A year in crisis

Politicians scuttled from one crisis summit to the next, the financial markets demanded ever-rising risk premiums for government bonds, and ratings agencies got tougher and tougher on the eurozone. But at the end of a traumatic year, Europe's debt crisis is still a long way from running its course.

And the year began so well for the euro, too. At midnight on New Year's Eve, Estonia became the first former Soviet republic to join the single currency. The small Baltic nation enjoyed a reputation as the European Union's teacher's pet, keeping its finances neat and tidy to earn its place as the eurozone's 17th member.

But then things quickly took a turn for the worse. In February Axel Weber, president of the German Federal Bank, announced his retirement. The man who had long been seen as a potential candidate for the presidency of the European Central Bank (ECB) found he could not have his way with the institution he once hoped to lead.

Six months later, ECB chief economist Jürgen Stark also resigned, for "personal reasons." Like Weber, Stark was considered a guardian of financial stability and opposed the ECB buying billions of euros in bonds.

Stark had good arguments on his side. For a start, the treaty that governs the methods of the European Union forbids the ECB from directly buying debt instruments, a rule intended to guarantee its independence. The central bank is, after all, meant to be a guardian for the stability of the euro, and not a money printer for cash-strapped nations.

But on the other hand, the ECB is not forbidden from buying bonds as such. It's only the "direct purchase" that is forbidden, according to article 123 of the EU treaty. In other words, the bank can't buy bonds from the governments themselves.

Wholesale buying

But the ECB is allowed to buy bonds from the secondary market, if the stability of the euro is threatened – a rule it has certainly made liberal use of in recent times. Since May 2010, the central bank has bought 203.5 billion euros ($265.5 billion) worth of bonds.

The ECB justifies the massive purchases by saying they support the markets, but the intervention puts pressure on the interest charges of the euro's problem children, like Italy and Spain.

In Brussels, meanwhile, caterers barely had time to clear the plates of one top-level crisis summit before the next was being booked. In March, the 27 EU states approved a multi-faceted euro rescue package. Europe's bailout fund, the European Financial Stability Facility (EFSF), in force until 2013, was topped up to a total of 500 billion euros. In 2013 – though perhaps sooner – it is to be replaced by the 700-billion-euro European Stability Mechanism (ESM).

In August, German Chancellor Angela Merkel and French President Nicolas Sarkozy called for the establishment of a finance ministry for the eurozone, and a debt limit for all eurozone countries. The eurobonds option, however, was not on the table, at least for now.

Political victims

There followed two summits in four days in October, when a haircut on Greece's debt was finally agreed deep into the night of the second. Private creditors were forced to accept a 50 percent cut in their demands.

On top of that, the heads of state drew up a new rescue package for Greece. By 2014 the crisis-hit country will receive an additional 100 billion euros in loans. Other decisions were also reached at the summit: banks deemed essential to the financial system were forced to ensure they have more capital, and the EFSF was to be beefed up by means of a leverage. But it remains unclear how exactly that will work.

Meanwhile, the debt crisis claimed political victims, too. At the end of October, Greek Prime Minister George Papandreou, rapidly running out of cards to play, announced he would put the EU rescue plan to a referendum. The EU was taken completely by surprise, and stock markets plummeted. The German stock index DAX shed five percent. Then Papandreou, under massive pressure from international creditors, gave in, took back the idea – and resigned.

In November, the Italian financial markets came under increasing pressure. The Mediterranean nation was forced to pay a record interest rate of 6.7 percent on its government bonds. Then-Prime Minister Silvio Berlusconi finally lost a vote in parliament, and he too stepped down on November 12.

In Spain, meanwhile, the conservative People's Party won a landslide victory in an early election. Defeated Prime Minister Jose Luis Rodríguez Zapatero suffered a debacle of historic proportions, while Prime Minister-elect Mariano Rajoy warned his people of tough times ahead.

Crisis deepens

As governments fall across Europe, the debt crisis began to bite deeper into the heart of the eurozone. Following Italy and Spain, France got sucked into the whirlpool. The US credit ratings agency Moody's warned that the second biggest eurozone country was in danger of losing its triple-A rating, should refinancing costs remain high and impact the country's budget.

As a consequence, the interest that France and Belgium pays on ten-year state loans reached new heights, while Spain was being forced to pay its highest interest rates for 14 years.

With alternatives running out, the eurozone's banks borrowed more and more money from the ECB – more than at any time in the past two years. For stock exchange operators, the inter-bank market practically died, as the suspicion among financial institutes continued to increase.

"It is much worse than at the time of Lehman bankruptcy in 2008, because the governments are now incapacitated, too," one Frankfurt trader observed.

Sweeping blow

At the beginning of December, US ratings agency Standard and Poor's delivered a sweeping, European-wide blow – threatening Germany and almost every other eurozone country with a downgrade. In an unprecedented step, S&P's slapped a total of 15 countries with negative prognoses, which could still lead to downgrades in the next three months.

Finally, the European Union decided to put its own unity on the line. At the beginning of December, the EU member states agreed to sign an unprecedented new treaty to impose budget discipline on themselves – all except the British whose Prime Minister David Cameron dramatically wielded his veto.

That means that Germany and France only partially achieved their aim. The EU also used the summit to beef up its protection against the looming debt crisis. Up to 200 billion euros of central bank funds will be transferred to the International Monetary Fund (IMF), so it can help bail out struggling eurozone nations. All 17 eurozone countries are on board with the new euro pact, as are nine non-euro EU countries,though some still have to get the approval of their parliaments.

Author: Rolf Wenkel / bk
Editor: John Blau