EU Considers Wielding $1.3T to Break Debt Impasse

By James G. Neuger and Tony Czuczka - Oct 21, 2011 2:23 PM GMT+0700

European governments may unleash as much as 940 billion euros ($1.3 trillion) to fight the debt crisis, seeking to break a deadlock between Germany and France that is forcing leaders to hold two summits within four days.

Negotiations on combining the European Union’s temporary and planned permanent rescue funds as of mid-2012, while scrapping a ceiling on bailout spending, accelerated this week after efforts to leverage the temporary fund ran into European Central Bank opposition and provoked the French-German clash, two people familiar with the discussions said. They declined to be identified because political leaders will have to decide.

The option may be one way out of the impasse between Europe’s two biggest economies as President Barack Obama presses for them to find a solution. Finance ministers meet in Brussels today from about 2 p.m. to lay the groundwork for an Oct. 23 meeting of government leaders that had been the deadline for a solution to the debt crisis. A summit for Oct. 26 was set yesterday after Germany and France said the EU needs more time to seal a “global and ambitious” accord.

“The market wants the euro crisis solved yesterday, and the politicians and finance ministries seem to be saying ‘yes we can, but no we won’t,’” Chris Rupkey, an economist at Bank of Tokyo-Mitsubishi UFJ Ltd., said in an e-mail. “Europe has the wealth to deal with Greece, it is just that the process is incredibly complex.”

Disclosure of the dual-use option helped reverse declines in U.S. stocks and the euro yesterday. The Euro Stoxx 50 Index added 1 percent, led by banks, at 9:20 a.m. in Brussels.

Greek Vote

In Greece, Prime Minister George Papandreou won a parliamentary vote late yesterday on further austerity measures to secure more aid under the 2010 bailout. As hooded protesters threw rocks and battled riot police outside the parliament in Athens, one man died of heart failure after a rock hit him on the head, the government said.

EU officials weighing deeper losses for Greek bondholders in a revamped bailout are concerned that any investor involvement risks further roiling markets, say people familiar with the deliberations.

Greece has accumulated at least 20 billion euros in additional financing needs since a 159 billion-euro package was set in July, because of a deepening recession and delays in enacting the plan, said the people, who declined to be identified because leaders have yet to agree on their strategy.

Debt Options

The EU is considering five scenarios, ranging from sticking with July’s voluntary swap to a so-called hard restructuring, where investors could be forced to exchange Greek bonds for new ones at 50 percent of their value, the people said.

Greek two-year notes currently trade at less than 40 percent of face value.

The 440 billion-euro European Financial Stability Facility has already spent or committed about 160 billion euros, including loans to Greece that will run for up to 30 years. Instead of replacing it with the European Stability Mechanism, which will hold 500 billion euros, in mid-2013, a consensus is emerging on merging the two funds, the people said.

The ESM will operate with paid-in capital as opposed to the EFSF, which sells bonds guaranteed by governments.

The 500 billion-euro total was deemed sufficient when Greece, Ireland and Portugal were the primary victims of the debt crisis. Widening bond spreads in Italy, Spain, Belgium and France upended that calculation.

Credit Lines

Standard & Poor’s said France is among euro-region sovereigns likely to be downgraded in a stressed economic scenario. The sovereign ratings of Spain, Italy, Ireland and Portugal would also be reduced by another one or two levels in either of New York-based S&P’s two stress scenarios, it said in a report.

The EFSF may be authorized to provide credit lines of as much as 10 percent of a country’s economy, according to a proposal prepared for this week’s meetings. By that measure, credit lines for Spain and Italy, countries that required ECB support, could reach 270 billion euros ($371 billion).

“EFSF will need to be leveraged up,” Lael Brainard, the U.S. Treasury’s undersecretary for international affairs, said to a Senate subcommittee yesterday in Washington.

Germany and France, the euro region’s biggest financial backers, are at odds over how to do that. The fund’s tasks include recapitalization of banks and buying bonds in primary and secondary markets.

Franco-German Dispute

France favors creating a bank out of the EFSF, boosting its financial clout with backing from the ECB, a proposal that Germany rejects, Finance Minister Wolfgang Schaeuble told lawmakers in Berlin this week. French Prime Minister Francois Fillon said yesterday that the euro region should agree to use leverage to make the fund “massive.”

The focus on the lending ceiling came after central bankers ruled out giving the EFSF a banking license, blocking the most potent option for scaling it up. France has pushed Germany to go beyond a less powerful, ECB-backed option of using it to insure 20 percent to 30 percent of new bond issues.

Still, the 280 billion euros left in the EFSF cannot be wholly committed to bond insurance, since that would drain the fund to zero, the people said. Instead, finance ministers are likely to decide on the use of the EFSF’s instruments on a case- by-case basis, the people said.

German Chancellor Angela Merkel and French President Nicolas Sarkozy face growing pressure from the U.S. and other global partners to end the wrangling. Obama and British Prime Minister David Cameron discussed the debt crisis with Merkel and Sarkozy yesterday on a call.

“Chancellor Merkel and President Sarkozy fully understand the urgency of the issues in the Eurozone,” a White House statement said. The two plan to meet one-on-one in Brussels tomorrow on the eve of the first summit.

To contact the reporters on this story: James G. Neuger in Brussels at jneuger@bloomberg.net; Tony Czuczka in Berlin at aczuczka@bloomberg.net

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