The 17 governments of the euro area have agreed to rely on Byzantine financial engineering and outside help to beef up the firepower of a rescue fund aimed at comforting investors that the group can fix Greece's debt woes and handle future crises.
Euro-zone leaders said the souped-up rescue fund, known as the European Financial Stability Facility, would have the capacity to provide guarantees for about €1 trillion, or about $1.4 trillion, of bonds, and expressed hope this would be enough to assist large euro-zone members such as Italy and Spain.
But the plan, crafted in the wee hours of Thursday by euro-zone leaders gathered in Brussels, contained many blanks. It didn't spell out how much money the fund would have at its disposal and mentioned the prospect of luring private and public investors from outside the euro zone, without firm commitments.
The EFSF said its chief, Klaus Regling, would travel to Beijing on Friday to discuss how China might contribute to the fund. The EFSF is planning to approach other cash-rich nations such as Brazil and petrostates in the Middle East, people familiar with the matter said. Russia said it would consider the possibility of contributing to the euro-zone fund but added that it would prefer giving Europeans a helping hand through the International Monetary Fund.
"Instead of relying on our own strengths, we're left going on a world tour to beg for help," French Socialist lawmaker and former Finance Minister Michel Sapin said in an interview. "It leaves us in a weak spot vis-à-vis China and other countries."
The complex solutions used to create a mighty backstop fund highlight the limitations of the euro-area architecture, where member states cannot freely tap into the European Central Bank's deep pockets when they run into trouble. The ECB has been buying bonds from troubled euro-zone nations but has warned that the scope of such intervention would be limited in time and volume.
Thursday's intricate plan also underlines the weaknesses of one of the euro zone's main economies, France, which would have struggled to contribute more money to the EFSF without jeopardizing its prized triple-A credit rating. France's President Nicolas Sarkozy said Thursday that his government would unveiled austerity measures in the coming days, its second package in two months, to take into account a much weaker economic-growth outlook.
Germany might have had the capacity to plow more cash into the fund, but last month German lawmakers said they would veto any such move.
Euro-zone governments thought they had found a way to regain investor confidence in July when they announced the EFSF would be equipped with €440 billion. But the amount failed to provide a "shock-and-awe" remedy.
The fund has already earmarked up to €100 billion to help recapitalize European banks and about €100 billion to bail out Greece, Ireland and Portugal. With little over €200 billion left, it became clear the fund wouldn't have the capacity to douse yet another bond fire in a large country such as Italy.
Under the tentative arrangement, the EFSF will use part of its money to offer investors comfort that the initial losses in the event of any default on, say, Italian or Spanish bonds, will be met by the facility.
The mechanism is similar to the insurance policy that investors can subscribe to when they purchase credit default swaps, or CDS, to secure their bond investments.
The EFSF said it would be for investors to judge which solution they prefer but noted that the partial protection provided by the EFSF would be backed by triple-A assets—which is unlikely to be the case with those given by a CDS provider.
To further increase the EFSF's firepower, euro-zone governments have agreed to create one or several funds, possibly placed under IMF supervision. The funds would be seeded with EFSF money and contributions from outside investors.
Whether investors will bite remains a big question. Mohamed el-Erian, chief executive of the world's largest bond fund Pimco, said the agreements need to be translated into concrete decisions, which he said could be a significant challenge.
"The implementation challenge is as high, if not higher than the design challenge," Mr. Erian said in an interview. "There's the wallet, but not the will right now," he said, referring to emerging-market appetite for European assets.
read more: Olympus Wealth Management
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