The European Central Bank (ECB) in Frankfurt is widely seen to have enhanced its international standing by its brave and speedy reactions to the banking meltdown beginning in 2007. But the EU institutions in Brussels have not had a good financial crisis. That at least is the widely held judgement of many experts.

According to Jean Pisani-Ferry, director of Bruegel, a Brussels-based economics think-tank, the EU institutions were “badly equipped” to deal with the crisis because they lacked solid crisis-management capacity. When the chips were down, it was national governments that called the shots as they scrambled to save their banks. Daniel Gros, director of the Centre for European Policy Studies (CEPS), says: “In this crisis, the EU did not matter.”

The Eurogroup, the collective of eurozone finance ministers, was largely missing in action. It even attracted public criticism from President Nicolas Sarkozy of France, who convened a meeting of prime ministers of the eurozone. The European Commission, too, despite the important and effective co-ordinating role it has played behind the scenes, has come under attack for not providing sufficient leadership in the past two years.

Stung by these criticisms, both the Eurogroup and the Commission are turning their attention to contingency planning, to put in place mechanisms that might be deployed to head off another downward twist in the economic cycle, renewed problems in the banking sector, or, more immediately, a sovereign debt crisis starting in Greece.

That is why the discussions are now under way about whether the Eurogroup should be at the centre of efforts to co-ordinate support for a crisis-hit eurozone country, rather than the International Monetary Fund (IMF), the traditional port of call for troubled governments seeking emergency finance. The discussions extend to whether, with back-up from the Commission, the Eurogroup might oversee the management of a (heavily conditional) medium-term credit facility.

Debt disease

Concern about the threat of a Greek sovereign debt-crisis that might spread to other eurozone countries is now intense. If the eurozone does not support Greece, or if support is so hedged about with conditions that it is politically impossible for the Greek government to accept, then Greece might yet default on its sovereign debt. If that happened, then the financial markets would speculate on defaults by other eurozone countries with precarious public finances: the cost of borrowing for the likes of Italy, Spain and Portugal would rise sharply.

At the ECB’s monthly press conference on 14 January, Jean-Claude Trichet, its president, had to fend off questions about Greece and the public finances of other eurozone countries. “No government, no country can expect special treatment from us,” he said in response to a question about Greece and other financially weakened eurozone states. He warned that the threat from “sudden changes in market sentiment”, could undermine EU institutions.

Trichet’s remarks left open the question of what to do about providing Greece with official support if it became necessary and where the money should come from.

At a gathering of Brussels think-tanks last week (12 January), Pisani-Ferry noted some of the challenges that the eurozone would face if it decided to create an emergency funding facility.

He pointed out that implementing sovereign bail-outs required the IMF to draw on its long experience in managing economic adjustment-programmes and to be tough and unpopular with the government – and often with the people – of the country in crisis. “Does the European Union have the institutional ability to do this?” he asked.

Political sensitivity

So far-reaching are the implications of any decision to set up a eurozone financial-support facility and such would be the political sensitivity of the issues involved, that the principle would need to be approved by eurozone leaders and could not be left to finance ministers sitting in the Eurogroup, says one expert observer.

Some EU officials say it would be politically and diplomatically humiliating – even damaging to the single currency – if a member of the eurozone had to turn to the IMF. But other experts point out that it would be unwise to understate the challenge facing the EU or eurozone countries if they decided to take on the job of trying to dragoon a country such as Greece into restructuring its economy.

Apart from the time it might take to get an agreement and to establish adequate crisis-management structures, the path back to economic stability in a country receiving support is usually strewn with boulders, as the IMF can testify. Countries borrowing from the IMF often try to avoid fulfilling the conditions under which bail-out loans are made, sometimes even encouraging their citizens to riot in order to put pressure on official lenders. Sometimes (as was the case with Argentina), they end up defaulting on the loans anyway.

One expert familiar with these dangers points out that the EU cannot plan on the basis that dealing with Greece would be a one-off. Others could follow. In all likelihood any ‘in-house’ solution for the eurozone would turn into a troubled multi-year commitment.

There are a host of further questions, prominent among them that of moral hazard. Might setting up a eurozone sovereign rescue scheme, even discussing its creation publicly, discourage a hard-pressed eurozone member from following the path of economic virtue? Who would run such a scheme? How would its purposes be defined and decisions taken and enforced? Memories (bad in Germany) of ambitious, but unrealised, burden-sharing schemes dating from as early 1973 might be summoned up.

Attractive governance

On the other hand, a decision to manage a eurozone sovereign-debt crisis within the EU and the eurozone might be attractive to those countries, particularly France, who long campaigned for a strengthening of the eurozone’s ‘economic governance’.

Success could reinforce the credibility of the single currency, deepen the eurozone’s political and economic integration without directly compromising the role of the ECB, and send a strong signal to non-members about the advantages of joining. It would, coincidentally, also further remove the UK from some of the EU’s vital decision-making processes.

Stewart Fleming is a freeland journalist based in London.