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Euro-Area Fund Is Created to Combat Debt Crisis

Belgium's finance minister Didier Reynders
Belgium's finance minister Didier Reynders arrives for the European Union finance ministers meeting in Luxembourg. Photographer: Hannelore Foerster/Bloomberg

European finance ministers put the finishing touches on a rescue fund being backed by 440 billion euros ($524 billion) in national guarantees, seeking to halt the spread of Greece’s debt crisis.

The European Financial Stability Facility would sell bonds backed by the guarantees and use the money it raises to make loans to euro-area nations in need, the finance ministers agreed yesterday in Luxembourg. The new entity would sell debt only after an aid request is made by a country.

The ministers aim for ratings companies to assign a AAA rating to the facility, whose bonds would be eligible for European Central Bank refinancing operations. The fund will be based in Luxembourg.

“We’ve sent a clear signal of stability,” Austrian Finance Minister Josef Proell told reporters at the Luxembourg meeting. “We’ve opened the rescue umbrella and I’m convinced it’s working.”

The fund, being created for three years, is the main part of a 750 billion-euro aid package that European Union finance ministers hammered out a month ago to combat a sovereign debt crisis. Another 60 billion euros will come from the European Commission -- the EU’s executive arm -- and 250 billion euros from the International Monetary Fund.

Prodded by the U.S. and Asia to stabilize markets, European governments approved the unprecedented financial backstop on May 9-10 in a bid to end speculation that the euro area might break apart because of a debt crisis that started in Greece. A 110 billion-euro loan package for Greece unveiled on May 2 after the country was cut off from markets failed to stem a surge in Portuguese and Spanish borrowing costs.

Aid Model

The euro-area backstop, while “Herculean,” might fail to save the 11-year-old European single currency and usher in an “extended period” of market stress and disorder, according to Royal Bank of Scotland Group Plc.

“Maybe we reach the point where this Herculean effort works and enough policy stimulus is provided so countries can fly again,” David Simmonds, global head of research and strategy at RBS, said in Singapore today. “However, I do not subscribe to this view because one cannot treat a debt-fueled over-consumption problem with a lot more debt.”

Governments abandoned the aid model for Greece, based on national loans, when crafting the euro-area fund, which is simpler because it avoids the need for domestic action on disbursement. Delays by Germany in approving its share of the rescue for Greece led to speculation that the Greek package might falter.

Legal Procedures

All euro-area countries plan to be shareholders of the European Financial Stability Facility, or EFSF. The holding of each country will correspond to its share of the ECB’s capital.

“National legal procedures to participate in the facility are well on track,” the euro area said in a statement on the fund’s operations.

The obligation of euro-area countries to issue guarantees for EFSF debt instruments will enter into force as soon as nations representing 90 percent of the shareholding have completed domestic parliamentary procedures, according to the statement.

Luxembourg Finance Minister Luc Frieden signed an act yesterday legally establishing the fund, whose board will be composed of euro-area government representatives.

Its chief executive officer will be Klaus Regling, a German national who is a former head of the economic and financial-affairs department of the Brussels-based commission, the Luxembourg government said today.

To ensure the highest credit rating for debt sold by the facility, the finance ministers approved a 120 percent guarantee of each country’s pro rata share for each bond issue, according to the statement on the fund’s operations.

In addition, the ministers authorized the creation, when any loans are made, of a “cash reserve to provide an additional cushion or cash buffer for the operation of the EFSF,” according to the statement, which held out the prospect of more measures to improve creditworthiness.

“Other mechanisms would be adopted if needed to further enhance the creditworthiness of the bonds or debt securities issued by the EFSF,” according to the statement.

‘Sheer Size’

EU Economic and Monetary Affairs Commissioner Olli Rehn said last week that he hopes the “sheer size” of the fund, along with the extra 60 billion euros in possible support from the commission, “will help to stabilize markets” and make aid unnecessary.

“No euro has been yet consumed and I hope that no euro will have to be consumed,” Rehn told a June 2 conference in Brussels.

Any loans from the EFSF would impose the kinds of budget- austerity conditions on recipients that Greece faces as part of a program for receiving quarterly aid disbursements under the May 2 accord, he said.

“In case any country would have to resort to this European financial stabilization mechanism, it would work in the same principles as we are now working with Greece,” Rehn said.

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