor Merkel may have saved the eurozone despite herself.

Author:Engelen, Klaus C.
 
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The endgame for Greece is at hand. Eurozone policymakers appear to accept that the country is insolvent. That acceptance comes "a bit late but not too late," as the Financial Times recently summed up the situation in its Lex column.

A year into the crisis and alter driving up the bailout costs of taxpayers horrendously, Berlin has won the bail-in of the private sector that it needed in order to calm voters. Whether this will save Greece and monetary union remains uncertain.

Why did it take so long? Last spring, as Greece's problems began to mount, Deutsche Bank CEO Josef Ackermann, who chairs the Institute of International Finance, offered to put together a 30 [euro] billion bridge loan on a public-private partnership basis. He and other bankers wanted to secure Greece's external liquidity needs for a year. But the proposal was rejected by German Chancellor Angela Merkel, other EU leaders, and the EU Commission. They thought they could handle any eurozone crisis with public resources, and they ignored the advice of bankers and economists who had experience with Latin America and especially with Argentina's default.

Ackermann's motive behind his proposals and his well-reported trip to Athens was to give eurozone governments enough breathing room to establish something of a European Monetary Fund to cope with Greece and other highly indebted eurozone members in the periphery.

Such private-sector involvement at a much earlier stage would have been helpful. It could have contained the Greek sovereign debt virus from spreading to other members. But only as the specter of a breakup of monetary union started to haunt Europe's policymakers was the taboo against including private-sector involvement finally broken. In the run-up to the special EU summit in July 2011, key European leaders called on the IIF and its director Charles Dallara to spell out how leading European financial institutions could contribute toward helping Greece avoid an insolvency. The recommendations of an IIF white paper on Greece are reflected in the central elements of the EU summit's second Greek rescue package (see box).

The special EU summit seems to be an appropriate time to look back at the turbulent Berlin government efforts to have banks and other Greek bond investors share some of the rescue burden.

The markets have tested Chancellor Merkel's trial-and-error approach. "Is there an endgame in sight?" was the timely question raised in TIE s Winter 2011 issue, looking at Germany's role in the dismal management of the eurozone's sovereign debt crisis and how much could be attributed to Merkel's governing style. Merkel has stuck to a short-term, politically low-cost strategy, trying to maintain or gain political power while making a minimum of political enemies. After all, she is a "power frau," and indeed for many years her approach has been quite successful.

In the effort to involve the private sector, Germany--as the financially strongest member of the eurozone---has been supported by other creditor countries such as the Netherlands, Austria, and Finland. This "northern" creditor bloc, however, has been lacing increasing opposition the farther south one looks. In Italy, Spain, and Portugal, the calls for eurobonds, larger rescue facilities, and lower support interest rates have been getting louder. While Belgium, with a precariously high sovereign debt but unable to form government, has stayed on the sideline, France, fearing that it also might be contaminated, has been warming up to the idea of private-sector involvement. With the crisis reaching a breaking point, certain questions arise. What did the German effort to push for burden sharing so far achieve? What have been the consequences for market and risk premiums, and the impact on total bailout costs for taxpayers in creditor countries?

With Italy and also Spain now confronting escalating risk premiums and bond selling pressures from an eroding eurozone investor base of banks, insurance concerns, and other institutional investors, the European debt crisis has entered a new and far more costly phase.

There isn't a bailout big enough to rescue the third-largest economy in the eurozone the way there was with Greece, Ireland, and Portugal. Italy can only rescue itself. With a gross debt to-GDP ratio of 120 percent, Italy owes about one-quarter of all government debt in the eurozone.

When Berlin insiders talk of an "endgame" in the context of how Merkel, Finance Minister Wolfgang Schauble, and company have responded to the eurozone debt, they could summarize the zigzagging journey under the heading: "How a strategy of minimal political costs since February of last year led to self-entrapment, leaving Berlin policymakers with only extremely costly options."

When asked in one of the recent traditional summer interviews about her plans for resolving the escalating crisis, Merkel answered that she "only does what is necessary." This explains why she avoided from the beginning investing too much of her own political capital, but instead looked for opportunities to maintain and strengthen her domestic political power.

Let's follow Merkel's politically low-cost journey step by step. When Deutsche Bank CEO Josef Ackermann, Germany s most successful but controversial banker, started early last year to put together a large private-public syndication of about 30 billion [euro] to cover Greece's rollover needs for 2010, Merkel and her then-chief economic advisor Jens Weidmann rejected the idea. Ackermann's plan was a bridge loan given to Greece through the state-owned KfW Group, backed half by loan commitments from leading banks without guarantees and half by public loans from eurozone governments. What the Merkel chancellery and the Schauble finance ministry missed was that such a liquidity bridge loan would have given Berlin and other eurozone governments some time to come up with a new financing framework for Greece and other over-indebted eurozone countries. Why did the Berlin government not take up the Ackermann offer? For Merkel, taking into consideration the elections in North Rhine-Westphalia (her party lost), even a $15 billion liquidity loan from major eurozone countries was considered inopportune.

It would have made a big difference if, at that early stage, the Berlin and Paris governments had brought in the Institute of International Finance through Ackermann and other top CEOs of other European banks. With about four hundred major international banks and other financial service institutions as members, the IIF, chaired by Ackermann, has a long history of dealing with sovereign debt issues. Late, but maybe not too late, EU finance ministers are finally working together on the issue of private-sector involvement in crisis resolution. Under the leadership of IIF Managing Director Charles Dallara, a task force on Greece with experts from major banks produced a white paper that was presented to EU leaders and finance ministers on July 9 of this year.

Following her politically low-cost strategy, Merkel let the Greek fires smolder for critical weeks without reaching a political agreement that would calm alarmed bond investors when Greece lost its access to the capital markets. Eventually, in May 2010, Merkel did what she had to do and consented to a huge support mechanism for Greece worth about 110 billion [euro], including loans from the...

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