Published October 04, 2012
MADRID/PARIS – The euro zone is considering aiding Spain by providing insurance for investors who buy government bonds in a move designed to maintain Spanish access to capital markets and minimize the cost to European taxpayers, European sources said.
One senior European source said the plan could cost about 50 billion euros ($64.5 billion) for a year. It would enable Spain to cover its full funding needs and trigger European Central bank buying of Spanish bonds in the secondary market.
If the gamble succeeds, it would achieve two important aims. Spain would be rescued without draining Europe's entire bailout fund and there would be no contagion to Italy.
Under the scheme, which officials say is under consideration in Madrid, Paris, Berlin and Rome, the euro zone's new permanent rescue fund (ESM) would guarantee the first 20 to 30 percent of each new bond issued by Spain.
The sources spoke on condition of anonymity because they were not authorized to talk about the discussions.
Finnish Prime Minister Jyrki Katainen aired the idea after meeting French President Francois Hollande on Tuesday: "To safeguard our public money, we could study the possibility of the ESM intervening on the primary market with a leverage effect which guarantees just a part of the debt issued by Spain."
It would be the first time the euro zone had used this first loss insurance scheme, created last year to support vulnerable countries before they lose market access, unlike the full bailouts granted to Greece, Ireland and Portugal.
Another option would be for the ESM to buy Spanish bonds outright at auction, but that might be more expensive and not achieve the same degree of leverage. The rescue fund's rules allow it to buy up to half of any bond emission as part of an assistance program.
In either case, Spain would have to sign a memorandum of understanding with its euro zone partners, committing itself to a timetable for implementing austerity measures and economic reforms, and accept international monitoring of its compliance.
In EU jargon, the bailout would take the form of an Enhanced Conditions Credit Line with investor protection (ECCL+).
A Spanish government spokeswoman said she was not aware of any such discussions and that Spain was focused on establishing a European banking union and on euro zone leaders meeting the commitments they made at a June summit.
Financial markets and most of euro zone countries are pressuring Spain to seek aid to finance itself after it obtained a 100-billion-euro lifeline to recapitalize its banks in June.
Growing expectations that Madrid will apply for assistance helped bring down Spanish bond yields in an auction just short of 4 billion euros on Thursday, with a sharp fall in the 5-year yield to 4.766 percent from 6.459 percent when that maturity was last auctioned in July.
Senior euro zone sources said this week Madrid was ready to move ahead with a request but that Germany had signaled it should hold off. Faced with an increasingly restive Bundestag, Chancellor Angela Merkel would prefer to bundle aid requests into a single package for parliamentary approval and avoid a series of difficult votes on Spain, Cyprus and Greece.
"We're talking of no more than 50 billion euros," said the senior European source, who spoke on condition of anonymity because of market and political sensitivity. "Under this scheme, the states would pose the conditions and make sure they're met, and the ECB would supply the firepower."
A second senior euro zone source said this option was the main one currently being looked at.
"A full program that would take Spain off the market would cost around 300 billion euros over two years... But nobody wants a full program, no one wants to take them off the market," said the second source.
"So it could be a precautionary credit line, which could be used to buy bonds on the primary market, using the leveraging instrument of the 20-30 percent first loss insurance."
A third source said such a plan would fit well with Madrid's problems. Spain has gross debt needs of 207 billion euros in 2013 so first loss insurance option worth 50 billion euros should enable it to raise that amount entirely from private investors.
The second source said the program could cost as little as 30 billion euros, allowing Madrid to raise around 150 billion euros, more than its long-term borrowing plans for 2013.
The euro zone rescue fund's guidelines state that a precautionary credit line should be comprised between 2 percent and 10 percent of a country's Gross Domestic Product, which means 20 to 100 billion euros in Spain's case.
The program runs for one year, renewable twice for six months at a time. Each renewal would require a separate unanimous decision by euro zone governments.
NO DECISION YET
All three sources said no decision had yet been made and it may take weeks before the plan is fully discussed and finalized.
ECB President Mario Draghi has said that a precautionary credit line would provide sufficient conditionality and supervision for the ECB to consider bond purchases.
However, some euro zone officials in contact with market participants say such a plan could have a mixed impact, drawing some investors back into Spanish debt while others would take the opportunity to sell. One diplomat, who said he had not been briefed on the plan, said it could backfire.
"By asking for a first-loss guarantee scheme on primary issuance you are saying that there is a credit risk on your bonds and that's not the message Spain needs to be sending."
Euro zone officials are determined to find a solution that keeps Spain in capital markets. If it lost market access, the cost of covering Spanish borrowing would exhaust the money left in the rescue funds.
"We wouldn't have any money left for others and the market would start to speculate against Portugal, Italy or whomever," one policymaker said.
The leaders of France, Italy and Spain will discuss the timing of plans to help Spain with its finances when they meet on the sidelines of a Mediterranean summit in Malta on Friday, two sources said.
(Additional reporting by Jan Strupczewski and Luke Baker in Brussels, Paul Taylor and Catherine Bremer in Paris and Noah Barkin in Berlin; Editing by Janet McBride)