The German economic performance intrigues politicians, researchers and countries worldwide. How can this country, after 10 years of poor economic achievement, reach growth rates that match those of China in some quarters, and that is well above those of its European neighbors? Intriguing indeed, but unfortunately for the Chancellor, her popularity is nothing compared to this rather good news: unemployment down, German industry booming, but still Misses Merkel is loosing ground to a strong left- wing coalition driven by the astonishing success of the Green Party.
Given this situation, it seems only logical that she wants to reinforce her much weakened coalition partner (see: The collapse of the German Liberal Party), the German Liberal Party, in order to get back on the track to a successful reelection in 2013. Finally realizing an election promise, Misses Merkel is searching for support to cut taxes, hoping to win over the voters lost during the coalition’s two years of headless government.
The risk that she’s running is tremendous. Not only does she have a growing opposition in her own ranks, including the powerful finance minister Wolfgang Schäuble, but also she’s likely to lose more ground among the voters. Indeed, cutting taxes at a moment when the Euro zone and whole Europe is heavily shaken by a debt crises, does not find the approval of the population other then high income tax payers hoping to further comfort their fortunes. The future being highly unpredictable, and heavy costs likely to arise from money dedicated to prevent Greece and other countries from bankruptcy, one does not have to be an economists to realize that such politics are insane.
Worst of all, it will cost her the last bit of credibility she had within the German population. Despite the economic recovery, most Germans are aware of the highly precarious situation Europe and the world economy is confronted with. Even if Angela Merkel is going to score some points by pushing through tax cuts, she will not gain in the field that wins elections: politics that comfort the population and make them feel that the country is on the right track to a better future. But maybe the German chancellor is all to desperate to even consider this. In one of the most difficult times that Europe has been in since 1945, its leading economy has literally lost its head. http://www.intelligence-strategique.eu/2011/the-wrong-strategy-of-angela-merkel/
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Merkel: Euro bonds wrong solution; harmful at this stage By Jamie Coleman || December 1, 2011 at 16:22 GMT 7 comments
* ECB is independent and must choose method for currency stability
She continues to push against the idea of a grand bargain, though I believe she will be dragged to accept it eventually. Even the ECB is showing greater willingness to play along, .. http://www.dw-world.de/dw/article/0,,15570152,00.html .. so long as the fiscal house gets tidied up.
* Update: Merkel says to protect ECB independence we must address the causes not just the symptoms of the debt crisis
IT SEEMS odd, at first sight, to see the markets taking so much hope from two speeches in two days - one by France's President Nicolas Sarkozy and the other by Germany's Chancellor Angela Merkel - that revealed more differences than agreement on how to resolve the euro zone's debt crisis.
Perhaps it is the fact that both say the European Union's treaties should be changed, and any agreement on any subject is good news. Or perhaps it is the hope that, whatever they say in their opening bids, they will come up with enough of a deal at the next European summit on December 8th-9th to allow the European Central Bank to deploy its “big bazooka”.
Then again, markets have often rallied ahead of summits in the expectation of an agreement, only to be disappointed within days, or even hours, of the latest half-step being announced.
Neither Mr Sarkozy nor Mrs Merkel offered any real detail of what should be included in a revision of the treaties. But even their vague outlines reveal contrasting philosophies. I give a fuller analysis of the speeches in the next post (here). .. http://www.economist.com/blogs/charlemagne/2011/12/euro-crisis-0 .. In summary:
NOTE: that "next post" above so they can be read beneath each other i'm going to post in full in another reply to the one i'm replying to here, it's too long for here now.
- Mr Sarkozy places the emphasis on “solidarity” among European states (ie, joint Eurobonds, and no defaults or debt-restructuring after Greece), while Mrs Merkel gives priority to budgetary discipline and rules.
- Mr Sarkozy urges the European Central Bank to act; Mrs Merkel is jealous of guarding its independence
- Mr Sarkozy wants to create a hard core of euro-zone countries within the European Union; Mr Merkel wants to include as many non-euro states as possible
- Mr Sarkozy wants to Europe to integrate through the action of leaders (reproducing France's presidential system, with lots of discretion for the executive); Mrs Merkel favours more independent institutions like the European Commission and the European Court of Justice (more akin to Germany's federal structure, which retricts politicians' leeway)
These differences should come as little surprise. It has been ever thus in the EU. The Franco-German motor is not made for harmonious co-operation, but rather to manage and contain the many disagreements between Paris and Berlin.
