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Dithering European policymakers fail to calm volatile stock markets

• Germany divided over bolstering bailout fund
• Analysts expect US-style Tarp €150bn relief scheme

Stock markets endured a day of sharp volatility amid uncertainty about how eurozone leaders intend to solve the ongoing – and increasingly pressing – crisis that is gripping the single currency and threatening global growth.

While the US and UK hope that eurozone leaders will come up with a scheme strong enough to build a firewall around the most indebted countries in the eurozone, Germany has emerged as a stumbling block to any plan that might be drawn up to increase the bailout funds for the eurozone to €2tn (£1.7tn) or more.

German politicians told the Guardian of their dismay at reports following the last weekend’s meeting of the International Monetary Fund about beefing up the existing bailout fund – known as the European Financial Stability Facility.

Frank Schäffler, a politician from North Rhein-Westphalia, said any scheme to bolster the fund from its existing €440m capacity would be a “catastrophic development” that he feared would lead to inflation.

“It must be stopped,” he said in a phone interview. Schäffler is from the pro-business Free Democratic Party (FDP), which rules in coalition with the Christian Democratic Union (CDU) of the chancellor, Angela Merkel.

Germany’s finance minister, Wolfgang Schäuble, appeared to downplay any attempt to bolster the EFSF. “We do not intend to increase it,” he said in a television interview.

His remarks came after European markets closed and after France’s CAC40 closed 1.8% higher and the Dax in Germany rose 2.9% – but not after moving 6% from peak to trough. Gains in London were more muted with the FTSE index ending 0.4% higher at 5,089.37, while Wall Street was gyrating.

Louise Cooper, of BGC Partners, said: “These massive moves tell us how deeply uncertain is the future. Trying to trade or invest in such markets is more than difficult, I would suggest it is almost impossible.” Gold prices are falling – down by and off 0 from its ,920 an ounce high on 6 September – as traders liquidate positions to release cash to cover losses elsewhere.

But earlier, Lorenzo Bini Smaghi, an executive board member of the ECB, had insisted that discussions were under way about how to bolster the EFSF. “I know that people are thinking about these things. They may not be willing to admit it in the public, but they are thinking about these things,” he said, referring to the Troubled Asset Relief Programme (Tarp) used in the US after the 2008 banking crisis.

Analysts at JP Morgan expect European banks to get a capital injection of up to €150bn through a Tarp-like deal. “Euro-Tarp is, in our view, the best risk-reward medicine for opening the Eurobank funding market,” JP Morgan analyst Kian Abouhossein said.

There is also speculation about recapitalisation of eurozone banks, particularly because the losses, or “haircut”, on Greek bonds are expected to rise to 50%. The second bailout for Greece in July put the loss at 21% and fears of large writedowns drove shares in Greek banks – big holders of their country’s debt – to a 19-year low.

French banks are also of concern to the market and remarks by the Banque de France’s Christian Noyer at the weekend were seen as suggesting the central bank was ready to step in if necessary.

While a wide-ranging solution is needed, the focus is still on Greece. It needs the sixth tranche of payouts – €8bn – from its original bailout to be released next month or it will run out cash, potentially defaulting on its debt and being unable to pay its public-sector workers.

The EFSF must also be endorsed across the eurozone, even before any plans can be adopted to bolster its firepower. A key vote in Germany is due on Thursday and Schäffler suggested Merkel and Schäuble were not being honest with parliament about what lay ahead. “The ink has not dried on this second bailout and already there is talk about more money,” he said.

On Tuesday afternoon the FDP will hold a meeting to decide whether the party should support Merkel but Schäffler says he will vote “no” regardless.

Doubts remain about whether enough will be done. Philip Booth, from Cass Business School, said: “The IMF and the EU still has not woken up to the realities of the sovereign debt situation.”

Haircuts, blackmail and how to turn one euro into five

What is the new rescue plan?

There isn’t one. This is a wish list dreamt up by Tim Geithner, US Treasury secretary, along with possibly the UK and more than likely some emerging nations. In Brussels they say it’s “wildly premature” to talk of a multitrillion-euro bailout fund and an “orderly” halving of Greece’s €315bn debt within the six-week deadline set by Geithner and George Osborne.

OK, but what’s all this about €2tn?

EU officials know the current plans to stabilise the eurozone and resolve the sovereign debt crisis don’t cut the mustard with the markets. So there’s feverish talk of raising the bailout facility’s financial firepower to €1tn, €2tn – or even €4.5tn (roughly ten times what’s now available). One idea is to leverage this firepower by effectively turning it into a bank, which, armed with a triple-A rating and access to virtually unlimited European Central Bank capital, could lend money to countries in trouble. By distancing the ECB from these loans this would overcome political hurdles – notably in Germany. Another idea mooted is to bring forward by a year – to July 2012 – the date for turning the EFSF into a permanent European Stabilisation Mechanism and, ultimately, European Monetary Fund. French president Nicolas Sarkozy and several thinktanks like the EMF idea. Another idea is for an orderly default on Greek debt of 50%. But that will be resisted by bondholders (largely banks) who in July agreed a 21% “haircut”.

Aren’t they still trying to sort out the old rescue plan though?

Yes. The first Greek debt crisis forced EU leaders to adopt a rescue plan in May 2010 and its failure prompted a bigger one in July. The core element is a bailout mechanism known as the European Financial Stability Facility, which provides “temporary” financial assistance to eurozone members in difficulties. It has €440bn (£380bn) available and has used about €142bn of this to prop up Greece, Ireland and Portugal. There are fears that unstoppable crises in Spain and/or Italy would swiftly exhaust this firepower.

So, what’s the (relatively paltry) €8bn they’re arguing about in Greece then?

This is the sixth payment from the first €110bn emergency package agreed in May 2010. It must be signed off by the EU, ECB and IMF but the price is further spending cuts, tax rises, privatizations, wage-cuts etc. The economic and social cost is now said to be too high.

So, what’s happening with that plan – and why is there a big vote in Germany this week?

Leaders agreed in July to modify the EFSF as part of a second bailout of Greece and those reforms have to be ratified by every government in the eurozone. The German parliament (Bundestag) votes on Thursday on increasing the EFSF’s funds – and raising Germany’s contribution from €123bn to €211bn or almost half the total. A positive vote is likely but MPs are talking of being “blackmailed” into approving even bigger contributions in future; they vote next month on the second Greek rescue package as a whole. Austria, Cyprus, Estonia, the Netherlands, Slovenia and Slovakia are yet to approve the July package.

What if one country doesn’t ratify?

Market chaos – and back to the drawing board. “The way things are going the Bundestag will be asked to vote every second week on a different, new rescue package,” one insider said. So, if it’s Germany, the whole euro project will be doomed.

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