European ministers to spar over bailout fund

[January 17, 2011]  BRUSSELS (AP) -- Eurozone finance ministers will lock horns on Monday over how to fight their crippling debt crisis, which some fear could yet push Portugal to need a bailout and spread to infect the region's larger economies.

At the center of talks Monday and Tuesday in Brussels is the region's euro750 billion ($1 trillion) bailout fund, set up last spring to convince financial markets anxious over some countries' mounting debt levels that the euro currency was safe.

The European Union's executive Commission -- supported by the head of the European Central Bank and some finance ministers -- has said the fund needs to be given more money and powers to quell any concerns that it could be overwhelmed if a big economy like Spain runs into trouble.

But Germany, the eurozone's economic powerhouse, has so far ruled out any substantial increase of the fund's size. German Finance Minister Wolfgang Schaeuble insisted Monday that bolstering the fund so it can actually lend out the advertised euro750 billion -- which it currently cannot do due to technical reasons -- is as far as his country will go.

Eurozone governments make their euro440 billion contribution to the region's bailout fund by guaranteeing bonds issued by the so-called European Financial Stability Facility. The remaining euro310 billion come from the European Commission and the International Monetary Fund.

To get a triple-A credit rating for the EFSF's bonds -- and make them attractive to wealthy investors -- governments had to guarantee 120 percent of their value, while bailed out countries have to deposit a certain portion of the loans they receive "as a cash buffer." That take's the EFSF's lending capacity down to only about euro250 billion.

"We have to discuss in the medium term what we can do there, but currently there is no need for this agitated discussion -- it only unsettles the markets," Schaeuble said of the EFSF in an interview with Deutschlandfunk radio ahead of the meeting in Brussels.

The EU should instead "work calmly on implementing" decisions taken by its leaders' last summit -- that members should reduce their deficit, strengthen competitiveness and improve economic coordination, Schaeuble added.

Everyone making a contribution "cannot consist only of Germany and France having to give more guarantees, but the debtor countries must solve their problems better -- then we will achieve overall solutions," Schaeuble said.

But the Commission's demands go beyond merely giving the fund more money. It wants to widen the scope of the fund's activities, including giving it the right to buy government bonds on the open market to support their prices and keep interest rates in check.

That role has so far been fulfilled by the ECB, but the central bank's purchases have reached only about euro75 billion since May. That is a tiny amount compared with bond buying programs the U.S. Federal Reserve and the Bank of England have embarked on to boost their economies. Unlike the Fed and Bank of England, the ECB also sterilizes its purchases, a process which makes sure they don't increase the amount of money in the economy.

Most analysts say the eurozone's current strategy to deal with the crisis has failed. That approach sees countries bail out their struggling banks to then provide them with expensive rescue loans, conditioned on steep budget cuts, when they run out of money.

A euro67.5 billion bailout of Ireland -- necessary after massive capital injections for big banks pushed the country's budget deficit to almost one-third of economic output -- didn't succeed in containing the crisis. Most economists expect Portugal to also ask for help soon, while markets are worried about the financial health of much larger Spain. Spain's economy makes up about 10 percent of the eurozone's gross domestic product and bailing it out could easily overwhelm the existing facility.

French Finance Minister Christine Lagarde said last week that she and her counterparts were examining widening the fund's role to buy bonds. But Lagarde cautioned that discussions were at an early stage and happening in preparation for a meeting of European leaders in March.

Giving the bailout fund broader powers, such as directly intervening in financial markets in times of turmoil, or even providing short-term cash injections to re-capitalize wavering banks could attack the crisis at its roots, said Daniel Gros, director of the Brussels-based Centre for European Policy Studies and a former IMF economist.

One big part of this new approach would be to let banks' debtors take losses if a firm is actually insolvent, and then quickly spend large sums of money buying up government and bank bonds to stop panic on financial markets, Gros said.

[Associated Press; By GABRIELE STEINHAUSER]

Geir Moulson in Berlin contributed to this article.

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