EU Leverage Seen Falling Short

Europe's effort to expand its bailout fund to 1 trillion euros ($1.3 trillion) is falling short, forcing renewed consideration of a role for the European Central Bank in insulating Spain and Italy from the debt crisis, two officials familiar with the discussions said.

Finance ministers are holding an initial discussion today on channeling ECB loans to cash-strapped euro nations through the International Monetary Fund, aiming to bring the central bank onto the front lines without violating its ban on direct lending to governments, said the people, who declined to be identified because the talks are at an early stage.

With renewed prodding from the U.S., European leaders are pondering a fifth “comprehensive” fix after an October blueprint failed to stop a widening rout in Italian markets or quell speculation that France will lose its top credit rating. Germany is pushing for governance changes at a summit next week that would tighten enforcement of budget rules, a move that might make it easier for the ECB to step in.

The rescue fund “alone will not be able to solve all the problems,” Luxembourg Finance Minister Luc Frieden told reporters before tonight's Brussels meeting. “We have to do so together with the IMF and with the ECB in the framework of its independence.”

Solving the European crisis is of “huge importance” to the U.S., President Barack Obama told European Union President Herman Van Rompuy and European Commission President Jose Barroso at the White House yesterday.

Four weeks after taking over from Jean-Claude Trichet, ECB President Mario Draghi hasn't tipped his hand about a possible role for the central bank, apart from saying the ECB's 18-month- old bond-buying program is “temporary” and “limited.”

Over the opposition of the two Germans on its 23-member council, the bank has bought 203.5 billion euros of bonds of three countries receiving financial aid — Greece, Ireland and Portugal — plus Italy and Spain.

“The ECB has to save the euro,” Holger Schmieding, chief economist of Joh. Berenberg Gossler & Co., said in an e-mailed note. “ECB members and Berlin may be starting to realize this.”

'Larger Role'

While German Chancellor Angela Merkel last week persuaded French President Nicolas Sarkozy to stop goading the politically independent ECB, Germany has failed to enforce a common line among other euro states with top credit ratings.

Austrian Chancellor Werner Faymann floated an enhanced ECB role last week, as did Finnish Finance Minister Jutta Urpilainen. Dutch Finance Minister Jan Kees de Jager declined to rule it out. As holders of AAA ratings, the three are part of a German-led bloc that has set tough conditions for bailouts.

“We envisage a larger role for IMF,” De Jager said in Brussels today.

Europe is considering the backdoor way of involving the ECB after failing to convince markets that it has found the right recipe for getting more muscle out of the government-guaranteed rescue fund, the 440 billion-euro European Financial Stability Facility.

Recycling European money through the IMF would also be designed to encourage asset-rich emerging powers such as China to contribute to the European cause, the people said.

While the 17 euro-area finance ministers will meet tonight's self-set deadline of working out how to leverage the rescue fund, the method is unlikely to unleash the targeted 1 trillion euros.

De Jager spoke of bulking up the EFSF by a multiple of 2 to 2.5. With roughly 270 billion euros of EFSF funds uncommitted, that would put the bulked-up EFSF in the neighborhood of 675 billion euros at most.

The first leveraging option, using the EFSF to insure 20 percent to 30 percent of new bond sales, faces a credibility test in the markets and may not be ready until January. It also might splinter the Italian and Spanish bond markets, by creating insured bonds that are more attractive than bonds currently trading, the people said.

“The focus in Europe is very much on the political situation to see if we're going to get another bailout package in some shape or form that takes us forward,” James Nixon, chief European economist at Societe Generale SA, told Ken Prewitt and Tom Keene on Bloomberg Radio's “Bloomberg Surveillance.”

Bloomberg News

Complete your profile to continue reading and get FREE access to Treasury & Risk, part of your ALM digital membership.

Your access to unlimited Treasury & Risk content isn’t changing.
Once you are an ALM digital member, you’ll receive:

Thought leadership on regulatory changes, economic trends, corporate success stories, and tactical solutions for treasurers, CFOs, risk managers, controllers, and other finance professionals
Informative weekly newsletter featuring news, analysis, real-world case studies, and other critical content
Educational webcasts, white papers, and ebooks from industry thought leaders
Critical coverage of the employee benefits and financial advisory markets on our other ALM sites, PropertyCasualty360 and ThinkAdvisor