France, Germany Split on Solution

Dispute centers on the European Central Bank's role in the rescue plan.

France and Germany wrangled over how to tackle Europe’s debt crisis a day before a finance ministers’ meeting in Brussels intended to set a common strategy on dealing with the turmoil.

With a summit of European leaders scheduled for two days later, a disagreement over the European Central Bank’s role in the rescue plan threatens to stymie progress on the banking and economic questions needed to deliver the comprehensive strategy demanded by global policy makers. Luxembourg Prime Minister Jean-Claude Juncker, who chairs the group of euro-area finance ministers, indicated an impromptu meeting of European leaders in Frankfurt last night failed to resolve differences. “We are still meeting,” he said as he departed.

French President Nicolas Sarkozy, whose wife was reportedly giving birth to his first daughter, jetted into Frankfurt to meet with officials as they attended an event to honor outgoing ECB President Jean-Claude Trichet. Sarkozy, German Chancellor Angela Merkel and International Monetary Fund Managing Director Christine Lagarde left the event at the Frankfurt Opera House without commenting.

“Even with the current problems in the negotiations, we expect that there will be at the end a compromise,” economists including Juergen Michels at Citigroup Inc. in London said in an e-mailed note. “However, with the participants having still very divergent views, the outcome probably will not be a credible, comprehensive package.”

Euro Weakens

Stocks fell and Spanish and French bond yields rose on the split over Europe’s rescue strategy. The Stoxx Europe 600 Index fell 0.6 percent as of 12:14 p.m. in Paris, while the CAC 40 dropped 1 percent. The Spanish two-year note yield jumped six basis points, while the extra yield investors demand to hold French 10-year bonds instead of benchmark German bunds rose to a euro-era record.

French Prime Minister Francois Fillon stepped up calls for the 440 billion-euro ($608 billion) European Financial Stability Facility to be turned into a bank and given leverage by the ECB which, along with Germany, has rejected using its balance sheet to bolster the fund. Germany has endorsed enabling the EFSF to insure a portion of cash-strapped nations’ bond sales.

The EFSF “needs to be massive,” Fillon said in Paris.“The 440 billion euros need to be used with a leverage effect, a bit like a bank.”

French Finance Minister Francois Baroin also said the EFSF should be turned into a bank, though he noted the “reticence” of the ECB and the “German position.”

“For us it is and will remain the most effective position. The Americans do it, the British do it,” he said.

Primary-Market Purchases

Trichet has been a key part of Europe’s crisis-fighting effort, reluctantly pushing the ECB to buy bonds in the secondary market, a role it may be forced to keep under a revamped strategy.

Primary-market purchases by the enhanced EFSF generally should be limited to no more than 50 percent of the final issued amount, according to draft guidelines for the backstop from the European Commission, the European Central Bank and senior officials from the 17 euro-region nations, obtained by Bloomberg News. The EFSF should participate at the weighted average price of the auction, it said.

“That means that EFSF’s share is no larger than the share bought by the market,” the draft says. “It gives an incentive to the issuer to accept market bids, because for each million of accepted market bids the member state will receive an additional million from EFSF.”

‘Disconcerting’ Pace

Canadian Finance Minister Jim Flaherty said that European leaders’ slow pace toward a solution is “disconcerting,” while adding they have the “sense of urgency required.” The rescue fund isn’t sufficient to deal with the crisis and will need to be leveraged, he told reporters in Ottawa yesterday.

The disagreements among policy makers came as banks lobbied against forced recapitalization and deeper writedowns on Greek debt.

While Merkel this week sought to lower expectations that the crisis-fighting effort would climax at the Sunday summit in Brussels, Group of 20 finance chiefs last week set the meeting as a deadline. Failure risks a global economic slump, they said.

“Many expect to be underwhelmed at the weekend,” David Mackie, chief European economist at JPMorgan Chase & Co., said in an interview. “If they haven’t settled the leverage issue, then the sense of being underwhelmed will be overwhelming.”


Policy makers are struggling to end a crisis that began in Greece two years ago this week. In Athens yesterday, protesters clashed with police outside Parliament before Prime Minister George Papandreou won a preliminary vote on a new austerity package. The final vote is scheduled for today.

The issues frustrating European authorities include how to write down of as much as 50 percent on Greek bonds, setting up a backstop for banks and finding a continued central bank role.

The world economy is facing the “threat of profound and traumatic disruption,” Norman Chan, chief executive of the Hong Kong Monetary Authority, said in a speech published on the de facto central bank’s website.

Also attending the event in Frankfurt last night were Mario Draghi, who replaces the retiring Trichet on Nov. 1, European Union President Herman van Rompuy and European Commission President Jose Barroso. Baroin and German finance minister Wolfgang Schaeuble were there as well. No statement was issued.

Van Rompuy praised Trichet for taking “unconventional” steps and not being beholden to dogma, while Barroso told reporters in Brussels that he was optimistic that an accord will be reached.

“Independence doesn’t mean detachment from political decision-making,” Van Rompuy said at the Trichet farewell ceremony. “Monetary policy cannot be conducted in a social and political void. The central bank’s independence is a right, but also entails duties.”


Bloomberg News


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