Europe’s leaders were hoping their debt crisis had taken a break for the summer. On Monday, financial markets announced they were in no mood to relax.
Spanish bond yields surged to new highs, forcing the European Union to contemplate its fourth and biggest sovereign bailout, after Greece, Portugal and Ireland. On top of this, fear that Greece might have to leave the euro mounted again, after reports that it won’t meet the terms of its latest aid program. Italy and Spain announced emergency curbs on short-selling of securities. Investors hammered stocks on both sides of the Atlantic -- a reminder, if anyone needed it, of the global ramifications of this crisis.
It’s worth recalling that the problem is far more tractable than the EU’s leaders have made it seem. There’s no mystery about what needs to be done. The European Central Bank must act as lender of last resort to the euro area’s distressed sovereign borrowers. The ECB, with its power to print money, has the technical means to take on this role. It lacks the political and (some insist) legal authority to act. European leaders’ unwillingness to resolve these issues keeps bringing the global economy back to the edge of the abyss, and this week it looks again as if it might fall.
Europe’s governments thought they had contained the Spanish crisis after the recent EU summit. They came together on the terms of a bailout for Spanish banks. More important, they accepted in principle that future help for banks would go directly to distressed institutions rather than being supplied via governments, a change that avoids adding to sovereign debt burdens. In addition, access to existing rescue funds -- the European Financial Stability Facility and its permanent successor, the European Stability Mechanism -- would be granted more flexibly, they said.
Compared with what had gone before, this was progress, and financial markets liked it. Following a long EU tradition, however, confusion over what had really been agreed on soon undid much of the benefit. Markets refocused on a crucial fact: The funds available to the EFSF and ESM remain far too small to cover the foreseeable financing needs of governments such as Spain and Italy should markets get spooked and refuse to lend them money.
Now, that worst-case scenario has re-emerged. The catalyst is Greece. Over the weekend, Germany’s economy minister, Philipp Roesler, said he doubted that Greece would keep the fiscal promises it made in return for its bailout. If help for Greece is cut off, a disorderly exit from the euro becomes much more likely. For the rest of Europe and the world, that’s alarming less in its own right than because of the risk of contagion.
Spain would probably be the first to suffer, and as things stand there’s nothing to stop the situation from unraveling. With anxiety about Greece rising again, it was reported that Spain’s regional governments were seeking bailouts from Madrid, threatening to add to the central government’s debt burden. The Spanish economy is contracting, the latest figures showed last week. At the same time, Prime Minister Mariano Rajoy sparked protests when he said he would press on with further fiscal tightening, which is likely to slow growth even further.
On Monday, Spain’s 10-year bond yields rose for the first time above 7.5 percent. Rates sustained at this level are unaffordable and, in effect, make the Spanish government insolvent. Disturbingly, yields rose sharply at shorter maturities, too, and the cost of insuring against a Spanish default set a record -- both signs that confidence is evaporating.
Spain is the fourth biggest economy in the euro area. If it has to be bailed out, the EFSF and ESM will be overwhelmed. Then comes Italy, whose 10-year bond yield just climbed to a six-month high, remaining well above 6 percent. That’s no less crippling than Spain’s cost of borrowing, because Italy’s debt burden is far greater.
If Europe’s governments continue to stand aside, they will sink not only Greece, Italy and Spain, but the wider European and global economies as well. Europe’s leaders must either greatly expand the ESM and start to use it more proactively, or urge and empower the ECB to buy or somehow guarantee distressed sovereigns’ debt. One way or another, bond yields have to be capped at a supportable level.
Yes, providing such emergency backing involves pooling the resources of euro-area governments, and raises big questions about EU members’ fiscal and financial obligations to one another. Over time, such risk-sharing would require new rules for the operation of the euro currency system, including an effective mechanism to keep sovereign debts in check. Those issues can be sorted out later. Right now, the order of the day is effective crisis management.
Up to now, financial markets have shown extraordinary patience. Time is running out for the policy of having no policy.
Today’s highlights: the editors on how to replace Libor; Jeffrey Goldberg on what’s next for the Arab Spring; William Pesek on the price of economic growth in South Korea; Ramesh Ponnuru on Obama’s welfare mistake; A. Gary Shilling on higher education’s broken financing model; Betsey Stevenson and Justin Wolfers on sham economics; Bill Mallon on obscure sports in past Olympics; Ilian Scarlatov on why Greece should act like Bulgaria.
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