How politicians excited financial markets' attack on the Eurozone

Yet upon returning back home, Ms. Merkel announced a unilateral German ban on short selling that one again unsettled markets and pushed up spreads on the Bund (event 23), since it was seen as further indication of wanting coordination. A German member of the ECB governing board publicly voiced his disagreement with ECB support to the sovereign debt market. After coming down sharply in the days immediately following the new measures, spreads have been crawling up in a climate of mistrust and confusing statements by Eurozone governments. Good news from the economy and agreement within the Eurozone on the special purpose vehicle (event 24) have so far not managed in calming the waters.

Conclusions

In sum, governments may have contributed quite a bit to turmoil with their public display of confusion and their statements to assuage domestic public opinions. Their behaviour undermined the credibility of the specific actions they were undertaking and, more broadly, of their ability to address effectively underlying imbalances in the Eurozone.

The good news is that even this confused and ill-advised bunch was eventually forced to come together and approve unprecedented measures to rescue the euro from disaster. At the recent meeting of the European Council, they have now agreed to publish in July the results of stress tests on 25 large banks in the area (event 26) – which should help dissipate uncertainty on their real exposures.

If Eurozone governments continue to show unity of purpose, and that they seriously intend to address underlying imbalances threatening the sustainability of the euro, there is hope that financial markets will relent and accept that the Eurozone is not about to crumble.

References

Eichengreen, Barry (2010), “Drawing a line under Europe’s crisis”, in Richard Baldwin and Daniel Gros (eds.), Completing the Eurozone rescue: What more needs to be done?, A VoxEU.org Publication, 17 June.

Fatás, Antonio and Ilian Mihov (2010), “Fiscal policy at a crossroads: The need for constrained discretion” in Richard Baldwin and Daniel Gros (eds.), Completing the Eurozone rescue: What more needs to be done?, A VoxEU.org Publication, 17 June.

Appendix

Timeline of significant events - December 2009 – June 2010

1. December 8: Fitch cuts rating on Greek debt to BBB plus with negative outlook - first time in 10 years a leading rating agency has rated Greece sovereign paper below A grade
2. January 11: IMF announces mission to Athens.
3. January 12: Greece is damned by the European Commission for falsifying data on its public finances. Angela Markel says that Greece’s mounting deficit risks hurting the euro, which faces a “very difficult phase” in the coming years (comment posted on a government website and later removed). Three days later Merkel praises “Herculean effort” of Greek government to tame the budget deficit.
4. January 28: Bungled attempt by Greece to sell government debt to China becomes public.
5. February 9: EU Commission (Rehn) offers “support in broad sense” to Greece – German governments reported to be preparing an assistance package for Greece, though depending on “strict conditions”.
6. February 11: Eurozone leaders promise support to Greece in exchange for deficit reduction plan.
7. February 15: Greece to lose voting privileges in the EU in case of bailout, says Kurt Lauk, head of CDU’s Economic Council.
8. February 24: Hans Michelbach, influential CSU lawmaker, says that Germany must resist any moves to provide financial aid for Greece because any assistance would provoke a “spiral without end”.
9. March 11: Schaeuble calls for tough sanctions to back EMF, so as to enforce budgetary discipline, including expulsion from Eurozone as a last resort sanction.
10. March 21: Merkel: “I do not see Greece needs money at the moment, and the Greek government has confirmed that. We do not want to create unrest in the markets by raising false expectations”.
11. March 25: Eurozone agrees on emergency plan for Greece, but immediately after divergent interpretations of agreement surface between member states and unsettle markets.
12. April 9: German government demands emergency financial aid to Greece be at close to market rates.
13. April 11: Eurozone members commit to provide up to €30 billion in loans to Greece, to be supplemented by money from the International Monetary Fund that could yield an additional €15 billion. Germany accepts to lend to Greece at below market interest rates.
14. April 22: Moody’s cuts Greece downgrade for the second time in the year. German government lawmaker Frank Schaeffler says Greece should be prepared to leave the euro region if it can’t push through enough austerity measures to cut its budget deficit.
15. April 23: Greece asks activation of Eurozone/IMF loan – EU says terms of aid may be agreed in a matter of days, but Merkel says Greek government must satisfy very stringent conditions.
16. April 26-27: Merkel says she won’t give funds until Greece shows it has a sustainable credible plan to cut its budget deficit – “I have said for weeks that Greece must do its homework first”- “Germany will help when the correspondent conditions are fulfilled”. Standard and Poor’s downgrades Greece’s long-term credit rating to junk.
17. April 29-30: emergency multi-annual loan programme for Greece from Eurozone and IMF announced to be concluded within days. Greece adopts €24 billion austerity package – Merkel confident it will keep the euro stable.
18. May 1: Merkel says EU should be able to temporarily revoke voting rights from member states who violate deficit limits.
19. May 2-3: €110 billion Eurozone-IMF support package for Greece adopted. ECB relaxes collateral policy for Greek sovereign debt.
20. May 7: German Parliament approves law to release funds (€22.4 billion) to Greece.
21. May 10: EU stabilization mechanism adopted (€500 billion from Eurozone and EU; €250 from the IMF). European Central Bank adopts package of measures to ease tensions in financial markets, including purchase of Eurozone government bonds and reactivation of US dollar swap lines with the Federal Reserve. German court refuses to block Athens rescue.
22. May 15-16: Merkel: “if euro fails, more fails”. Germany calls for Eurozone budget laws (based on German model).
23. May 18: Germany adopts ban on short-selling.
24. June 7: Eurozone ministers establish the €440 billion SPV (the European Financial Stability Facility) envisaged in the May 10 package and find an agreement on its functioning.
25. June 14: Moody’s downgrades Greek sovereign debt to junk.
26. June 17: EU leaders decide that detailed results of stress tests on the health of 25 big European banks be made public.

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