The financial markets reacted positively on Monday to a promise by the leaders of Germany and France on Sunday in Berlin to reach an agreement to recapitalize banks and tackle the euro-zone debt crisis hand-in-hand. European shares made slight gains despite reluctance by Chancellor Angela Merkel and President Nicolas Sarkozy to provide details of their plan. Instead, they set a clear deadline for its completion -- by month's end, just before Sarkozy hosts the upcoming G-20 summit in Cannes from Nov. 3-4.
When pressed by journalists to give more detail on just how Germany and France planned to boost European banks, both leaders refused to offer specifics pending discussions with their euro-zone counterparts mid-month at a summit in Brussels. "We are determined to do the necessary to ensure the recapitalization of Europe's banks," Merkel said. Having noted the two countries' particular sense of responsibility in stabilizing the currency union, Sarkozy added that their response would be "sustainable and comprehensive." The French president also insisted that he and Merkel were in "total agreement" on their approach to recapitalizing unstable European banks, despite rumors to the contrary.
Without recapitalization, some analysts fear that European banks would fail to withstand a potential government bond default by Greece, which could cause some to go bust. "The market is looking for a road map for a solution to the euro-zone crisis. Merkel and Sarkozy details are scratchy and investors will need to see the detail by the end of the month," Richard Batty, a strategist at Standard Life Investments, which has $245 billion in assets under management, told news agency Reuters on Monday.
While details were scarce, Merkel did say that recapitalization measures would include the analysis of all euro-zone banks according to the same criteria, coordinated by authorities including the European Banking Authority and the International Monetary Fund.
Though the European Union has disputed the figures, the IMF has estimated that euro-zone banks could require up to €200 billion ($267 billion) in fresh capital. Among the Contintent's biggest Greek bond holders, France reportedly wants to tap the EU's €440-billion European Financial Stability Facility (EFSF) backstop fund instead of its own national resources to recapitalize its threatened banks. There are fears in the country that concerns about French banks could endanger the country's AAA credit rating. But Merkel has said the EFSF should be used only if banks fail to raise fresh capital on the markets and their country can't manage to shore up the financial institutions on their own. Still, Sarkozy said on Sunday, "there are no disagreements" between the two countries on the use of the EFSF.
In an interview with the Financial Times published on Monday, British Prime Minister David Cameron urged France and Germany to set their differences aside and implement a clear plan, taking a "big bazooka" approach to the crisis before year's end. "The situation with the world economy is very precarious ... you either make the euro zone work properly or you confront its potential failure," he told the paper.
Meanwhile, the implosion a Belgian subsidiary of the struggling bank Dexia due to its exposure to Greek and Italian debt added a critical element to the talks. While France, Belgium and Luxembourg have agreed to a massive bailout, the debacle seemed like a harbinger of what could befall other banks as the soveriegn debt and currency crisis continues to unfold. Over the weekend, Ireland estimated that euro-zone banks would need upwards of €100 billion ($135 billion) in capital to weather the debt crisis, while the IMF suggested that figure be doubled.
Debt Haircut Rumors
Greece is expected to run out of cash by mid-November without more aid, which is still pending approval by the "troika" inspectors from the European commission, the IMF and the European Central Bank. The group is analyzing whether Greece has fulfilled the reform requirements promised in exchange for the next tranche of the €110-billion bailout fund put together in 2010. After their meeting on Sunday, both Merkel and Sarkozy said they wanted to keep Greece as a member of the EU.
"We are working closely with the troika which is currently in Greece and we expect them to present a sustainable solution for Greece that keeps it in the euro zone and also ensures the financial stability of the euro zone," Merkel said.
A total Greek default remains improbable, but German news agency DPA published a report on Monday citing sources in the finance industry and individuals familiar with negotiations indicating that euro-zone finance ministers are discussing scenariors for a Greek haircut of as much of 60 percent. Meanwhile, in a guest commentary for Financial Times Deutschland newspaper on Monday, former German Chancellor Gerhard Schröder also called for an "intelligent debt haircut of some 50 percent," adding that the EFSF fund would also need to be expanded.
Comments by German Finance Minister Wolfgang Schäuble on Sunday also indicated that European leaders were preparing for a massive Greek debt haircut. In July, private financial institutions taking part in the second, €109-billion bailout for Greece had agreed to have their Greek bond holdings slashed by 20 percent, but Schäuble suggested this may not have gone far enough. "So far we have probably assumed an insufficient percentage of debt reduction," the member of Merkel's conservative Christian Democrats told the Frankfurter Allgemeine Sonntagszeitung newspaper. "There is a big risk that this crisis will spread further."