EU's New Drive to Stamp Out Euro Region Debt `Fire' May Fall Short Again

European leaders enter year two of their fight to contain the euro region’s debt woes still struggling to put out the fire.

After committing almost $1 trillion, bailing out Greece and Ireland and asserting their determination to save the euro over the past 11 months, policy makers are returning to the drawing board after those previous efforts failed to pacify investors.

Their latest plan, elements of which will be debated when finance ministers meet next week, may extend help to Portugal, increase the size of their aid reserves, lower interest rates on bailout loans, and authorize purchases of outstanding bonds.

That still may not be enough, said Barton Biggs, managing partner of New York-based hedge fund Traxis Partners LP, who is “short” European securities, betting on their decline. He said officials should issue joint euro-region bonds, a measure opposed by Germany.

“The European Union and the ECB and the governments are being foolish,” Biggs told Bloomberg Television’s Deirdre Bolton yesterday. “The first rule of central banking and crisis management is do what you’ve got to do and do it big enough. You’ve got to risk overkill rather than not do enough.”

Spain will test investor sentiment today when it auctions as much as 3 billion euros of five-year bonds, while Italy will market 6 billion euros of securities maturing in 2015 and 2026. Portugal yesterday won some respite as borrowing costs fell at an auction of 10-year bonds.

Stocks Climb

Speculation European officials are stepping up efforts to end the debt crisis propelled stocks higher globally yesterday with the MSCI World Index rising to its highest level in more than two years. Yields on Irish and Spanish 10-year bonds fell, while CMA data showed the cost of insuring Portuguese government debt against default fell 25 points to 511.

The euro rose the most in a month against the dollar, climbing as high as 1.3 percent to $1.3145.

Underscoring the move toward what EU Economic and Monetary Affairs Commissioner Olli Rehn called a “comprehensive” package, German Chancellor Angela Merkel yesterday indicated a desire to do “whatever is needed to support the euro.”

Europe’s battle began last February when governments pledged “determined and coordinated action” to support Greece’s efforts to regain control of its finances. A month later it brought in the International Monetary Fund to assist and activated aid for Greece in early May, the same month it crafted a rescue facility for the continent and the European Central Bank began buying bonds. Banks were subjected to stress tests in July and by November a lifeline was extended to Ireland.

‘Neighbor’s House’
Efforts last year stumbled on Merkel’s demands for Greek budget cuts in rescue negotiations. Italian Finance Minister Giulio Tremonti said Germany can’t afford to do nothing while its “neighbor’s house” burns.

Policy makers may still not be acting “quickly enough in order to avoid further market disruptions,” Mohamed El-Erian, chief executive officer of Pacific Investment Management Co. in Newport Beach, California, told “Bloomberg Surveillance” with Tom Keene yesterday.

“Over the long term, Europe is both able and willing” to find a solution, said El-Erian. “The question is do you get the leadership up front for it to happen without collateral damage.”

Now in discussion in the euro area’s 17 capitals is a plan which may include a loan to Portugal of about 60 billion euros ($78 billion), adding to the 178 billion euros provided to Greece and Ireland. Officials may also temper concern that their 440 billion-euro Financial Stability Facility is too limited in size and scope by amending collateral rules to boost its effective lending ceiling, paring the borrowing costs it imposes and allowing it to buy debt.

Lending More

Collateral rules curb the fund’s lending ability to 255 billion euros, leaving the region with about 380 billion euros to provide when EU and IMF contributions and previous commitments are taken into account, estimates Gilles Moec, co- chief European economist at Deutsche Bank AG in Frankfurt.

“That would be enough to take care of Portugal and Spain, but would not leave any room for maneuver to deal with an extension of the crisis,” said Moec, a former Bank of France official. “It probably makes sense to preemptively increase the size of the ‘euro rescue pot’ as a step to restore confidence in European bond markets.”

Trichet’s Gain

Interest rates on cash may need to be cut by as much as 300 basis points to provide additional indirect support, estimates Julian Callow, chief European economist at Barclays Capital. Ireland’s government calculates it now pays an annual average of 5.8 percent over seven years on its emergency loans.

The proposals may mark a victory for ECB President Jean- Claude Trichet by potentially reducing the burden on his institution to buy the bonds of distressed nations and after he told governments that his central bank can’t fight the crisis alone.

The ECB has spent 74 billion euros buying bonds, dividing its Governing Council, which convenes in Frankfurt today. While policy makers last month delayed a withdrawal of emergency liquidity, Trichet told German lawmakers on Jan. 7 that “monetary-policy responsibilities cannot substitute for government irresponsibility.”

Ultimate agreement on fresh policies may have to wait until after a Feb. 4 summit of leaders because the debate over aiding cash-strapped countries is so sensitive in Germany, Europe’s largest economy, said one official familiar with discussions among EU policy makers.
The proposed remedies would still leave the onus on individual countries to restore order to their balance sheets and pursue reforms to make their economies healthier and more productive, said Callow at Barclays Capital.

“What’s we’re hearing about is necessary but not fully sufficient,” said Callow. “The whole challenge is to persuade markets that these countries are fiscally solvent.”

To contact the reporters on this story: Simon Kennedy in London at skennedy4@bloomberg.net James G. Neuger in Brussels at jneuger@bloomberg.net

To contact the editors responsible for this story: James Hertling at jhertling@bloomberg.net Craig Stirling at cstirling1@bloomberg.net