EU Revives Buyback Idea as Crisis Hits Italy

European finance ministers revived the prospect of bond buybacks to ease Greece’s plight and declined to rule out a temporary default, struggling to contain the debt crisis as investors pounded Italy, the continent’s third-largest economy.
Prodded by investors and the European Central Bank, the euro’s guardians said a bailout fund set up last year may be used to buy bonds in the secondary market or enable Greece to retire its debt at a discount. They offered another cut in rates on its emergency loans.
As exploding bond yields in Italy and Spain brought the crisis closer to the heart of the euro area, Europe’s search for answers took it back to proposals that were scuttled by Germany earlier this year. After a nine-hour meeting, the 17 euro ministers issued a six-paragraph statement pledging to flesh out details of a new strategy to end the 21-month-old crisis “shortly,” without setting a timeline.
“There are a variety of ways of enhancing the flexibility,” European Union Economic and Monetary Affairs Commissioner Olli Rehn told reporters late yesterday after the ministers met in Brussels. Buybacks are “one of those. I would at this stage not exclude any option. But instead we are exploring these possibilities.”
The decision to have another look at reinforcing the European Financial Stability Facility, the 440 billion-euro ($618 billion) bailout fund that was beefed up only last month, came after talks with bondholders over a “voluntary” rollover of Greek debt ran into a threat by credit-rating companies to put Greece in default.

Bonds Plunge

Financial markets growing impatient with the EU’s response punished its most debt-ridden states yesterday, with bonds plunging across the periphery, the euro sinking to a seven-week low and declines in banks and insurers depressing European stocks.
“The time for talking is over as Europe needs to take action fast,” said Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd. in New York. “It may already be too late as there is already contagion with the bond market vigilantes moving on from Greece to Italy and Spain.”
Finance ministers offered varying interpretations of the commitment to explore a wider range of options. For Dutch Finance Minister Jan Kees de Jager, who insists on getting bondholders to roll over Greek debt, the pledge includes the possibility of the “selective default” opposed by the ECB.

‘Explore’ Default

“I cannot say whether or not it will include selective default in the end result, but we can explore the options,” De Jager told Bloomberg Television.
The statement singled out the ECB as opposing a “credit event or selective default.” Luxembourg Prime Minister Jean- Claude Juncker, the meeting’s chairman, said this doesn’t mean that European governments “would do everything in order to provoke a credit event.”
Greece, the trigger of the debt shock, was the only country mentioned. Juncker said the reassurances are “offering adequate responses” to concerns about Spain and Italy as well.
Europe’s lunge back to basics came after Greek Prime Minister George Papandreou complained that a “cacophony” had sowed “panic” that overwhelmed the budget cuts that he pushed through his parliament amid street riots last month.
The uphill struggle for solvency in Athens was dramatized by data yesterday showing the central government’s deficit widened 28 percent in the first half of 2011, with spending surpassing targets and revenue falling short.

Greek Loan

Greece last week obtained European and International Monetary Fund assurances of a loan payout of 12 billion euros in July, part of the 110 billion-euro package it was awarded in May 2010.
A second package will also include lower interest rates and longer repayment times for official loans, the statement said. In a nod to demands by Finland and Slovakia, it said Greece might be required to put up collateral.
In a letter to Juncker, Papandreou also said a French bond- rollover proposal under discussion with banks was potentially “too expensive, too little and too dangerous” and might tip Greece into formal default.
With Greek 10-year debt fetching less than 55 cents on the euro, buybacks were forced back onto the table by the Institute of International Finance, a group representing more than 400 banks and insurers that has tried to broker an accord on the French proposal.

Buybacks

Rejected by Germany earlier this year, the buybacks would pare Greece’s debt burden of 142.8 percent of gross domestic product by enabling it to retire bonds at a discount.
In discussions that wrapped up last month, Germany blocked proposals to add buybacks to the bailout fund’s toolkit, opposing the use of taxpayer money to help countries like Greece wriggle out of their debt.
German Finance Minister Wolfgang Schaeuble came to yesterday’s meeting opposed to a further reinforcement of the fund, saying there is “no discussion whatsoever” of another boost to its firepower. He wasn’t asked about buybacks. He is slated to speak to reporters after the meeting ends later today.
Italy, a focus of German concern in the 1990s runup to the euro with debt over 100 percent of GDP, returned to the forefront as investors dumped Italian bonds and stocks. Italy now has Europe’s second-highest debt load, at 119.0 percent of GDP in 2010.

Spread Widens

Italy’s 10-year bond spread over Germany surged to 301 basis points, a euro-era high. The extra yield, a sign of investors’ skepticism about Italy’s fiscal health, has more than doubled from a 2011 low of 122 basis points on April 12.
Italian assets were upended by doubts whether Prime Minister Silvio Berlusconi, plumbing record-low approval ratings with two years left in office, will muster the strength to push through 40 billion euros in planned deficit-cuts.
The bond rout engulfed Spain, the fourth-largest euro user. Spanish 10-year yields climbed 36 basis points to 6.04 percent, stretching the spread over German debt as wide as 336 basis points, also a euro-era record.
Finance ministers also signed a treaty to establish the European Stability Mechanism, which will replace the temporary fund in mid-2013 and include provisions for a private-sector role.
Euro-area governments will put 700 billion euros of cash and callable capital into the ESM, giving it the capacity to lend 500 billion euros. It requires unanimous government ratification to go into operation.
To contact the reporters on this story: James G. Neuger in Brussels at jneuger@bloomberg.net; Jonathan Stearns in Brussels at jstearns2@bloomberg.net
To contact the editor responsible for this story: James Hertling at jhertling@bloomberg.net