Angela Merkel and Nicolas Sarkozy are running out of road.
Whether to allow Greece to default and how to manage the fallout, questions they have tried to avoid for more than a year, may finally require answers as European officials turn to fortifying banks and consider ways to ease Greece’s debt load. It costs $6 million plus $100,000 a year to insure $10 million of Greek securities for five years, with credit-insurance prices pointing to a 91 percent chance of default.
As the German chancellor and French president prepare to meet in two days for their eighth one-on-one summit in 20 months, Merkel has cited the need to prepare for the default that investors see as a sure thing. Sarkozy, whose banks have the most to lose, is unwilling to gamble on letting Greece go.
“The whole German debate about a default of Greece is a German debate, not a European debate,” said Stefan Collignon, a former German Finance Ministry official and political economist at the Sant’Anna School of Advanced Studies in Pisa, Italy. “The commitment everywhere else, including in France, is very much to avoid that by all possible means.”
The heads of Europe’s two biggest economies meet in Berlin on Oct. 9 with the euro near a nine-month low against the dollar. French 10-year bonds yield 81 basis points more than their German equivalents, near the euro-era record set Aug. 8. Investors are demanding a premium of 21.4 percentage points to hold Greek 10-year bonds over benchmark German bunds of similar maturity.
The leaders’ contrasting approaches on Greece may reflect the relative vulnerability of their top credit ratings and economies. France’s AAA rating and its banks are on the front line of potential damage, while German exposure to Greek debt is smaller.
Credit-default swaps on Germany have almost doubled this year to reach a high of 121 basis points Oct. 4. French CDS exceeded 200 basis points last month. Higher prices indicate greater risk.
“Sarkozy is obviously the weaker partner,” Carsten Brzeski, an economist at ING Group in Brussels, said in a phone interview. Even so, “Merkel needs Sarkozy’s support on the debt restructuring issue, not necessarily that it’s going to happen now, but that it’s going to happen sometime.”
Already the biggest contributor to bailouts for Greece, Ireland and Portugal, Merkel may not offer much in return when she hosts Sarkozy at the Chancellery.
She’s been stressing the limits of joint action, saying Oct. 5 that Europe’s rescue fund will only be used as a last resort to save banks and that investors may have to take deeper losses in a Greek rescue. Germany is also resisting discussion of leveraging the 440 billion-euro ($586 billion) fund to boost its firepower.
European leaders are struggling to persuade investors they can stem the sovereign-debt woes as the crisis gnaws at the euro area’s core, prompting speculation of another government rescue of Dexia SA, the municipal lender bailed out by France and Belgium in 2008.
Underscoring the risks, Moody’s Investors Service lowered Italy’s credit rating by three steps on Oct. 4 and warned that euro-area nations rated below the top Aaa level may have their rankings cut.
Since the crisis broke out in Greece in late 2009, Merkel and Sarkozy have differed on key points -- including the role of the International Monetary Fund in rescues, sanctions for countries that break deficit rules and how to make banks take losses to help rescue Greece -- before finding a way forward.
“Franco-German cooperation hasn’t worked well in terms of solving the crisis,” Paul De Grauwe, an economics professor at the Catholic University of Leuven in Belgium, said in a phone interview. “The two have pursued different objectives.”
As German Finance Minister Wolfgang Schaeuble urges euro- area counterparts to develop individual plans to protect their nations’ banks, Merkel is laying out the scenario of Greece defaulting without leaving the currency union she has vowed to preserve.
“We have to be able to put up a barrier,” she said on Sept. 26. “I don’t rule out at all that at some point we will have the question of whether one can do an insolvency of states just like with banks.”
She raised the specter of running out of time, patience and money on Oct. 5, prodding other European Union governments to figure out whether banks need capital boosts. “Time is short,” she said.
In contrast, Sarkozy has referred to Europe as a “family” that must stick together to support its weakest members. After hosting Greek Prime Minister George Papandreou at his Elysee Palace on Sept. 30, Sarkozy rejected daring the markets with an insolvency.
‘Paid the Price’
“The failure of Greece would be the failure of all of Europe,” Sarkozy told reporters. “Remember in 2008, when the U.S. let Lehman Brothers fail, the global financial system paid the price. For both economic reasons and moral reasons, we can’t let Greece fail.”
Sarkozy, whose popularity is near a record low as he decides whether to seek a second term next year, has reasons for concern. At the end of March, French financial firms had $672 billion in public and private debt in Greece, Portugal, Ireland, Italy and Spain, according to Basel, Switzerland-based Bank for International Settlements. That’s the biggest exposure to the euro-area’s troubled countries and almost a third more than German lenders.
Bank of France Governor Christian Noyer said last month that French banks don’t need recapitalization as Societe Generale SA, BNP Paribas SA and Credit Agricole SA, the country’s largest lenders, have announced plans to reinforce their capital by cutting assets.
Merkel, who faced down two junior parties in her government that flirted with anti-bailout stances, won a victory last week when her coalition’s lawmakers passed an expansion of the rescue fund, known as the European Financial Stability Facility, that allows it to buy sovereign bonds in the secondary market and recapitalize banks.
Merkel signaled that Germany’s largesse is now exhausted, saying Oct. 5 that the rescue fund’s new powers must only be used if the “stability of the euro as a whole” is at risk.
Merkel and Sarkozy issued coordinated statements on Sept. 14 after a three-way phone call with Papandreou, saying they are “convinced” Greece will stay in the euro area.
In focusing on Greece, Europe’s leaders are “asking the wrong question,” Irish Finance Minister Michael Noonan said yesterday in a speech in Ireland’s upper house of parliament. Europe should recapitalize banks to build a “financial firewall against contagion,” tackle Greek debt and then sort matters of governance, he said.
“The question is what should Europe do about the euro zone, and if you answer that question then Greece falls into context,” Noonan said.
© Copyright 2015 Bloomberg News. All rights reserved.