Still, something has changed recently. In the past year, Mrs Merkel and Mr Sarkozy (“Merkozy”, as they are known) have tried to resolve their differences behind closed doors, and then issued a joint declaration setting out their position ahead of European gatherings.
This happened at the Franco-German summit in Deauville in October last year, when they agreed that private creditors should share the pain of rescuing collapsed economies. A year later, the two leaders claimed to have found “total accord” when it was patently untrue: they soon had to postpone the EU summit in October, and then held a second one days later, in order to overcome their differences over a second Greek package and how to boost the euro zone's rescue fund.
So now, just a week before a key summit of European leaders, Merkozy chose to set out their stalls separately, before meeting at a Franco-German summit on December 5th, that may find some kind of compromise.
Mr Sarkozy's appearance was, in effect, a campaign speech, with many barbs aimed at the opposition Socialist party as well as exhortations to fellow Europeans. He spoke at a party rally in Toulon, where in 2008 he had vowed to reform capitalism. Now he says it is time to reform the European Union. Mrs Merkel, by contrast, gave a matter-of-fact speech in the Bundestag to outline her negotiating position at the forthcoming summit.
In a sense, neither of these speeches really matters. Any new treaty, even a limited one, will take month to negotiate and, probably, years to ratify. What is important, in the short term, is whether European leaders come up a sufficiently credible promise to reform, and rein in those who break budgetary rules, to allow the European Central Bank to use its “big bazooka” more freely without fear of moral hazard.
Earlier this week, the ECB president, Mario Draghi, hinted that he might be willing to do so, if euro-zone countries reached a new "fiscal compact". He did not define it, and did not say treaty change was needed. Another hopeful sign is that Germany, while rejecting permanent Eurobonds, is now floating a proposal to mutualise, probably temporarily, all excesive debt above 60% of GDP.
This is not quite joint Eurobonds, but may set a precedent for them. In any case, for the first time Germany may be saying ja to something after months of nein. That would be something to cheer. http://www.economist.com/blogs/charlemagne/2011/12/euro-crisis
Steph .. to your what if? question .. i know it doesn't help, but we'll never know .. i agree with your drift, that faster stimulatory action was a better way to go than the austerity path .. to a non economist it makes more sense and seems some evidence is in to support that position ..
THE two speeches in two days by Nicolas Sarkozy and Angela Merkel reveal the many differences between them ahead of next week's European summit. I give a brief analysis in my earlier post. What follows is a more detailed exegesis (a link to Sarkozy's speech in French is here and a PDF Merkel's address in German is here): [those links inside]
Sarkonomics and the origin of the crisis
The French president offers a strange bit of Sarkonomics to explain that the crisis was caused by external forces – the unregulated globalisation of trade and finance – of which France is essentially a victim.
"Financial globalisation established itself to compensate artificially the ravages that [trade] liberalisation without rules caused in the economies of developed countries. It was necessary so that the surplus of some could finance the deficits of others. It was necessary so that debt could compensate for the unacceptable fall in living standards of households in developed countries. It was necessary to finance a social model that was crumbling beneath deficits. It was ineluctable so that financial capital could seek elsewhere the profits that it could no longer hope to gain in developed countries. Thus was established a gigantic machine to create debt."
Mr Sarkozy says France cannot be blamed for the troubles it faces because other rich countries are in trouble too; yet he does not explain why some developed countries (Germany and several Nordic states, for example) have survived the crisis better than France despite the infernal debt machine. Later on, Mr Sarkozy says France has to cut back on state expenditure to preserve its destiny (this was tricky for him, as he had vowed three years earlier in Toulon not to conduct a policy of auterity)
Mrs Merkel, for her part, does not speak much of great uncontrollable forces unleashed by laissez-faire capitalism. Instead she emphasises the responsibility of individual states. The problem, in her view, is that countries have broken fiscal rules, and there has been nobody to enforce the limits on deficits and debt.
