Another Notch in the Euro Crisis, Another Bailout
Business + Economy

Another Notch in the Euro Crisis, Another Bailout

Miguel Villagran/Getty Images

European leaders unveiled yet another financial reform plan late last week that requires member states to adopt stricter fiscal changes aimed at providing stability to the debt-laden euro zone. The announcement in Brussels came on the heels of a debt crisis in Portugal that forced the resignation of Prime Minister Jose Socrates.

The latest plan, Euro Pact Plus, is a permanent $706 million bailout pool  for countries like Ireland and Portugal, both of which are struggling with debt amounting to tens of billions of dollars. The pact also commits member states to social welfare spending cuts, wage reforms, reduced infrastructure spending and transitions from labor-based taxes to consumption-based taxes.

European leaders, including German Chancellor Angela Merkel and French President Nicolas Sarkozy, hailed the plan as the solution to Europe’s debt crisis and looked forward to Friday’s summit as an opportunity to celebrate an important breakthrough. Instead, the summit continued a familiar pattern of European leaders scrambling to quell concerns about the euro zone’s fiscal health, after Fitch downgraded Portuguese debt two levels, with warnings that future downgrades were likely.

“Europe has done exactly what we needed to do,” Sarkozy said. “I don’t see really at this stage what we could do more, which doesn’t mean that in a few months from now we won’t have new ideas up our sleeve.”

The pact is part of the so-called European Semester, an effort by Brussels to coordinate economic policy across the euro zone to prevent a reoccurrence of the crises that have rocked the continent since January 2010. Last spring, the European Union, led by Germany, created a $614 billion bailout fund to save Greece from bankruptcy. Since then, the finances of all E.U. members have come under scrutiny, as countries have been forced to make steep cuts in social benefits and defense spending in order to better balance their books.

“All the countries participating in the Euro Plus Pact, also those that have no governments with full powers, will send us a list with their concrete commitments complying with the five or six targets," European Council President Herman Van Rompuy said in Brussels Friday.

But this latest plan masks more fundamental problems. For instance, numerous countries within the euro zone are still carrying unmanageable levels of debt. The newly established bailout fund will allow Portugal to pay off some $12.7 billion due in coming months. However, the Royal Bank of Scotland estimates that the total bailout necessary for Portugal could be as high as $113 billion. Meanwhile, Ireland is still struggling with its debt payments, and will continue to need assistance from Brussels.

“They have things under control in a muddling-through kind of way,” said Mitchell Orenstein, a professor of European studies at the Johns Hopkins School of Advanced International Studies (SAIS).

At the same time, smaller E.U. countries, which lack the economic maturity of countries like France and Germany, are balking at contributing to the bailout fund. When the plan was first announced last month, diplomats from Belgium, Austria and other small member states complained that Berlin and Paris bullied the plan through Brussels.

Political and economic instability in Germany is also of growing concern. There are swirling doubts about the fiscal health of many German banks, some of which are still borrowing money from Berlin to pay for bad bets made during the bubble. In addition, Merkel’s political future is uncertain. Merkel’s conservative Christian Democrats on Sunday suffered a major defeat in a historic stronghold in southwestern Germany, where the Green Party appeared poised to head a state government for the first time, according to official preliminary results. Japan’s nuclear disaster and Merkel’s subsequent reversal on nuclear power played a key role in the elections in the southwest state of Baden-Württemberg, where the Christian Democrats have governed since 1953.

German voters have become increasingly skeptical of Germany’s outsized role in European politics, and have made Merkel pay at the polls.

In fact, Merkel had long opposed broad, E.U. wide reforms. But as it became clear that the burden for any permanent bailout fund would be shouldered by Germany, Merkel reversed course and has championed the pact.

If there is a silver lining to last week’s summit, it’s that it accomplished what the leaders set out to do: create a permanent bailout fund. SAIS’s Orenstein said this is a far cry from last year, when European leaders scrambled to deal with Greece’s debt crisis but failed to act for months, making the crisis worse.

“They have a plan in place and people agree on what to do,” he said. “Europe is always going to have decision-making problems that slow things down, but this pact will get them through to the next crisis and will be seen as the point at which Europe started to get its act together.”

Related Links:
Mideast Protests Drive Up Oil, Threaten Recovery (The Fiscal Times) 
Portuguese Government Collapses Over Debt Crisis (Washington Post) 
Euro Falls From 4-Month High Reached on ECB Rate Speculation (Bloomberg)