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Euro zone ponders merits of bond buybacks
January 20, 2011 / 1:09 PM / 7 years ago

Euro zone ponders merits of bond buybacks

<p>Euro notes are spread out at a bank branch in Madrid January 13, 2011.Andrea Comas</p>

BRUSSELS/BERLIN (Reuters) - Euro zone ministers are considering whether the bloc's rescue fund could buy back the bonds of troubled member states, a source said on Thursday, and debt-ridden Portugal said it supported the proposal.

Berlin and Athens insisted Greece, the first to succumb in the currency bloc's debt crisis, needed no help with debt repayments.

Under the proposal being discussed, the European Financial Stability Facility -- set up after Greece was bailed out last year -- would be able to conduct buy-back operations of bonds of a distressed country, which could help stabilise its debt market, one euro zone source told Reuters.

The changes would be part of a wider package of new measures that the euro zone is expected to announce by mid-March as it tries to draw a line under the sovereign debt crisis, which has forced Greece and Ireland to seek EU and IMF financial help.

"It was one of the options more seriously considered. Some people were quite pushing this," the source with knowledge of Monday's euro zone finance ministers meeting said.

Portuguese Finance Minister Fernando Teixeira dos Santos backed widening the remit of the 440 billion euros EFSF to include potential purchases of government bonds and said its size should be increased.

The plan tallies with reports in two German publications this week.

On Thursday, the Financial Times Deutschland said euro zone finance ministers had discussed a plan for the fund to buy bonds specifically from Greece or Ireland or give favourable loans for repurchasing debt.

The euro zone source said there was no "specific country" discussed regarding the scheme which would involve buying bonds in the secondary market with the EFSF doing so direct.

It was not certain whether bondholders would be paid the face value of the debt or not, leaving open the crucial question of whether investors faced a "haircut."

But the source said the EFSF could pay a small premium over market prices to encourage bondholders to sell.

With Ireland already tapping the fund, and Portugal and Spain potentially needing it, Europe is discussing how to beef it up without raising the headline sum, which would be difficult to sell to the German parliament and public.

A Barclays Capital research note said it was "very likely that euro area governments will decide to upsize the EFSF to its statutory lending limit of 440 billion euros."

Its real lending capacity is currently much lower because of its complex guarantee system.

Hurdles to Jump

It is far from certain that European parliaments would accept rule changes for the 440 billion euros fund to allow it to buy bonds.

One economist with influence on the German government, Hans-Werner Sinn who heads the Ifo institute, told Reuters he did not believe Greece would be able to service its debt.

"The sooner that is recognised the better it will be for all parties involved," said Sinn, whose institute's forecasts feed into official German government policy.

But Chancellor Angela Merkel's conservatives looked set to oppose any attempt to use the EFSF to buy up debt, which would have to be approved by national parliaments first, a senior lawmaker from her Christian Democratic Union said.

"I do not see a quick willingness for a purchase of state debt by the EFSF," Hans Michelbach told Reuters.

Barclays Capital said changing the EFSF rules to permit buying bonds outright was unlikely because parliaments would have to vote on it. But EFSF loans to governments to buy back bonds were "more likely to gather support," including from the European Central Bank which would be relieved of such a role.

The Greek and German governments have repeatedly denied that plans are afoot to prepare for a Greek rescheduling or restructuring and did so again on Thursday.

Merkel's spokesman Steffen Seibert denied it outright and Deputy Finance Minister Steffen Kampeter told Reuters that such talk was a "fantasy based on rumours and not facts."

Analysts believe Germany's denial is rooted in domestic political considerations, with Merkel facing seven state elections this year.

"The key danger for the market is internal German politics where Merkel faces a key state election in Baden-Wuerttemberg just days after the EU summit (in late March) and given the resistance of the population to bailouts this could lead to procrastination," wrote RBS in a research note.

Merkel's conservatives risk losing the state after 60 years while her Free Democrat (FDP) coalition partners are faring so badly in polls that their leader, deputy chancellor and foreign minister Guido Westerwelle, faces calls to step down.

But Merkel's government is being warned by at least some of its select group of "Wise Men" economic advisors to prepare for the worst, such as a Greek debt rescheduling.

Economist Peter Bofinger, a left-leaning member of this group of five, told Handelsblatt daily the European Union should create a "Marshall Plan" for the most indebted euro countries.

Lars Feld, who takes up a "wise man" post in March, told the paper he did "not believe Greece will manage without a cut in its debt" and Germany should take measure so that the guarantees it will provide do not violate a new "debt brake" fiscal law.

Additional reporting by Jan Strupczewski in Brussels, Dave Graham and Annika Breidthardt in Berlin, George Georgiopoulos in Athens and Nigel Stephenson in London, editing by Mike Peacock

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