Early victims
There is an interesting contrast in how Mr Sarkozy and Mrs Merkel speak of the countries that have already succumbed to the markets: Greece, Ireland, Portugal, Italy and Spain. For Mr Sarkozy, their fate is a warning of what might happen if France does not act in time.
"Let's take a moment to look around ourselves at the situation of other European countries that have not taken the measure of the crisis in a timely manner, that did not make the necessary efforts. They have been forced to lower salaries and pensions, and massively increase taxes."
Mr Merkel, aware of criticism that Germany is wantonly pushing vulnerable countries into recession, even depression, praises those that are undergoing the pain of adjustment:
"I think we often have no idea of the contribution that people in the countries are making to ensure that the euro will be a permanent and stable currency. So I want today to express my absolute respect for these efforts. Because this is a contribution to a sustainable Europe."
She also makes a point of praising eastern European EU members outside the euro zone – the Baltic States, Romania and Bulgaria – that have also tightened their belts, sometimes brutally. Germany, moreover, does not seek to impose its will, only to promote a "stability culture".
Rushing and waiting
Both agree the euro zone and the wider European Union face their gravest crisis. Mr Sarkozy is in a hurry, not least because France's AAA-rating is in danger. Europe, he says, could be “swept away” unless it acts.
"There is urgency. The world will not wait for Europe. If Europe does not change fast enough, History will be written without Her."
Mrs Merkel, though, is in no rush.
"There is no possibility for a quick fix. There is not one last shot, as some say before every summit. This is not my language nor my thinking. There are no easy and fast decisions.The debt crisis is a process. It will take years."
Even senior Americans officials come away from Berlin perplexed by the way Germany seems oddly unperturbed by a crisis that is alarming the rest of the world. Perhaps Germany feels less exposed to the crisis. Or perhaps it thinks that only by dangling countries over the abyss will they understand the need to reform. In any case, Germany is reluctant to risk more of its taxpayers' money.
Discipline or solidarity?
Both Mr Sarkozy and Mrs Merkel speak of a crisis of confidence” in the markets. But they mean very different things by this phrase.
For Mrs Merkel, markets have lost confidence that the rules of the Stability and Growth Pact (which limits deficits to 3% of GDP and total debt to 60% of GDP) will be kept. Now there must be legally-enforcable rules – including legal debt brakes in each country and intrusive monitoring at the European leavel - with real sanctions for breaches.
"This crisis is a chance to make a turn for the better, to repent. The lesson are quite simple: rules must be adhered to; compliance must be monitored and non-complicance should have consequences. National responsibility and European solidarity are mutually dependent."
Mrs Merkel does not speak much of “solidarity”, except to say that it must go hand in hand with discipline. She specifically rules out joint Eurobonds, of the kind being examined by the European Commission. These would breach the German constitution.
However her officials are now signalling that they may be willing to consider a partial, and probably temporary, mutualisation of debt. The best-know scheme, promoted by the Bruegel think-tank, would see joint Eurobonds issued for good debt (blue bonds) under 60% of GDP. Anything above that (red bonds) would be issued nationally and would incur higher yields. But Germany is floating the idea, inspired by a panel of wise men, of mutualising the bad debt above 60% of GDP to try to restore some order.
For Mr Sarkozy, the crisis of confidence is driven by the worries in the markets about the prospect of a succession of defaults or debt-restructurings, and the doubts about the survival of the euro. The answer is, first and foremost, cast-iron solidarity. He does not say Eurobonds, but he hints at them strongly. And he wants to stop all talk of imposing losses on private bond-holders – a prospect that many in Germany want to maintain so that markets can impose discipline on governments. The French president says:
"If we want the euro to survive, we don't have any choice: we must establish solidarity without weakness against all those who doubt the viability of the euro and speculate on its break-up. It must be absolutely clear that all the countries of the euro zone will be in solidarity with each other. It must be clear that what was done for Greece, in a very particular context, will not happen again, that no state in the euro zone will be pushed into default. It must be absolutely clear that in future no saver will lose a cent in the reimbursement of a loan granted to a country of the euro zone [ie, a bond-holder]"
Like Mrs Merkel, Mr Sarkozy says solidarity must go hand in hand with discipline. On this, at least, there is some agreement.
