Scenarios: Pressure on ECB, euro zone to act on debt crisis

BRUSSELS (Reuters) - 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.

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.


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 program 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 program, 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 economy, labor 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.


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 stretched 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 favorable 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.


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 programs 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 outstanding 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 skeptical, 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.


Daniel Gros, an economist and the director of the Center 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 (here).

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 market has been destabilized,” 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