November 10, 2011

Europe in Disarray as Contagion Spreads

Italian bonds set record; non-euro leaders meet

As both Italy and Greece fumbled with successor governments, worries over officials’ failure to find a solution to the debt crisis spread contagion to Italy, where bond yields broke records.

As if that were not enough bad news for the region, France and Germany are squabbling over rules for a euro zone debt repayment plan. And non-euro-using nations warned against forming “a club within a club”—a two-tier system within the European Union (EU) that seems geared toward creating a two-speed Europe of nations within the euro zone and those that do not use the joint currency.

Investors growing increasingly fearful for the survival of the euro hammered Italian bonds Thursday, even as the European Central Bank (ECB) bought them in an attempt to keep worries under control. That failed, however, with 10-year Italian bond yields soaring above 7% and with Reuters reporting that the ECB also declared that it does not intend to rescue governments with unlimited funds.

Failure of both Greece and Italy to come up with successor governments has been an unlooked-for complication. The Greek debacle has the elements of a sideshow, as Prime Minister George Papandreou on Wednesday announced that a previously arranged coalition would take over, and Filippos Petsalnikos would succeed him as prime minister, according to Reuters.

He departed to meet with the country's president only to learn that the coalition between his own PASOK party and the opposition New Democracy party had fallen apart, with both refusing to back Petsalnikos. Instead the man to succeed Papandreou is Lucas Papademos, according to a Bloomberg report; Papademos is a former vice president of the ECB, who was named Thursday to be prime minister.

Meanwhile, Italy has its own troubles. After finally agreeing to step down, Prime Minister Silvio Berlusconi insisted that a successor must be chosen by early elections, Reuters reported. Now, however, it looks as if his party may have moderated its insistence on elections and is instead considering former European Commissioner Mario Monti to take over from Berlusconi.

That has not helped in the broader crisis, however. A New York Times report said that non-euro-zone countries in the EU were concerned that a possible two-tier system might result from the wranglings of France and Germany, and that the 10 leaders from the broader EU met at a Brussels dinner Wednesday, following which Nicholas Clegg, deputy prime minister of Britain, warned the euro zone against creating “a club within a club” as they try to save the joint currency. This after President Nicolas Sarkozy of France has called for a two-speed Europe, with the possible exit of weaker nations from the euro zone. Chancellor Angela Merkel of Germany opposes such an idea, and is instead advocating changes in EU treaties.

Sarkozy and Merkel were still arguing over several issues, including the successor bailout mechanism. France, which has instituted its own austerity measures, advocates bondholder-loss provisions to be stripped from the European Stability Mechanism (ESM) treaty, according to a Bloomberg report, along with Spain, Portugal, and Ireland. Germany, however, is standing firm against such a plan, and the delay is further worrying investors as it appears the ESM may not be put in place on schedule.

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