"Let us examine our budgets together. Let us more rapid, automatic and severe sanctions on those that do not respect their commitments."
The EU and its treaties
All this, say both leaders, requires the treaties to be changed. For Mrs Merkel, this is a matter of completing the economic and monetary union, and establishing a “fiscal union” (though she does not define the term). For Mr Sarkozy, “Europe must be re-thought; it must be refounded”.
So far so good. But Mrs Merkel and Mr Sarkozy disagree deeply on the nature of a reformed union. Who, for intance, should be responsible for monitoring budgets and economic policies, and imposing sanctions?
Mrs Merkel is clear: independent institutions, free from political interference, are essential for credibility. Preserving the independence of, for example, the courts and the ECB, is “for the highest good of our democracy”. On the question of budgetary rules and sanctions, she says:
"There must be no political leeway when it comes to determining whether the limits are violated or not. There must be real automaticity."
Mr Sarkozy sees it completely differently: the decisions must be taken by leaders. Political involvement is the essence of democratic legitimacy, in his view. This passage is telling, even though Mr Sarkozy begins by casting the argument in terms of his opposition to economic liberalism.
"Europe without politics, Europe on automatic pilot that blindly applies rules of competition and free trade, is a Europe that cannot confront crises...A more democratic Europe is one where responsible politicians decide. The foundation of Europe is not the march towards more supranationalism...The crisis has pushed heads of state and government to assume growing responsibilities because, in the end, only they have the democratic legitimacy to be able to decide. Thus European integration will pass through intergovernmentalism because Europe must make strategic choices, political choices."
Intergovernmentalism may well ensure that decisions have greater legitimacy, but it also has drawbacks. National vetoes make it much harder to reach decisions and implement them, as seen throughout the debt crisis. Mr Sarkozy tries to address this by suggesting that decisions be taken by “qualified” majority (ie, a weighted majority).
There are other problems. Leaders that need each other to make political deals have too often turned a blind eye to each others' flaws, as happened with Greece. Without institutions to guard the common interest, smaller countries tend to feel bullied by bigger states: just see the growing rancour over the involvement of Merkozy in unseating George Papandreou and Silvio Berlusconi, the leaders of Greece and Italy respectively.
Europe at 17 or 27?
Mr Sarkozy has recently spoken bluntly about the need to create a core eurozone more or less separate from the ten non-euro states, including Britain (see my last post here). In his Toulon speech Mr Sarkozy toned down his latent separatism, though he still speaks of a “euro-zone government” and is filled with rancour about “social and fiscal dumping” and “disloyal competition" within the EU (ie, by low-tax Ireland and low-cost eastern European members).
Mr Merkel, by contrast, has been careful to sound inclusive. Under presure from Mr Sarkozy, she has agreed to hold more summits of the 17 member-states. But when it comes to reforming the treaties, her stated preference is to do it with all 27 members of the EU “to avoid splits within euro members and non-euro states”. She knows that treaty change at 27 is the best way – perhaps the only way - to ensure that the European Commission and the ECJ are involved.
Whether it is feasible will depend, in large part, on the price that Britain seeks to extract for its agreement to changing the EU's treaty. Though he did not express a preference, a separate new treaty at 17 is probably Mr Sarkozy's preference. This would help create a harder, more exclusive core; ensure that it it becomes as intergovernmental as possible; and exclude the more liberal British, Scandinavians and easterners. Mrs Merkel says this would be “second-best” and, even she is forced down this route, she will seek to ensure that the euro “outs” are able to join its budget strictures and remain free to join the euro in future.
