SCENARIOS-Pressure on ECB, euro zone to act on debt crisis

By Luke Baker

BRUSSELS, Dec 6 (BestGrowthStock) – Euro zone finance ministers meet
on Monday to discuss next steps in the euro-area crisis, with no
sign of market pressure abating on the sovereign debt of Spain,
Portugal, Greece, Ireland or Italy. [ID:nLDE6B50LO]

In the past few days, senior European and International
Monetary Fund officials have laid out radical and previously
unthinkable proposals for dealing with the crisis in the hope of
stopping the contagion from spreading further.

Following is a look at some of more prominent proposals,
which EU sources say will be among the topics discussed by
finance ministers on Monday. [ID:nLDE6B40EJ]

LARGE SCALE EUROPEAN CENTRAL BANK BOND BUYING

There has been widespread talk in financial markets and
among euro zone policymakers in the past week about the need for
the European Central Bank to massively step up its bond-buying
programme to take the pressure of peripheral euro zone countries
struggling to fund themselves in the market.

Last Thursday, the ECB disappointed expectations of such a
move by making no specific announcement about its bond-buying
intentions, saying only that it would keep giving banks
unlimited liquidity well into 2011.

However, traders said the ECB was quietly buying up the
sovereign debt of peripheral euro zone member states, including
Ireland and Portugal. The central bank itself has not said which
countries’ debt it was buying or how much.

Until last week, the ECB had only bought around 67 billion
euros worth of sovereign bonds as part of its programme, hardly
enough to make an impact in the current crisis.

Fixed income strategists have said the ECB would have to
step up purchases to the tune of 1 trillion euros or more over
an extended period of time — at least a year — if it were to
have an impact and assuage debt market concerns.

The advantage to such a move is that it could be quickly
implemented and would probably have an immediate impact.
However, it is strongly opposed by some members of the ECB
Governing Council and goes against the bank’s mandate.

There are some euro zone finance officials who say it would
also let highly indebted countries such as Portugal and Spain
off the hook too easily. The long-term answer to their problems
is structural reforms that are politically difficult to
implement but necessary. If the ECB stepped in to save them from
debt market pressure, the urge to drive through reforms to the
econmy, labour markets and pensions system might also abate.

Stepped up ECB bond-buying remains the leading proposal for
tackling the crisis, however, and was endorsed in an
International Monetary Fund report, seen by Reuters, that is
expected to be presented to finance ministers on Monday.

ENLARGED EUROPEAN FINANCIAL STABILITY FACILITY

The EU/IMF-funded European Financial Stability Facility is a
750-billion-euro loan fund set up in May — after Greece’s debt
crisis erupted — which was tapped in the 85 billion euro EU-IMF
bailout of Ireland last month.

While the EFSF is large, various restrictions — including
cash buffers on loans and other credit guarantees — mean it is
smaller than its headline figure and could be streched to handle
a bailout of both Portugal and Spain if they requested help.

As a result, some euro zone finance ministers, including
Belgium’s Didier Reynders at the weekend, have called for an
increase in the size of the EFSF, with some suggesting the fund
needs to be doubled to around 1.5 trillion euros.

The IMF report seen by Reuters also advocates an increase in
the size of the EFSF, although it does not set a figure, and
says the remit of the fund should also be widened.

“There is also a strong case for increasing the resources
available for this safety net and making their use more
flexible, including for the purpose of providing more effective
support to banking systems,” the report said.

A U.S. official told Reuters last week that the United
States would be favourable to an enlarged contribution to the
EFSF via an increase in its contribution to the IMF.

An advantage of the EFSF is that any loans disbursed from it
come with heavy conditionality, which means pressure can be
applied to loan-takers to get their finances in order — a stick
euro zone member states such as Germany want to retain to keep
errant colleagues such as Ireland and Greece in check.

The disadvantage is that it was hard enough to get the EFSF
approved by euro zone governments in the first place —
enlarging it would face strong opposition and could be voted
down. A decision to increase the fund has to be unanimous.

Germany said on Monday it saw absolutely no need to increase
the size of the fund.

EURO AREA TREASURY BONDS OR E-BONDS

The idea of euro-zone bonds — debt collectively issued by
all 16 countries that use the euro, rather than each
having its own debt management office and sovereign bond market
— has been around for years.

While a nice idea in principle, it is strongly opposed by
Germany, France, Finland and others, who have well-functioning,
sustainable bond issuance programmes of their own and would
rather not share their credit status with less creditable
sovereign bond issuers such as Greece, Ireland and Portugal.

In the Financial Times on Monday, Jean-Claude Juncker, the
chairman of the euro zone finance ministers, and Italy’s finance
minister, Giulio Tremonti, formally proposed setting up a
European Debt Agency that would issue euro-area bonds, financing
up to 50 percent of EU member states’ debt issuance.

They suggest EU leaders could move as early as this month to
create such an agency “with a mandate gradually to reach an
amount of outsanding paper equivalent to 40 percent of the gross
domestic product of the European Union and of each member
state”, which would be around 5 trillion euros.

The impact would essentially be to push up Germany’s yield
curve and drag down those of the more risky euro area member
states so that the euro zone ended up with one curve —
reflecting credit risk across all 16 sovereigns together.

With Germany adamantly opposed and many other ‘northern’
European countries sceptical, it seems unlikely to get off the
ground at least until there is much greater economic and fiscal
convergence among the euro zone, which could be decades away.

“BIG BANG” DEBT RESTRUCTURING

Daniel Gros, an economist and the director of the Centre for
European Policy Studies, an influential Brussels think tank, has
proposed a “big-bang” solution, which would effectively involve
all troubled euro zone countries simultaneously opening
restructuring talks over their debt
(http://www.voxeu.org/index.php?q=node/58920).

Under the plan, the countries would at the same time try to
continue to service their debts and would be helped by the EFSF
if necessary. The European Central Bank and core euro zone
member states — Germany, France, the Netherlands, etc — would
at the same time help restructure any troubled bank debts.

It is in effect an “all in” strategy, with every instrument
being brought to bear on what is both a debt crisis and a crisis
of confidence in the euro zone and its currency.

“Muddling through is more attractive in the short run, but
it does not lead anywhere when doubts about debt sustainability
persist and the maket has been destabilised,” said Gros.

“The big-bang approach is not without risks. It could be
prepared in a weekend, but it would require months of patient
negotiations to get bondholders to agree.”
(Additional reporting by Jan Strupczewski in Brussels; editing
by Janet McBride)

SCENARIOS-Pressure on ECB, euro zone to act on debt crisis