'Intensified Stresses' European Commission Prepares Expansion of Rescue Fund

Under plans now being considered, the euro rescue fund will be dramatically increased. The Luxembourg-based body would also be given the power to buy bonds from beleaguered euro-zone countries and provide aid to crippled banks. Resistance in Berlin to the plans isn't as great as is it is being portrayed.

The European Commission believes its plans to expand the euro rescue fund could relieve pressure on heavily indebted euro-zone countries facing massive bond interest payments.

The European Commission believes its plans to expand the euro rescue fund could relieve pressure on heavily indebted euro-zone countries facing massive bond interest payments.


It didn't take any longer than his first press conference after the holidays for Jean-Claude Trichet make his first wish for the new year public. Speaking on Thursday, the European Central Bank (ECB) president said he is hoping that the rescue program for the beleaguered euro zone will be enhanced both "qualitatively and quantitatively."

If the European Commission has its way, the French official's wish will soon be fulfilled. European Currency Commissioner Olli Rehn's staff of experts has already sent a comprehensive plan for reforming the rescue package to their colleagues in selected European capitals.

The strategy for tackling the euro crisis comprises 11 pages. According to the document, all previous efforts have failed to ease investors' concerns about the future of the single currency. So far, the main measure taken has been for the ECB to step in and purchase large amounts of bonds issued by euro-zone countries in trouble. But that is not a "durable solution," the Brussels experts write in the paper. "Renewed and more severe tensions seem inevitable in the early months of 2011," it states.

Comprehensive Overhaul

In order to bring the situation under control, the eurocrats believe that the member states need to address a number of challenges themselves. They must reform their labor markets and also cut social spending. Nevertheless, the core element of the EU plan is the comprehensive overhaul of the European Union's existing rescue mechanism, the European Financial Stability Facility (EFSF). Under the plan, the rescue fund, which is based in Luxembourg, and is headed by Klaus Regling of Germany, would be bestowed with new responsibilities and, if necessary, also additional money.

"The overall effective funding capacity of EFSF will be increased to at least €440 billion," the paper states. In theory, the European states have already made that amount available, but those means cannot currently be mobilized in their entirety. The EFSF is required to maintain massive securities in order to hold on to the best possible rating by ratings agencies, which limits its actual current lending limit to countries in need to €250 billion.

The European Commission and member states are currently working to expand that buffer. In addition, solvent member states, led by Germany, are expected to make available further guarantees and billions of euros in additional funds to increase the rescue fund's capital base. The European Commission wants a maximum of flexibility in terms of the fund's lending abilities. "Member states stand ready to revisit the size of EFSF whenever necessary," the paper states.

Under the plan, Regling would also be empowered to purchase bonds from ailing countries in order to reduce the European Central Bank's burden. At the same time, the EFSF could purchase securities from investors or directly from the country in question. But it also implies that the EFSF could be used in such a way that all euro-zone member states would finance the budgets of states that have trouble raising money on the capital markets.

Cheaper Interest Rates for Borrowing Countries

The plan also calls for Regling's rescue fund to be provided with additional money for buyback actions. Under the plan, the EFSF would be able to provide nations with money that could be used to buy back bonds sold at a higher interest rates and unfavorable maturities, thus taking them off the market. That would reduce interest burdens, since the EFSF would make the money available at cheaper rates than the market would.

In order to increase savings potential, the penalty interest a country would have to pay would also be reduced if it requested the money from the Luxembourg fund. A country's debt situation could be further improved by the measures because loans provided by EFSF would come due later than those on the market, thus providing additional breathing room.

If the Commission succeeds in pushing its plan through, it is already clear what the result will be: The countries concerned would be more indebted to their partner countries in the future and less to the markets, both domestically and abroad. Under the plan, the rescue fund could also be used to assist banks that run into financing problems.

Euro zone member states now have until the beginning of February to submit their desired changes to the plan. They are expected to be discussed at the next meeting in the spring of the European Council, the body comprised of EU leaders.

Some Objections Persist in Germany

Officially, German Chancellor Angela Merkel of the conservative Christian Democratic Union (CDU) was still rejecting calls last week for her country to provide additional money for the rescue fund. But in their discussions with the European Commission, German government officials haven't been as defensive as the appearance they have given publicly. The staff of Finance Minister Wolfgang Schäuble, also a member of the CDU, have already tacitly approved most of the proposals. But objections remain to a plan for the EFSF to be able to purchase sovereign bonds.

And more general resistance remains within the CDU's junior partner in the German coalition government, the business friendly Free Democratic Party. "We cannot just continue to inflate the rescue fund without (new) conditions," FDP Economics Minister Rainer Brüderle has said. "It would mean successful countries would automatically be made responsible for countries with lax budget policies."

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