The ECB's bazooka
The independence of institutions is essential for Germany, and none is more sacrosanct than the ECB. Mrs Merkel bristles at the demands, from Europe, America and elsewhere, that the ECB use its big bazooka and take decisive action to stop investors' run on sovereign debt. But the ECB's statutes prevent it from lending directly to euro-zone members. Instead, it has provided liquidity to banks – this week the ECB and other world central banks acted to reduce the cost of obtaining dollars. It has also been buying government bonds intermittently, and in a limited manner, in the secondary markets to improve “the transmsision of montary policy”. Even this has caused divisions within the ECB. In America and Britain, by contrast, the central banks have no compunction about acting as the government's lender of last resort. Mrs Merkel say:
"I will make no comment on what national and European courts, and the European Central Bank, should do or not do in future. It is obviously important to point out once again: the task of the European Central Bank is different from that of the Fed in the United States of America, for example, the Bank of England. This is enshrined in the treaties. The task is to ensure monetary stability."
Mr Sarkozy, for his part, pays lip service to the independence of the central bank but is less shy about telling it to act.
"There are debates on what the statutes authorise it [the ECB] to do. I don't want to enter these debates. The ECB is independent and will remain so. I am sure that, faced with the risk of deflation that threatens Europe, the central bank will act. It is up to it to decide when and with what means. That is its responsibility. None must doubt that it will assume it and, moreover, I am glad it has already started to do it."
The speech that matters
Any treaty change will take time, whether it is limited to imposing more discipline or includes a path to Eurobonds in future; whether the integration is intergovernmental or relies on supranational European institutions; whether it reopens the treaties of the 27 EU members or is done through negotiation at 17 (or even fewer).
The nature of the treaty will affect the well-being of the euro zone in decades to come, so it is worth doing right by turning the euro zone into a coherent economic unit. This is something that long-term investors care about, and giving the right signals now helps.
But what panicking investors really want to know is whether the euro will survive the coming weeks and months. Tougher fiscal rules adopted within the current treaties have so far had no effect on confidence. The impact of new governments in Greece, Italy and Spain is still uncertain. The euro zone's rescue fund, known as the European Financial Stability Facility, is inadequate. No amount of financial engineering will make it big enough to save Italy and Spain (let along France) if investors dump their bonds entirely.
For the immediate future - and possibly for as long as it takes to change the treaties - only the ECB can avert a collapse by dint of its ability to print money. Nobody should expect the ECB to declare unequivocally that it stands ready to deploy its unlimited power behind all sovereigns. But it can do more.
The word in Brussels is that Mrs Merkel is ready to let the ECB act more intensely, though she could never say so. And Mario Draghi, the ECB president, could never be seen to ask for political guidance. That said, he will probably need to have confidence that, firstly, enough discipline is being restored so the ECB will not be left holding junk bonds and that, secondly, Germany's Bundesbank will hold its tongue if he prescribes a bigger dose of unorthodox medicine.
The real question is whether European leaders will give Mr Draghi enough a wink to act. Speaking in the European Parliament on December 1st, he sent them his own wink, implying he was ready to move if leaders adopted a new "fiscal compact". His was the speech that probably matters most, so it is worth reading carefully (full .. http://www.ecb.int/press/key/date/2011/html/sp111201.en.html .. version here):
"Fundamental questions are being raised and they call for an answer. At the heart of these questions are not only the credibility of governments’ policies and the actual delivery of the promised reforms, but also the overall design of our common fiscal governance.
I am confident the new surveillance framework will restore confidence over time. I am also quite sure that countries overall are on the right track. But a credible signal is needed to give ultimate assurance over the short term.
What I believe our economic and monetary union needs is a new fiscal compact – a fundamental restatement of the fiscal rules together with the mutual fiscal commitments that euro area governments have made.
Just as we effectively have a compact that describes the essence of monetary policy – an independent central bank with a single objective of maintaining price stability – so a fiscal compact would enshrine the essence of fiscal rules and the government commitments taken so far, and ensure that the latter become fully credible, individually and collectively.
We might be asked whether a new fiscal compact would be enough to stabilise markets and how a credible longer-term vision can be helpful in the short term. Our answer is that it is definitely the most important element to start restoring credibility.
Other elements might follow, but the sequencing matters. And it is first and foremost important to get a commonly shared fiscal compact right. Confidence works backwards: if there is an anchor in the long term, it is easier to maintain trust in the short term. After all, investors are themselves often taking decisions with a long time horizon, especially with regard to government bonds.
