Bigger Bailout Fund for Europe Needs Work as Germany Faces Parliament Vote

By Brian Parkin and Rainer Buergin - Oct 25, 2011 4:57 PM GMT+0700

Boosting the effectiveness of Europe’s bailout fund will require further talks with investors as German lawmakers prepare to vote on its new powers tomorrow, a European Union document showed.

While the European Financial Stability Facility can be bolstered under two models that may be combined and implemented “quickly,” the extent to which the fund is leveraged can only be ascertained after discussions with investors and rating companies, the document provided to German lawmakers said.

The draft underscores the gaps remaining in European Union efforts to address the debt crisis as Chancellor Angela Merkel and fellow leaders prepare to return to Brussels tomorrow for a second summit in four days. EU leaders are still jousting with banks over the size of losses they take on Greek bonds while deliberating over leveraging the fund after ruling out tapping the European Central Bank’s balance sheet.

“A lot of people will wait to see the detail” of how the EFSF capacity is increased, Kit Juckes, head of foreign-exchange research at Societe Generale SA in London, said in an interview on Bloomberg Television’s “Surveillance Midday” with Tom Keene. “It’s hard to see that the ECB isn’t going to have to print some of this.”

The euro gained 0.2 percent to $1.3945 as of 11:33 a.m. in Berlin. European stocks fluctuated near an 11-week high, with the benchmark Stoxx Europe 600 Index little changed at 242.05 in London.

Leverage Models

German budget lawmakers are due to convene in private in Berlin today to begin scrutiny of the two leveraging models. The first would raise the EFSF’s capacity by insuring a fraction of countries’ funding requirements, and the second combines capital from European and non-European public and private investors, the draft said. The two are not “mutually exclusive,” Steffen Seibert, Merkel’s spokesman, told reporters yesterday.

“The capacity of the extended EFSF can be enlarged without extending the guarantees underpinning” it, the draft said. Even so, “the leverage which can be achieved can only be determined after dialog with investors and rating agencies around the new instrument, and in the light of prevailing investor appetite over time for the sovereign bonds of particular member states.”

German Party Conditions

Merkel’s Free Democratic coalition partner, which has flirted with bailout skepticism, indicated support for the revamped fund that should allow it to pass in tomorrow’s German parliamentary vote. Merkel has a majority in the lower house.

“The instruments are acceptable because the ECB won’t be turned into a money-printing machine, the EFSF won’t be given a bank license and the guarantees will remain capped at 211 billion euros,” Christian Lindner, FDP general secretary, said in Berlin today, according to an e-mailed transcript.

Two years after the sovereign debt crisis came to light in Greece, Europe’s response to the market turmoil once more hangs on German willingness to remain the biggest contributor to euro- area bailouts.

Europe’s highest-rated countries aren’t ready to provide “considerably” more “fresh capital” than agreed at a July EU summit, Austria’s Finance Minister Maria Fekter said.

“The AAA countries Germany, the Netherlands, Austria and Finland have signaled that they won’t consider putting up very much in fresh cash,” Fekter told reporters in Vienna today. “We’re committed to our contribution, but the measures can’t cost much more than that because we’ve got to look after our AAA ratings.”

Australian ‘Uncertainty’

Australian Prime Minister Julia Gillard became the latest world leader to urge European officials to act swiftly in resolving the crisis.

“Our deepest uncertainty comes from Europe,” Gillard told a Commonwealth Business Forum in Perth today. “We acknowledge the steps Europe has taken and how painful they have been. But more needs to be done and needs to be done fast.”

The yield on Greek two-year notes jumped 199 basis points to 80.30 percent, while German two-year yields fell two basis points, or 0.02 percentage point, to 0.63 percent at 9:34 a.m. London time.

Merkel is pushing for investors to accept losses on Greek debt of as much as 60 percent and for bank recapitalizations of about 100 billion euros, Greens party co-leader Juergen Trittin told reporters after talks with the chancellor. He said the EFSF might be leveraged to “more than 1 trillion” euros.

Greek Writedowns

Financial companies, represented by the Institute of International Finance, proposed a loss of 40 percent on Greek debt, said a person with knowledge of the discussions, who declined to be identified because talks are confidential. The EU is calling on investors to forfeit as much as 60 percent, making a compromise at 50 percent possible, the person said.

“There are limits, however, to what could be considered as voluntary to the investor base and to broader market participants,” Charles Dallara, the IIF’s managing director, said in an e-mailed statement. “Any approach that is not based on cooperative discussions and involves unilateral actions would be tantamount to default.”

Greece’s deteriorating finances have narrowed Europe’s room for maneuver in battling the contagion, which threatens to pitch the country into default, rattle the banking system, infect Spain and Italy and tip the world economy into recession.

Berlusconi’s Defense

“Nobody has anything to fear about Europe’s third-largest economy,” Prime Minister Silvio Berlusconi said in an e-mailed statement, defending his government’s commitment to fiscal rigor after the EU urged Italy to pass “comprehensive” measures to fight the debt crisis. The government is preparing to push through “important decisions” on structural changes, he said.

According to the document, Option 1 calls for the EFSF to lend a distressed state the money to buy EFSF bonds with detachable “partial protection certificates” that can be traded separately from the EFSF bonds themselves, which would be used to collateralize the certificates in the event of a default.

What would constitute a default still has to be decided, the paper says. If a state failed to meet its obligations, the owners of the certificates would be paid off with the EFSF bonds held in a separate trust, the document states.

Using the option would risk triggering so-called negative pledge clauses in the documents governing some of the bonds, according to the draft. A negative pledge forbids an issuer selling new debt senior to existing bonds. The option would also risk increasing the beneficiary country’s tally of debt as reckoned by Eurostat, the EU’s statistical office in Luxembourg.

The paper says Option 2 involves setting up a special purpose investment vehicle, or SPIV, to buy the bonds of the country in question in both primary and secondary markets. The purchases would be funded by the SPIV issuing senior bonds, which would be rated and targeted at traditional fixed income investors. A more junior portion aimed at higher risk investors could also be issued, would rank ahead of the EFSF investment, and share any gains with the EFSF, the draft says.

To contact the reporters on this story: Brian Parkin in Berlin at bparkin@bloomberg.net; Rainer Buergin in Berlin at rbuergin1@bloomberg.net

To contact the editor responsible for this story: James Hertling at jhertling@bloomberg.net