European leaders' breakthrough defied expectations

Banks would be centrally regulated, bailed out directly

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BRUSSELS — Europe’s leaders finally rose to the challenge Friday, backing bold ideas to help weak countries and frail banks ravaged by a debt crisis that has crippled economic growth and threatened the global financial system.

Markets roared their approval after leaders of the 27 European Union countries agreed on a plan to fix the financial crisis.

For the first time in 19 summits since the start of the crisis, the EU leaders declared they would:

• Centralize regulation of European banks and, if necessary, bail them out directly, instead of funneling loans through governments that already have too much debt.

• Ease borrowing costs on Italy and Spain, the euro region’s third- and fourth-largest economies.

• Rescue floundering countries, without forcing them to make painful budget cuts if they’ve already made economic reforms.

• Tie their budgets, currency and governments more tightly.

The decisions made at the EU summit in Brussels won’t end the crisis that has gripped Europe for nearly three years. Plenty of questions remain about how the bank bailouts would work, whether there’s enough money committed to rescue banks and governments and whether impoverished, indebted Greece will be forced out of the 17-nation euro club.

But for EU leaders who have consistently underwhelmed their exasperated publics and nervous financial markets, Friday’s efforts marked a breakthrough.

British Prime Minister David Cameron said that “for the first time in some time we have actually seen steps ... to get ahead of the game.”

There was an immediate sign that Europe’s latest plan was easing fear in financial markets: The cost for the troubled government of Spain to borrow fell dramatically. The interest rate, or yield, on the country’s 10-year bonds fell by more than half a percentage point, to 6.34 percent.

The Dow Jones industrial average recorded its second-biggest gain of the year, and stocks advanced even further in Europe – in strong and weak countries alike. The benchmark stock index in Germany rose 4.3 percent, by far its best performance this year.

Previously, European leaders insisted that the two bailout funds be used only to rescue governments. If money was going to be used for troubled banks, it had to first go to a government. But that added to the debt on a government’s books because it was responsible for repaying the money.

The EU also called for a single regulator – probably the European Central Bank – to oversee Europe’s banks. As part of a broad “banking union,” the new regulator will likely get power to close failing banks if their national regulators won’t do it. The plan is also expected to include deposit insurance across Europe. Individual European countries now insure bank deposits within their borders. But bank failures could overwhelm those national funds.

The bank overhaul is supposed to be completed by the end of the year.

The leaders said they were committed to linking their countries closer together economically and politically, but didn’t discuss how. Such integration would likely require countries to give up some of their taxing and spending powers to a European budget authority.

Most analysts cheered the EU plans but worried about the questions left unanswered. And they said the bailout funds are too small to handle the tasks that could be thrown at them.

Europe’s two bailout funds have a combined $625 billion in lending power; up to $125 billion of that is already committed to helping Spain bail out its banks. The remaining $500 billion looks small compared with $3.1 trillion in Spanish and Italian bonds outstanding.

The solution hovering in the background, say some economists, is the European Central Bank. The ECB could buy any amount of government bonds, backed if need be by the bank’s theoretically limitless power to create money. So far the bank has been unwilling to take this step, which could violate its mandate to fight inflation and a ban on central bank financing of national governments. The ECB’s next policy meeting is Thursday in Frankfurt.

The summit deal leaves out crucial details of just how any bank bailouts would work. Would bank creditors have to take a loss on their investments, or would taxpayers foot the whole bill? The deal didn’t specify.

If the banking regulator and a rescue fund take ownership stakes in failed banks, manage those stakes in the taxpayer interest while forcing losses on shareholders and creditors, it could be positive, said Clemens Fuest, an expert in public finance at Oxford University’s Said Business School.

Otherwise, simply charging taxpayers could be “a huge burden on growth in Europe for a very long time,” Clemens said.


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