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Cyprus was struggling with the broader ramifications of the crisis when the 2012 writedown of privately held Greek debt led to more than €4 billion[1] in losses for Cypriot banks, or in excess of 22% of GDP.
The ESM headquarters in Luxembourg’s Kirchberg district, the long-time home of private sector banks and public sector European institutions, has a major advantage over some older institutions: it was unencumbered by legacy systems – or even walls.
When the ESM was launched in October 2012, it was important to secure the highest possible credit ratings, as the EFSF had done for its debut in 2010.
Even before the ESM became a permanent fixture, the need for a governance framework for Europe’s newest international financial institution became pressing. Secretary General Anev Janse had worked hard to establish strong relations between the institution and its governors and directors.
Germany’s ratification of the treaty cleared the way for the launch of the ESM at the next scheduled meeting of Eurogroup finance ministers, on 8 October 2012 in Luxembourg.
It was an opportune moment. Europe had put in place a robust crisis response plan.
On 10 July 2012, a panel of judges in the distinctive red robes of Germany’s Federal Constitutional Court filed into a hearing that would ultimately decide whether or not the ESM could proceed. Resentment against Europe’s new firewall was bubbling into legal challenges across the euro area, with cases pending in Estonia and at the Court of Justice of the European Union.
Spain’s crisis was a boom-bust cycle turned explosive by euro area contagion. In the 2000s, the Spanish economy was generally flourishing, its growth outpaced its European neighbours, and the budget recorded a solid surplus in many years. Most job seekers could find work, aided by a construction boom.
In the spring of 2012, Spain too was suffering from downgrades as it struggled to get its banking system under control. The banking crisis would soon force the Spanish government, under its Prime Minister Mariano Rajoy, to seek euro area aid. Yet Spain was far from alone in its concern about the financial sector.
Europe’s first rescue programmes, from the bilateral loans for Greece to the EFSF-led packages for Ireland and Portugal, were designed to operate in part on the principle of dissuasion, as well as to encourage a smooth programme exit.
With former ECB Vice President Papademos installed as interim prime minister in November 2011, Greece quickly began readying itself for a second rescue programme. First on the agenda was the proposed private sector debt exchange. An effort to put a deal together in late 2011 had collapsed, so negotiations needed to start again on a bigger scale[1].