A widening schism between Paris and Berlin—and supporters on either side—over a European vs. IMF rescue for Greece threatens the euro itself
Europe's leaders are scrambling to reach agreement on a sustainable plan to end the Greek crisis and restore stability to the eurozone.
As they prepare for their summit in Brussels next Thursday and Friday, European heads of government – as well as central bankers and Commission officials – are deeply divided.
The schism between Paris and Berlin – traditionally the axis that drives the EU forward – has become acute. A spokesman for President Nicolas Sarkozy said that the eurozone must act to restore investor confidence and shrink Greek borrowing costs. The EU Commission President Jose Manuel Barroso denied that an appeal by Greece to the IMF was a "matter of prestige" – but maintained "it's essential" that Europe takes the lead. The European Central Bank President Jean-Claude Trichet has described IMF intervention as "inappropriate".
Yet German government spokesmen, by contrast, are leaning to the view that Greece would be better off going to the IMF.
Divided Europe has so far been unable to reassure nervous markets that the eurozone has the means to avoid the Greek contagion spreading, or prevent similar crises recurring in the so-called PIIGS – Portugal, Italy, Ireland, Greece and Spain, the most highly indebted zone members. At stake is the future of the euro itself, barely a decade old. After a brief but idyllic period last year when it was talked of as a new reserve currency for the world, the idea of a break-up is being openly debated.
Some policymakers are starting to think the unthinkable. One board member of the Bundesbank, Thilo Sarrazin, when asked what should happen if Greece cannot refinance, said: "Then Greece must do what every defaulter does – just declare bankruptcy. There is absolutely no need to think about aid".
The European Commissioner for economic and monetary affairs, Olli Rehn, acknowledged the challenges facing the union: "It is important that the EU in the course of next week comes to a more specific conclusion, specific political conclusion about the European framework for co-ordinated and conditional action, if needed and required." His call was echoed by the European Central Bank member Mario Draghi. Mr Draghi is head of the Italian central bank and of the influential Financial Stability Board, the forum of G20 central bankers and regulators. "Obviously we need stricter rules. The Greek crisis showed us that we need to make our system more resilient," Mr Draghi said.
The rows have been sparked by a thinly veiled threat on Thursday by the Greek Prime Minister, George Papandreou, to turn to the IMF. "We are under a basically IMF programme," he said. "We don't want to be in a situation where we have the worst of the IMF, if you like, and none of the advantages of the euro. We need the strong political support to make these necessary reforms and to make sure that we aren't going to pay more than necessary."
While the worst of the Greek sovereign debt crisis has passed, investors are still demanding substantial risk premia, and Mr Papandreou has appealed to his fellow leaders to help reduce the debt interest burden.
Opinion across Europe is as varied as the continent itself. The Dutch finance minister, Jan Kees de Jager, has said that the IMF could pay "part" of Greece's needs; the Italian finance minister, Giulio Tremonti, conceded "it is even possible to contemplate the intervention of the IMF". Outside the eurozone, the UK seems content to stand aside from the European controversies.
Spanish and French leaders are the most determined to keep the IMF out. For the French establishment the arrival of the IMF in Athens would, to borrow a classical analogy, represent a Trojan horse for America. President Sarkozy has declared: "We cannot let a country fail that is in the eurozone. Otherwise there was no point in creating the euro." A complicating factor is that the managing director of the IMF, Dominique Strauss-Kahn, is a possible rival to Mr Sarkozy for the Elysée.
Longer term, behind the divisions, lies a deep scepticism in Germany, that the kind of "European economic governance" called for by President Sarkozy would undermine the independence of the ECB, and dilute Germany's fiscal independence – pressuring it to reduce its current account surplus, run a larger budget deficit and tolerate higher inflation than it is ready to. Berlin is friendlier to a tough "European Monetary Fund" that would ape the IMF.
In recent weeks there has been speculation that a German state-owned bank might be persuaded to buy Greek debt. That option seems less favoured in Berlin, but with opinion still so fluid, there seems little hope that next week's summit will put an end to the eurozone's agonies.
Credit default swaps: Time to get tough?
One reason for the euro's steep precipitate decline may have been activities of hedge funds and others shorting the euro and abusing the credit default swaps (CDS) in Greek government debt. The European Central Bank president Jean-Claude Trichet has called for tighter regulation of the CDS market of individual "over-the-counter deals". Mr Trichet said: "We need more transparency in CDS markets, and so do investors. In this respect, a key priority in terms of enhancing the resilience of the CDS markets is the establishment of central counterparty facilities."
Credit default swaps are in effect the cost of insuring against default on a debt security, but so-called "naked CDS" contracts are taken out where there is no underlying ownership of the asset – so players are betting on a Greek government default even if they do not own any Greek government debt, or indeed have Greek exposure at all. It has been likened to an individual taking out life assurance on someone else, creating an unfortunate incentive to homicide.
Clearing of CDS trades in the EU and United States began on a voluntary basis last year. The G20 agreed last year that as many contracts as possible in the world's $450 trillion derivatives sector, including CDS, should be centrally cleared on an exchange by the end of 2012. Naked shorting of bank shares allegedly added to volatility during the autumn of 2008, when it was banned for a time in New York and London. Some hedge funds have voluntarily agreed to avoid euro trading.