WORLD> Europe
Germany, France may have to bail out nations, not banks
(China Daily)
Updated: 2009-02-19 07:54

Germany and France may be forced to contemplate the bailout of entire nations rather than just individual banks as European government budgets buckle under the weight of recession.

German Finance Minister Peer Steinbrueck became the first senior policy maker to broach the topic this week, saying some of the 16 euro nations are "getting into difficulties" and may need help. French officials are also concerned about market tensions as the cost of insuring Irish, Greek and Spanish debt against default rises to records and bond spreads widen.

The nightmare for Angela Merkel and Nicolas Sarkozy is that widening deficits will prompt investors to shun the debt of some countries, sparking a region-wide crisis. While few investors are yet forecasting any defaults, the mere risk of it may prompt the bloc's two richest economies to ignore the European Central Bank and announce their willingness to come to the rescue.

"When push comes to shove Germany, France, the larger players will bail out those smaller peripheral players," said Alex Allen, chief investment officer of Eddington Capital Management. "You can't let one part of the system fail because it leads to failure of the whole system."

Allen's betting that the risk at least one nation will leave the bloc is higher than the market currently expects.

European deficits have ballooned as governments from Berlin to Dublin committed more than 1.2 trillion euros to save their banking systems from collapse.

The European Union's executive arm forecasts a deficit of 11 percent in Ireland, 6.2 percent in Spain and 4.6 percent in Portugal this year. The euro region's average budget gap was just 0.6 percent in 2007.

European officials have already expressed concern that their bond market could potentially face a crisis similar to that unleashed by the collapse of Lehman Brothers Holdings Inc in September. ECB board member Lorenzo Bini Smaghi said Feb 12 there's a "risk that the mistrust that there is today in financial markets" is "transformed into mistrust in states."

"I would be very reluctant to say: 'OK, let Ireland or Greece default, the market will sort it out, punish them for their irresponsibility of the past,'" said Thomas Mayer, co-head of global economics at Deutsche Bank AG in London. "They tried it with Lehman and realized that was not a good idea."

The gap between the interest rates Greece, Austria and Spain must pay investors to borrow for 10 years and the rate charged Germany yesterday rose to the widest since before they adopted the euro.

Agencies

(China Daily 02/19/2009 page17)