EU clouds bailout scheme in appropriate fuzziness

December 17, 2010

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

LONDON — You’ve got to know when to show ’em — and now is not the time. In a nutshell this is the message to investors from European Union leaders in spite of investors’ eagerness to see the details of the permanent bailout mechanism being introduced in 2013. This week’s Brussels summit agreed on a small but significant treaty amendment that makes it possible to aid a euro zone member in financial difficulties. The words chosen are deliberately vague. This is partly the result of divisions. But it is also intentional: keeping markets guessing is the best thing governments can do for the moment.

The limited scope of the amendment allows it to be adopted in all EU countries without the political drama of referendums and big national debates. The mechanism should be up and running when the European Financial Stability Facility, used for Greece and Ireland, expires in three years. It will be activated “if indispensable to safeguard the stability of the euro area as a whole” — a somewhat softer formulation than the “last resort solution” mentioned by German leaders. The aid will be dispensed on a case by case basis and may — or may not — include haircuts for private creditors.

As important as what the leaders decided is what they chose not to do. There was no increase in the firepower of the current European Financial Stability Facility, nor any extension of its remit to cover sovereign bond buying. But increasing EFSF funding, and giving a precise number, would have been immediately interpreted as a preparation for a major bailout (think: Spain), with the major risk of making that more likely.

Governments don’t have to show all their cards. They’re right to remain vague as to when and how the bailout mechanism would be triggered, and where and when private creditors would be hit. Suffice for them to repeat that they will do their utmost to keep the euro intact. Going into too much detail would increase moral hazard by giving credence to the idea that there’s a right to bailout — for both cash-strapped euro members and their creditors. In the current crisis, it’s a duty for governments to remain fuzzy.

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