Persuading Europe's political leaders to get a grip on the region's deepening sovereign debt crisis will be the focus of this week's meeting of the International Monetary Fund being held in Washington.
As economists warn of a deepening financial crisis, Tim Geithner, the US Treasury Secretary, is to step up pressure at the IMF's annual meeting. It will be attended by finance ministers from around the world, despite European leaders ignoring Mr Geithner's warning in Poland on Friday that unless they take action to tackle the debt crisis they face "catastrophic risk".
Mr Geithner, the first US politician to attend a meeting of EU finance ministers when he travelled to Wroclaw to try to stop the bickering, warned: "Politicians and central banks need to take out the catastrophic risk to markets. They have to definitely remove the threat of cascading defaults, and avoid loose talk about dismantling the institutions of the euro."
His blunt warning came as Europe's finance ministers agreed to withhold an €8bn loan payment to the Greek government until it comes up with even deeper budget cuts, while the IMF is also threatening to withhold its part of the package until tougher action is taken.
However, economists fear this could prove counterproductive – the Greeks are due to make debt repayments in October – dipping the country into default. Countries such as Germany, Finland and the Netherlands pushed for the loans to be delayed in an attempt to persuade their voters that they are being prudent.
But EU officials moved quickly yesterday to smooth fears of a new bank lending freeze even though senior aides have been privately warning Europe's politicians that the region is heading for a "systemic" crisis in sovereign debt, leading to a new credit crunch, unless tough action is taken.
Luxembourg's finance minister, Luc Frieden, said on Saturday, ahead of another meeting of finance ministers, that "the situation is not worrisome. All the instruments are in place to make sure the financial system continues to work properly."
Andrea Enria, who heads the European Banking Authority, added that central banks are doing a lot to provide liquidity to ease the threat of a Greek default – one of the reasons why US money market funds and other traditional dollar lenders have been reluctant to lend to European banks. However, according to a Reuters report yesterday, senior aides, at a meeting attended by the German finance minister, Wolfgang Schäuble, have been privately warning the politicians of a new credit crunch.
The Reuters story, which claimed that it had access to the documents written by EU officials, reported that they have warned: "While tensions in sovereign debt markets have intensified and bank funding risks have increased over the summer, contagion has spread across markets and countries and the crisis has become systemic." They are also urging finance ministers to reinforce banks' capital.
The EU document points the finger specifically at Germany and Spain for not helping their banks more, and for their failure to deal with struggling banks even after their weaknesses were exposed by recent stress tests.
The report will put even more pressure on Europe's leaders to act swiftly, particularly coming after last week's attempted US intervention following threats by US money market funds and other dollar lenders not to lend to European banks. It was this fear that led to the surprise decision by five central banks to pump extra liquidity into Europe's banking system.
The central banks' intervention helped smooth the markets, but bank stocks are now a third lower than in July. French banks continue to be among the hardest hit and some eurozone banks remain close to their lows, while the cost of insuring bank debt is pushing new highs.
Economists predict the markets will continue to punish eurozone countries until its political leaders take decisive action to sign off the Greek debt package agreed three months ago but which is now delayed until October.
Schröders chief economist, Keith Wade, said yesterday: "The markets want some sort of finality and clarity and will continue to be volatile until there is a political solution to this crisis.
"Investors know the only way forward is for a restructuring of the Greek debt, but everyone is scared because that would mean the European banks taking on even more losses, bigger haircuts on the debt. That means the banks, especially the French, which have so much Greek debt, will have to be recapitalised. Everyone knows this and the markets will continue to sell off until they have finality."
However, Mr Wade added, the biggest obstacle is the ECB which has been against restructuring the Greek debt because its officials accept it will lead to the banks taking bigger haircuts, and therefore will be forced to recapitalise.
"Germany's Angela Merkel is the only one who can take the lead in this crisis, as it's the only country which can afford to provide the money. Germany has to act," he said.Reuse content