A new fiscal compact would be the most important signal from euro area governments for embarking on a path of comprehensive deepening of economic integration. It would also present a clear trajectory for the future evolution of the euro area, thus framing expectations.
On the precise legal process that brings about a move towards a genuine economic union, we should keep our options open. Far-reaching Treaty changes should not be discarded, but faster processes are also conceivable.
Whatever the approach, companies, markets and the citizens of Europe expect policy-makers to act decisively to resolve the crisis. It is time to adapt the euro area design with a set of institutions, rules and processes that is commensurate with the requirements of monetary union."
BRUSSELS—As the euro zone's debt crisis threatens to draw in more victims and a plan agreed to expand the currency's bailout fund looks set to disappoint, the European Union's executive arm will this week float proposals for joint issues of bonds among the currency's 17 governments.
The proposal to end the crisis from the European Commission calls for the euro zone to use its combined strength in the bond markets to replace some or all of the fund-raising currently being done by national governments.
[VIDEO inside] .. WSJ's Charles Forelle reports European leaders are once again considering the issuance of bonds to help raise capital in light of the Eurozone's debt crisis. Photo by Sean Gallup/Getty Images
The proposals for common bond issues are unlikely to gain traction soon: Germany, the strongest economy in the common currency, remains resolutely opposed to the idea, fearing it would be stuck with the bill for other governments' spendthrift ways. But the commission's discussion document appears designed to trigger debate on one of the few ideas that economists think offers the prospect of ending the crisis.
The commission's proposal to create euro bonds reflects how critical is the search for a lasting fix to the euro-zone debt crisis, given the failure of the bloc's temporary patches. Most critically, confidence is waning that the European Financial Stability Facility, the temporary fund set up in the wake of Greece's bailout, will ever achieve the heft needed to reassure investors financing weak euro-zone governments that their lending is safe.
Related Video [inside with links for the two below]
Euro Bond Yields Still Going Higher (11/17/2011) How Should Investors React to Europe and U.S.? (11/18/2011)
The commission discussion paper suggests three options for issuing euro bonds. It concludes that they could be issued carrying limited guarantees from governments without changes to the European Union treaty that would require ratification from all 27 EU states. But it says that the benefits would be greater if all governments agreed to jointly guarantee bonds issued by the euro zone—but this would require changes to the treaty.
The least ambitious option would yield fewest benefits but could be implemented relatively quickly and could mark a step on the road toward the more ambitious approaches that would need treaty changes, the paper concludes. ...................... Three Visions of Euro Bonds
National bond issuance ceases. Euro-zone governments raise new funds in euro bonds, guaranteed jointly by all 17 members. Existing bonds are converted into euro bonds.
National governments raise funds as euro bonds, guaranteed jointly by the 17 members, up to a certain limit. Beyond that, governments issue national bonds.
National governments raise funds as euro bonds up to a ceiling. Unlike in the first two options, the bonds are backed by limited guarantees from the 17 euro-zone states.
Source: European Commission ...................... In a sign of how European officials are looking for other approaches to handle the debt crisis, they are exploring plans to pool representation of euro-zone nations into a single seat at the International Monetary Fund, a move that could boost the currency bloc's clout and reshape a battle for power at the institution. "The euro area will be strengthened because it speaks with one voice," Viviane Reding, a vice president at the commission, said in an interview.
THERE ARE A NUMBER OF VIDEOS INSIDE ...................... Euro Bonds: The Pros and Cons for Euro-Zone 3:15 ......................
A European Commission discussion paper on euro bonds to be released on Wednesday suggests three possible approaches for issuing common government bonds in the euro zone, Stephen Fidler reports on Markets Hub. Photo: Getty Images.
The 40-page paper from the commission, which has been reviewed by The Wall Street Journal, is due for official release on Wednesday. It highlights the danger that issuing euro bonds could weaken budget discipline among euro-zone governments and says that issuing such bonds would require new safeguards to tighten budget discipline and improve economic competitiveness, some of which would also require treaty changes.
