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Eurozone Rescue's Moment of Truth

Author: Christopher Alessi
October 24, 2011

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Twenty-seven EU heads of state meeting over the weekend once again failed to reach a concrete agreement for tackling a eurozone sovereign debt crisis that is threatening global economic stability. European leaders vowed to deliver a comprehensive solution to the two-year old crisis after they meet for another round of negotiations on October 26.

Sunday's meeting did indicate that EU officials are beginning to make progress (AFP) on three core issues: recapitalizing the continent's banks, leveraging the temporary European Financial Stability Facility (EFSF), and providing Greece with a second financial rescue package. The sovereign debt crisis has begun to infect Italy, the eurozone's third largest economy. And as the contagion spreads from Greece to the core of the single currency union, it has endangered many French banks that hold large quantities of Italian and Greek government bonds. This has put other exposed continental banks--and U.S. financial institutions-- at risk, feeding investor unease throughout global markets.

There has been a heightened sense of urgency on the part of Europe's leaders ahead of the G20 summit early next month. The world's leading developed and emerging markets will be looking to Europe to deliver substantive long-term solutions to safeguard the global economy.

Two proposals now on the table would essentially turn the EFSF into an insurance fund (WSJ). One option would allow it to guarantee a portion of potential losses on eurozone sovereign debt, while another would create a separate fund to be financed by international investors, including the International Monetary Fund. Either way, a leveraged fund would provide the eurozone with "armory" against investors speculating against the euro, a leading cause of recent  global market volatility, Giles Merritt, secretary general of Brussels-based think tank Friends of Europe, told CFR.

But Daniela Schwarzer, head of the research division for European integration at the German Institute for International and Security Affairs, questions whether an insurance model for the EFSF would be enough to reassure bondholders to stay where they are. "If it were combined with eurobonds it would be much more interesting to market actors," Schwarzer told CFR.  Joint bonds for the entire eurozone would be a signal of greater fiscal integration, reassuring investors of eurozone members’ commitment to the single currency.

EU leaders agree that the EFSF will need to guarantee at least some of the losses that will inevitably be suffered by private creditors as part of a second Greek bailout package. Indeed, a new report by the so-called troika of international lenders (Telegraph)--the IMF, the ECB, and the European Commission--shows that Greece's economy has further deteriorated in the past three months, due in large part to its failure to rapidly implement mandated austerity measures. Despite the ECB’s adamant opposition to any restructuring of Greek debt, Eurozone officials are now acknowledging that the new bailout could force private lenders to incur a haircut in excess of 50 percent.

But even as EU leaders find common ground over technical aspects of the crisis, analysts still remain skeptical of the ability of eurozone members to resolve their political differences. "The simple reason why there can be no technical quick fix is that the crisis is, at its heart, political," argues the Financial Times' Wolfgang Munchau. National parliaments--particularly that of Germany--continue to limit the amount of sovereignty they are willing to turn over to the larger monetary union, thus tying the hands of their leaders and repeatedly forcing them back to the negotiating table.

Background Materials:

"Death of a Summit," Economist

"A Weekend to Save the Eurozone," Financial Times

"The G20's Eurozone Problem," CFR Analysis Brief

"Preventing the Spread of Greece’s Crisis," CFR Video

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