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ECB Should Back Sovereign Bonds, GLG Co-Founder Lagrange Says

The European Central Bank should back the bonds of countries in the 17-nation euro bloc to stem a debt crisis that has hurt financial markets for more than two years, GLG Partners Inc. co-founder Pierre Lagrange said.

The ECB should support countries that agree to meet benchmarks for cutting their budget deficits over the next five years, Lagrange, who manages GLG’s European Long-Short Fund, wrote in a note to investors this month that was released by the London-based hedge fund. Such an approach would mitigate the crisis while reducing the moral hazard that bailouts will encourage countries to repeat risky behavior, Lagrange said.

“Markets will massively correct the current negative stance” if the ECB takes action, Lagrange, who manages more than $2 billion, wrote in his letter. “The execution period is much quicker than that required for euro bonds, fiscal unity and European bank regulation reforms, which can and should still be worked on.”

Investors and global political leaders are increasingly calling on Europe to introduce measures that can implemented quickly to combat the crisis as Spanish and Italian bond yields surge. A survey released yesterday by the ZEW Center for European Economic Research found that German investor confidence fell the most in 14 years this month as austerity measures across Europe hurt demand for exports.

Along with ECB underwriting sovereign bonds, debt-reduction goals should be set for each country based on what can be repaid, Lagrange wrote. While targets should be stringent enough to limit moral hazard, they should also be “realistic enough that they can be achieved,” he wrote.

Greek Exception

The central bank should also consider guaranteeing new short-term debt issued by countries “unconditionally,” according to Lagrange. Countries should be charged an annual rate of 50 basis points, or half a percentage point, to receive the backing, a level that’s more manageable than the yields they get in current bond markets, he said.

Lagrange said his plan should only apply to countries that have “strong prospects” of eventually returning to solvency, which said is unlikely to apply to Greece. Instead of European leaders providing more funds to keep Greece in the currency bloc, they should “keep that money to help them outside the euro,” he wrote.

The net asset value of Lagrange’s hedge fund, which bets on rising and falling stock prices, has more than tripled since the end of 2000, compared with a 31 percent decline for the pan-European Stoxx 600 equity benchmark. GLG was bought in 2010 by London-based Man Group Plc, the world’s biggest publicly-traded hedge fund manager, which oversees $59 billion.

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