By Robert Romano — Those concerned about the ongoing debt crisis in Europe — and its potential spreading to the U.S. — should pay close attention to a meeting between French and German leaders this weekend.
At issue are the terms of leveraging the €440 billion European Financial Stability Fund (EFSF) up to €2 trillion with freshly printed euros from the European Central Bank (ECB).
Once again on top of this important story is the UK Telegraph’s Ambrose Evans-Pritchard, who quotes French President Nicolas Sarkozy as telling his top advisors, “If there isn’t a solution by Sunday, everything is going to collapse.”
This harkens back memories of then-U.S. Treasury Secretary Hank Paulson threatening members of Congress with martial law, civil unrest, and a new Great Depression if the 2008 Troubled Asset Relief Program (TARP) were not adopted.
No doubt similar threats are being leveled at German Chancellor Angela Merkel if the fund is not leveraged, who is now in the hot seat. Her administration via Finance Minister Wolfgang Schäuble had promised Bundestag lawmakers the EFSF would not be leveraged at all. Germany’s highest court has also warned that such a move would be unconstitutional, tying the nation to liabilities beyond what the legislative body had approved.
Without leverage, critics argue the fund will be insufficient to cover the consolidated debts of Portugal, Italy, Ireland, Greece, and Spain (PIIGS), which total more than €3 trillion. Hence, the pressure on Merkel to agree to leverage the fund.
On the other hand, while additional leverage might enhance the reach of the fund, it would also magnify losses should anything go wrong, increasing the risks to German taxpayers who will wind up on the hook.
Leaving Merkel between a rock and a hard place. Complicating matters further are members of her own governing coalition who feel betrayed by what they see as an imminent agreement to leverage the fund despite promises not to.
Peter Schäffler, economics chief for the Free Democrats told the Telegraph he was upset with Finance Minister Schäuble, saying, “People feel deceived. He said there would be no leverage. It is absurd for him to claim that this plan is not leverage.
“The French want more money from Germany than we are prepared to shoulder,” Otto Fricke said, budget spokesman of the Free Democratic Party, a member of the majority coalition. The Free Democrats are not an insignificant obstacle to leveraging the fund — they garnered 14.6 percent of the vote in the last elections of 2009.
Making matters worse for EuroTARP, it appears there will be no widespread agreement by Oct. 23, already breaching Sarkozy’s artificial timeline, as another summit has been called for Oct. 26 to hammer things out.
Meaning, markets will likely open on Oct. 24 without any resolution in sight.
Americans for Limited Government President Bill Wilson has warned Germany against agreeing to leverage the fund, writing that the country “could wind up with the worst of all worlds: bank failures, followed by an inflationary plunge into further leveraging by EFSF and the ECB in the midst of worldwide panic — creating zombie institutions, and leaving the entire continent without a rudder in the face of a gathering storm — followed by Germany’s court striking down the entire bailout.”
If everything collapses, resulting in Greece and others defaulting without any net, as Sarkozy worries, whether from a lack of agreement over leveraging the fund or Germany’s constitutional court striking down said leveraging, U.S. financial institutions could be exposed to over $640 billion says the Congressional Research Service.
Wilson worries that such an outcome would most likely result in a bailout by the Federal Reserve of American banks, saying, “Fed Chairman Ben Bernanke must not be allowed to fire up the printing presses once again to prop up the financial institutions responsible for the crisis we are in.”
He added, “The bankers made the bad bets. They should pay. Not the taxpayers.”
Which may be the same attitude that German lawmakers are having. On the eve of potential destruction, only time will tell which attitude prevails in the end.
Robert Romano is the Senior Editor of Americans for Limited Government.