The first option it discusses would be to substitute all national issues by governments with euro bonds carrying what it calls a "joint and several" guarantee, meaning that euro-zone states would pool the credit risk and each government would agree to guarantee the debt of every other government. Under this approach, all new government bond issues would be euro bonds, and existing national government bonds would be converted into euro bonds.
The second option would be to partially substitute national issuance with euro bonds up to a limit, of say 60%, of a country's gross domestic product, or up to a ceiling that could change depending on how closely the government complied with euro-zone rules. These bonds would also be jointly and severally guaranteed. Beyond that limit, governments would still have to issue national bonds.
Those two options would require treaty changes, because they contravene the current treaty's clause forbidding one government from bailing out another, but the third option wouldn't. This third approach would have euro bonds replace some national bond issues—but the euro bonds would receive guarantees from each government only up to specific limits.
The quality of the bonds issued under option three could be further improved by providing collateral, such as cash or gold reserves, or earmarking tax revenues, the paper says.
This approach, the paper says, would "deliver fewer of the benefits of common issuance but would also require fewer preconditions to be met." These bonds would be unlikely to carry interest rates as low as those issued with joint guarantees.
The paper concludes that the third option "seems to be more easily ready for rapid deployment." But it would be introduced along with a road map to further development of the instrument along the lines of the first option, together with the stronger rules necessary to ensure that euro bonds with joint guarantees weren't abused by national governments.
The paper is issued as an agreement among euro-zone governments to use financial engineering to expand the EFSF, which has fallen short of early expectations that it might be able to muster as much as €2 trillion ($2.7 trillion) to backstop its wobbly giant Italy.
The EFSF, after subtracting its current and expected commitments to Greece, Ireland and Portugal, has between €250 billion and €300 billion available. That's less than a year's borrowing for Italy.
In recent weeks, the EFSF has been sounding out potential investors about two options to increase the fund's capacity to perhaps €1 trillion.
One is to use the fund's money to provide partial insurance on bonds issued by weak governments. The other envisions raising a big fund from outside investors, in which the EFSF would take a minority stake and suffer the first losses, which could be used to support weak countries.
But the EFSF hasn't raised any of these outside funds, and its chief has said he doesn't expect to do so before the end of the year. Many European officials doubt the approach is viable on a large scale, and Friday Dutch Finance Minister Jan Kees de Jager said it appeared unlikely to happen.
Instead, Mr. de Jager suggested in comments to a small group of reporters, "probably the IMF route will be used by some countries."
But it isn't an easy route either. The International Monetary Fund itself has available resources roughly comparable to the too-small EFSF, and there is great political reluctance in non-euro countries to increasing the IMF's size in order to help Europe.
That leaves the first option, partially insuring governments' bond issues. In theory, it could provide enough comfort to investors to permit them to continue lending to Italy and Spain. But it has several pitfalls.
First, as with the other leverage option, the amount that can be brought to bear is inversely proportional to the intensity of the crisis: If the crisis is particularly acute, potential investors will demand higher levels of insurance from the EFSF. Since the EFSF's resources are fixed, the volume of bonds it can insure would fall.
Second, the insurance can only practicably be attached to bonds newly issued by governments—the so-called primary market. But there is great disturbance in the secondary market, where investors sell bonds to each other. That couldn't be directly ameliorated by the insurance plan, and the secondary-market volatility is a major reason why investors are leery to buy debt from weak governments--they don't know at what price they'd be able to get rid of it if they need to.
Euro-zone finance ministers are scheduled to meet next week in Brussels; the bailout fund will be a top topic of discussion. In a worrisome development for the EFSF, the fund itself has suffered a stumble in investor confidence, likely reflecting worries both about its second-biggest guarantor, France, and about the fund's own future structure.
A bond the EFSF issued earlier this month to fund part of its bailout for Ireland, for instance, required a much higher premium to garner enough investor interest. And even since the issue, the bond has lost value. Friday, on the Luxembourg bourse, it closed 3.4% below the price at which it was issued. —Laurence Norman and Sudeep Reddy contributed to this article.
Write to Stephen Fidler at stephen.fidler@wsj.com and Charles Forelle at charles.forelle@wsj.com
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