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E.U. seeks to expand bailout fund to calm markets

By Michael Birnbaum
Washington Post Staff Writer
Wednesday, January 12, 2011; 8:57 PM

European Union leaders pushed Wednesday to expand the scope of the euro-zone bailout fund, saying more support is necessary as investors worry about the financial prospects of Portugal and Spain.

Analysts increasingly feel that Portugal will soon join Ireland and Greece in needing a bailout, although a Portuguese bond issue Wednesday gave the country some breathing room as borrowing costs fell slightly from the last such sale in November. But many investors are concerned that if both Portugal and Spain tapped the $577.8 billion fund, bailout resources would be stretched to the limit.

E.U. officials say that the fund, called the European Financial Stability Facility, could accommodate both countries at its current levels. But they say that boosting its reserves will help calm jittery markets.

To ensure "financial stability," the fund's "effective financing capacity must be reinforced and the scope of its activities widened," said European Commission President Jose Manuel Barroso in a speech in Brussels, adding that "it is perfectly possible" to do so no later than a European Council meeting Feb. 4.

A senior European Union official said that precise details are still under discussion and are dependent on agreement from France and Germany, which is by no means guaranteed. One proposal is to expand the fund's capital reserves so that a full $577.8 billion could be committed toward countries that request assistance. The fund as it is currently constituted cannot lend out its full reserves because of the creditworthiness of some of the countries that have contributed to it, and analysts have said that its true capacity is likely closer to $328.3 billion to $393.9 billion.

Another proposal is to allow the fund to purchase sovereign debt on the secondary market. Luxembourg Prime Minister Jean-Claude Juncker said last month that European finance ministers were considering such a change. It would lower the gap between the interest rates weak economies such as Greece must pay and the borrowing costs for stronger economies such as Germany's.

Juncker also said that a proposal was under consideration to allow the bailout fund's resources to be used in a precautionary way, to calm market anxiety instead of just reacting to a crisis.

This could take the form of extending credit lines to troubled countries that may or may not actually be used. Simply knowing that the credit line is there can be enough to reassure investors, staving off a spike in borrowing costs that could itself set off a need for a bailout.

Germany's support would be necessary to make any of the proposed changes to the bailout fund, since it bears the biggest chunk of the costs. German Chancellor Angela Merkel said Wednesday that "we will back whatever support the euro needs," while noting that there is still a significant amount of money left in the fund.

She did not specifically address the proposals to expand the fund's size, but any additional commitment will likely face a tough political fight in Germany, where many voters are concerned about the country's financial outlay to prop up troubled European economies.

Portugal on Wednesday managed to sell $1.64 billion of bonds, the upper limit of its goal. Of that amount, $786.5 million was in 10-year bonds at an average yield of 6.72 percent, down from 6.81 percent at the previous auction in November. But borrowing costs for shorter-term bonds rose; $853.5 million of bonds maturing in 2014 went for 5.4 percent, up from 4.04 percent in October. Spain plans to auction bonds Thursday, another test for investor confidence.

The euro gained 1.2 percent against the dollar Wednesday following the Portuguese auction, settling at $1.31.

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