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People play with balls bearing the euro symbol at Madrid's Puerta del Sol, shortly before the introduction of euro notes and coins. (ANDREA COMAS/REUTERS)
People play with balls bearing the euro symbol at Madrid's Puerta del Sol, shortly before the introduction of euro notes and coins. (ANDREA COMAS/REUTERS)

economy

Political 'paralysis' fosters debt chaos Add to ...

Political turmoil is exacerbating the financial chaos in Europe, even as its crisis deepens with yet another credit downgrade.

European leaders and finance chiefs are scrambling to find a long-overdue crisis relief plan to stop Italian and Spanish borrowing costs from reaching breaking point and prevent their monetary union from crumbling around them.

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But just as financial pressures ease on one front, others arise. Tuesday, for example, Italy calmed markets somewhat when it pulled off a successful bond auction. But just hours later, Moody's Investors Service sent the euro tumbling again by cutting Ireland's debt rating to junk status, suggesting it may need a further bailout.

Europe's leaders and policy makers have been unable to stem the crisis that has roiled financial markets for months, spreading from Greece to other periphery countries and now into bigger economies such as Italy and Spain. Finding that elusive answer is critical to the 17-member euro zone and its banks amid fears that a default by Greece would ripple through the financial system.

CMC Markets analyst Michael Hewson cited the "continued policy paralysis and discord" among EU leaders as the troubles escalate and borrowing costs in Italy and Spain, the latest focal points, near breaking point.

Greece's Prime Minister George Papandreou, for example, took a backhanded swipe at German chancellor Angela Merkel, who has always been reluctant to rescue clapped-out euro zone economies for fear of a taxpayer backlash.

In a letter to the euro zone finance ministers, which did not specifically mention Ms. Merkel, he called for "strong and visionary European leadership" to contain the crisis and an end to the "tactical politics" that has seen Ms. Merkel and the leaders of other wealthy countries hesitate to act boldly while the debt wave swamped Greece, Ireland and Portugal, all of which required costly bailouts.

Dutch MPs called for speedy resolution to the crisis, even though the Netherlands has been critical of bailing out countries it considers the authors of their own misfortunes. "The uncertainty surrounding tackling the Greek crisis is dragging on for too long," said Liberal Democrat MP Wouter Koolmees. "It sometimes seems as if everyone is performing for their home audience rather than coming up with a solution which is in everyone's interests."

In Rome, the new front in the debt crisis that began in Greece a year and half ago, Prime Minister Silvio Berlusconi abandoned his customary economic good cheer Tuesday to call for national unity and sacrifices to balance the budget, aimed at bringing down the continent's second-largest debt load, at 120 per cent of gross domestic product.

"We are in the front of this battle," he said. "We have to eliminate any doubts over the efficacy and credibility of our budget."

Italian finance minister Giulio Tremonti returned early from a finance ministers' meeting in Brussels to push forward a €40-billion ($54-billion) austerity program designed to balance the budget by 2014, delivering the message to the markets that Italy will fight the debt disease. There was talk that Mr. Tremonti will tweak the program to ensure that more of the spending cutbacks and tax hikes would come early in the four-year effort.

European markets fell again, after a severe rout that started late last week. But the decline was less severe and some of the Italian banks, whose prices had gone into near free-fall in the last week as the debt contagion hit Rome, moved back into positive territory. UniCredit of Milan, one of Europe's biggest banks, gained almost 6 per cent after a fall that had eliminated a quarter of its value.

Italian bond yields briefly broke through the psychologically scary 6-per-cent-yield level - a record high since the euro was launched 12 years ago - but fell back to about 5.8 per cent. The successful sale of €6.75-billion of Italian one-year bonds helped to restore confidence in Italy's debt operations. Buyers, however, demanded a hefty yield of 3.67 per cent, up substantially from the 2.15 per cent paid on a similar sale a month ago.

While European leaders pleaded for unity and alacrity in reining in the galloping debt crisis, no consensus emerged on how it should be accomplished. Finance ministers, economists and bankers continued to have wildly different views on how to fix Greece, let alone the other infected countries. "The problem is that slow-moving politics and fast-moving markets do not work well together," Juergen Matthes, senior economist at the Cologne Institute for Economic Research, in Germany, said in an interview.

On one extreme, there is the view that letting Greece default on its debt would only accelerate the debt crisis, by making the country's sovereign bonds nearly worthless and triggering a run on any bank that owns them in bulk. In a panel discussion in Milan on Tuesday, Lorenzo Bini Smaghi, a member of the European Central Bank's executive board, called a Greek default dangerous and implausible. "We think this [a default]is absurd," he said. "What is needed is a European solution."

On the other extreme is that view that Greece's debt, at 150 per cent of GDP and rising, is far too big to be repaid and that the only solution is a default, followed by a restructuring that would eliminate 50 per cent or more of its bond debt. Other proposals come at various points in between, ranging from rollovers of privately owned bonds to using the European Union's bailout mechanism, known as the European Financial Stability Facility Facility (EFSF), to buy Greek debt.

A statement released Monday by the EU finance ministers suggested that EFSF would become more flexible - details to come. In general, the finance ministers seem open to the idea of removing some of Greece's onerous debt load. Jean-Claude Junker, the Luxembourg prime minister who is head of the Eurogroup (the euro zone finance ministers) said "if the weight of Greek debt is corrected downwards, if the interest rates are lowered and if the maturities are extended, then you might get the impression that this will be of great help to Greece."

The plunging prices of Italian and Spanish bonds in recent days shows that investors are exploiting the political dithering. Economists say time is running out. "We need to see something credible soon," said James Ashley, senior economist with Royal Bank of Canada's investment arm.

Follow on Twitter: @ereguly

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