EU bailout: Rescue plan or Ponzi scheme?

Anaylysts question wisdom of issuing debt to fix debt problem; some AAA ratings may be at risk

May 11, 2010 @ 12:01 am

By Bloomberg News

Germany, France and the three other largest top-rated euro area states may compromise their AAA grades by standing behind the debts of weaker members with their 750 billion-euro ($955 billion) stabilization fund.

The package is “a kind of Ponzi game at the highest level,” said Stefan Kolek, a strategist at UniCredit SpA in Munich. It risks creating “more debt instead of cutting debt, as it obliges EU countries to buy troubled debt from member states.”

The unprecedented loan package was designed by the EU and the International Monetary Fund to halt a sovereign-debt crisis that threatened to push Greece, Portugal and Spain into default and shatter confidence in the euro. As part of the support plan, Germany's Bundesbank, the Bank of France and the Bank of Italy started buying government bonds yesterday.

Bonds of Portugal, Spain and other deficit-plagued nations on Europe's periphery soared yesterday and bunds -- the safe haven for holders of European government bonds -- weakened as the threat of a Greek default receded. The cost of insuring against sovereign losses using credit-default swaps tumbled, with contracts on Greece sliding 370 basis points, their biggest one-day decline, to 577, according to CMA DataVision.

Contracts on Greece declined again today, dropping to 562.5 basis points, Italy fell 2 to 155 and Spain was 2 lower at 172.5. Swaps on Portugal increased 6 basis points to 260.5, CMA prices show.

The average Standard & Poor's rating for the countries using the euro is AA-, three levels below the top, without adjusting for size, according to Gary Jenkins, a strategist at Evolution Securities Ltd. in London. After Germany and France, the largest top-rated nations that use the common currency are Netherlands, Austria and Finland.

“The fact that they have made clear that there will be no defaults, plus the sheer size of the fund, may make S&P take another look at all the ratings,” Jenkins said. “At least, it should do.”

S&P officials in London didn't immediately respond to calls seeking comment.

The rescue package, which may be a first step toward quantitative easing, risks compromising the independence of the European Central Bank, according to Jim Reid, head of fundamental strategy at Deutsche Bank AG in London. It is also part of a process that is increasing so-called moral hazard “exponentially,” he wrote in a note to clients.

The package “is not particularly pro-growth,” he wrote in the note. It may “be looked back on as a landmark day for the ECB. Their total independence may now be increasingly questioned.”

As well as the risk of hindering growth, by reducing the likelihood the euro area's weaker members will default, the stabilization fund may slow down fiscal consolidation in the stronger members, according to Eric Sharper, an analyst at Credit Agricole SA in Paris.

“This raises the possibility that stronger EU members, with more financial flexibility and under less scrutiny, will show less urgency in their own deficit-reduction programs,” he wrote in a note today.

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