As European leaders meet in Brussels with Greece potentially facing a devastating sovereign default, it is easy to forget that just six months ago it looked as though the European Union was about to turn the corner in its debt crisis.
The year started with a successful Portuguese debt auction that – with a little help from bond buying by the European Central Bank – raised 1.25 billion euros ($1.8 billion). Lisbon was forced to borrow at high rates, more than 6.7 percent, but that was lower than many analysts had predicted.
When Spain followed with a successful auction of its own later in the month, one could almost hear officials in Brussels breathe a collective sigh of relief. Thanks to co-ordinated action, policymakers looked like they were finally beating back the bond market.
EU leaders appeared to be coalescing around a proposal to give the fund powers such as purchasing bonds on the open market or lending money to struggling countries to buy back their own bonds.
The idea was to use the rescue fund pre-emptively to avoid full-scale bail-outs and prevent contagion. José Manuel Barroso, the European Commission president criticised for being too timid in the midst of the crisis, urged EU leaders to agree rapidly.
But the overhaul that could have put the euro zone on the front foot never happened.
Instead, European leaders have spent months discussing how much pain to inflict on private holders of sovereign bonds in a restructuring. They also devoted their energies to drawing up a “pact” to reform their economies – measures Daniel Gros, the Brussels-based economist, argues will solve the next crisis, but do nothing to alleviate the current one.
EU leaders insist the drawn-out process has not been for naught. Countries that long resisted economic reforms, particularly Portugal and Greece, are now addressing their structural problems and cutting their debt, measures officials believe will eventually return them to fiscal health.
“I saw a very deep recession in Sweden in the early 1990s. It took us somewhere around seven or eight years to actually solve these problems,” Fredrik Reinfeldt, Sweden’s prime minister, said. “What we are seeing is the beginning of their efforts, but it will probably take a long time to solve deep-rooted problems that should have been addressed very many years ago.”
But policymakers elsewhere, including in the US, are growing exasperated with the months of public hand-wringing.
“The simple rule in crisis management is: you want to have a simple, clear, unified declarative strategy,” Timothy Geithner, the US Treasury secretary, said this week on the bickering across the Atlantic.
Europe’s debate over how to deal with private bondholders has been particularly wrenching. Germany has for weeks threatened to press holders of Greek debt into swapping their current holdings for new bonds that would not be paid back for seven years.
Berlin insisted that bonds issued by the euro zone’s permanent 500 billion euros bail-out fund would have preferred creditor status, implying that private debt holders would suffer losses in the event of a debt restructuring. The ensuing bond market panic helped push Ireland into a bail-out.
At this week’s summit, both ideas will be formally abandoned. Some German analysts argue the exercise was a political necessity, important to convince German voters Angela Merkel, German chancellor, did her utmost to reduce the public cost of bailing out weaker eurozone countries.
But the result has been no less disruptive. The open debate of the Greek swap plan, for instance, forced all three major rating agencies to issue warnings – and then downgrade Greece’s bonds to barely above default, leaving leaders with almost no room to manoeuvre.
“Europe is now trapped in a political and civilisational crisis,” said Donald Tusk, Polish prime minister. “Nobody says it aloud yet but everyone can sense it: it questions the future of the European Union.”