Debate rages over source of euro rescue funds

If the eurozone is able to get over the short-term hurdles it faces – getting Greece €8bn in much-need aid and passing new enhancements to its bail-out fund through 17 national parliaments – officials will once again face a question that has dogged them for months: where will the money for the new rescue system come from?

Although the question has not figured prominently in parliamentary debates about the overhauled system, which would give the eurozone’s €440bn ($602bn) rescue fund powers to recapitalise banks and buy bonds of struggling states, behind closed doors the debate among officials is raging.

Many European policymakers are beginning to envisage the fund, known formally as the European financial stability facility, as a nascent eurozone treasury that could sit alongside the European Central Bank. It would be quickly tapped to deal with crises without relying on national parliaments, which cannot act at the speed demanded by markets.

Senior officials have even begun referring to this future construction by a new name, the European Monetary Fund, which would operate like many other European Union institutions – with decisions taken by a qualified majority vote rather than unanimity. Such proposals will feature in a review of eurozone governance overseen by Herman Van Rompuy, the European Council president, next month

Before such ambitions can be fulfilled, eurozone leaders must figure out how to give it the financial wherewithal to perform its more immediate duties.

The sum of €440bn was intended to “shock and awe” financial markets when unveiled in May 2010 during the first Greek crisis. The EFSF has since evolved from a temporary set-up to help small peripheral countries into a multipurpose firefighter to assist large banks and bigger eurozone economies such as Italy and Spain. Most analysts believe it is too small for the tasks it will soon be called on to perform.

Because increasing the size of the fund has proved controversial in many creditor countries – particularly Germany, Finland and the Netherlands – senior officials have tried not to discuss options publicly for fear of spooking parliamentarians who must approve the new powers in a matter of weeks.

“That is something we need to discuss more and we are not there yet,” said one senior European official.

The hurdles to increasing the fund are not just political. For some countries, bigger contributions to the EFSF will add huge pressure to their already strained public finances.

Daniel Gros, director of the Centre for European Policy Studies think-tank, estimated that under some scenarios, the EFSF – and its successor, a permanent agency called the European Stability Mechanism – would have to be as big as €4,000bn.

Such an increase would mean France, whose triple A rating is essential to the market credibility of the EFSF, would see its debt levels rocket, at a time when its bond rating is already under scrutiny. “It’s just not conceivable to have a much larger EFSF and still have France as triple A,” said Mr Gros.

Officials have instead begun debating proposals to get around an upfront increase Tim Geithner, US Treasury secretary, offered one solution during a summit last week of EU finance ministers modelled on Obama administration efforts to jump-start frozen securities markets.

Under Mr Geithner’s plan, the EFSF would offer guarantees against a small portion of sovereign bond losses, instead of actually buying them outright. The plan would allow officials to leverage a relatively small amount of public money into much more financial firepower.

German officials have reacted coolly, however, and more attention is now focused on a plan by Mr Gros and Thomas Mayer, chief economist at Deutsche Bank, which would essentially turn the EFSF into a bank, allowing it access to unlimited ECB funds in case of emergency.

Although there has been public opposition to the plan, Mr Gros said he had received private encouragement that it was workable. Other senior European officials said it had been debated extensively in private discussions.

Opposition has come primarily from Germany, where hostility to the ECB’s own bond-buying programme is strongest. Jens Weidmann, head of the Bundesbank, told the German parliament this week that the scheme for turning the EFSF into a bank was “very dangerous”, since it would give politicians access to the ECB’s currency printing press – a power normally allowed only to central bankers.

Mr Meyer argued that having the “EFSF backed by the ECB” would give the programme democratic legitimacy, since elected officials would make the bond purchase decisions. The ECB board is both independent and specifically protected from political pressure.

A March ECB legal opinion also called into question the legality of the arrangement, but Mr Gros argued that other EU institutions, such as the European Investment Bank, already rely on the ECB for backstopping and such legal hurdles could be cleared if national leaders agreed to change regulations.

Additional reporting by Ralph Atkins in Frankfurt and Gerrit Wiesmann in Berlin