Germany Votes Yes, But Chafes At Bailouts

Bigger Rescue Fund OK’d. EFSF will still be small, but German opposition to further actions high. Greek Default Seen As Inevitable

Chancellor Angela Merkel still gropes for domestic support to defuse Europe’s debt bomb, even though German lawmakers on Thursday approved the expansion of a euro zone rescue fund. Germany became the 11th country to approve changes in the European Financial Stability Facility.
The six remaining euro zone members likely will sign off by early October, analysts say.

A revamped EFSF would fast track the recapitalization of Europe’s banks, amid growing views that they must be shored up to deal with an ncreasingly likely restructuring of Greece’s debt. The EFSF would also buy the bonds of debt-laden countries, taking over or supplementing
the European Central Bank’s emergency debt purchases.

The EFSF stands to be hiked to 440 billion euros from 250 billion euros in a deal brokered by Germany and France in July. But that’s still too small to deal with the potential defaults of other troubled countries, including Portugal, Ireland and especially Spain and Italy. Germany has been the top contributor to euro zone rescue funds. Its taxpayers are nervous as the bailout tab grows and weakening global economies sap Germany’s export-driven growth.

Merkel’s Next Step Is Murky. Merkel’s government has resisted a plan pushed by Treasury Secretary Tim Geithner that would more than triple the size of emergency funding to around 2 trillion euros. While Germany stands to pony up over 210 billion euros to the expanded EFSF, its contribution could balloon to as much as 25% of GDP under the Geithner plan, says ING economist Carsten Brzeski.

While Merkel cajoled German lawmakers into approving the expanded EFSF, many in her own conservative Christian Democrat party — and coalition
partner Free Democrats—are at odds with her policies. “Merkel is walking on a tiny, tiny road and she knows it,” said Brzeski. “There is unrest and dissatisfaction even within the CDU. There is not a lot of room for her to maneuver. The big concern is over putting so much money on the line.”

Geithner’s plan would provide more liquidity via credit lines to governments much as the U.S. Term Asset-Backed Securities Loan Facility program did after the subprime mortgage crisis. Two German members of the European Central Bank have resigned this year over its policy of buying the bonds of troubled countries. Analysts say the ECB has been forging a quasi-fiscal union by putting distressed sovereign debton its balance sheet.

Germany’s constitutional court in early September OK’d its participation in bailouts. But vastly expanding the EFSF would require European Union treaty changes, a lengthy and uphill challenge at best, analysts say. Germany has been pressing private bondholders, including banks, to voluntarily reinvest Greek debt into new, long-term, EU-backed securities. Under a July deal brokered by Merkel and France’s Nicolas Sarkozy, they would have taken about a 20%loss.

German officials are now pushing “for 50% haircuts as a quidpro-quo for agreeing to leverage up the EFSF as per the so-called Geithner Plan,” economist Ed Yardeni says. France opposes bigger losses, he notes. While financial markets rose for a few days on hopes that Europe was finally coming to grips with its debt crisis, expect more disappointment, observers say.

“We’re going to continue seeing these see saw swings in market sentiment, where people think we’re in a crisis and then things seem OK,” said Stephen Stanley of Pierpont Securities. “It’s been a very slow-moving crisis, which is what has got markets frustrated.” U.S. stocks opened higher on
Germany’s vote after Wednesday’s sell-off. But the major averages reversed for a third straight day.

Internet companies and China-related plays led abroad reversal.Europe-sensitive financials closed higher, though. Faltering growth is making
Europe’s debt crisis worse, says Nariman Behravesh, chief economist at IHS Global Insight. “Europe is headed for a recession, and Germany will not be immune,” he said.

With Merkel losing a series of regional elections, Stanley says German voters are key. “There is resentment within the German public about the Greeks continuing to come hat-in-hand,” he said. “It seems to them like a bottomless pit whereas with Ireland and even Spain, we might be
seeing some light at the end of the tunnel.”

Greece needs a second dose of emergency loans. But it lags in cutting its deficit and carrying out austerity measures. The International Monetary Fund, the ECB and European Commission are evaluating whether bailout terms need to be renegotiated. The troika’s officials returned to Athens Thursday as they mull releasing the next loan payment.

A growing numberof analysts believe European leaders will allow Greeceto default once capital buffers for banks are in place. The preferred scenario is for Greece to stay in the euro zone, says Brzeski. Kicking Greece out, he says “would be an invitation to speculation over who’s next. You
would definitely see a bank run in the other peripheral countries.”

This post has been edited by sulifeisgreat: Oct 1 2011, 12:38 AM