GERMANY’S LEADING economic research institutes have thrown their weight behind Berlin’s drive to persuade euro-zone partners to agree on an insolvency mechanism for member states that are in effect bankrupt.

In a report to the government published yesterday, the institutes said merely reinforcing the rules of the euro zone’s Stability and Growth Pact – as proposed by the European Commission – would not be enough to prevent speculation against debt-laden states from destabilising the currency union.

EU finance ministers are attempting to draft regulations to prevent any repetition of the recent crisis in the euro zone, triggered by Greece’s debt problems.

The arguments from the heart of Germany’s academic-economic establishment are likely to be used by Berlin in its efforts to persuade the rest of the European Union to set up a “crisis resolution mechanism” – an insolvency procedure in all but name – even if it means amending the EU’s Lisbon Treaty.

The plan would face strong resistance from other member states, including France and the UK, if it meant any change of the treaty.

Opponents also argue that merely establishing some form of state bankruptcy procedure might encourage speculation.

The widely respected institutes – six in Germany, including the Munich-based Ifo institute, and the Institute for the World Economy in Kiel, as well as one in Austria and one in Switzerland – insist the emergency €440 billion euro-zone rescue package agreed by EU finance ministers in May was only a temporary solution and could encourage moral hazard for borrowers and lenders alike.

Instead they called for an "orderly insolvency" procedure that would involve private lenders, and fellow members of the euro zone, sharing in the costs of any debt rescheduling forced on any participant in the currency. – (Copyright The Financial TimesLtd 2010)