In Europe, Looking for Patient Bond Buyers

LONDON — As Europe slouches toward a monetary union aims to force euro area governments to cede control their banks and budgets, a crucial question remains unanswered: to persuade investors to buy, and hold the long term, the bonds of at-risk economies Italy and Spain.

countries have debt and deficit levels that are no worse, and some cases better, than of Britain, Japan and the United States. But because they cannot devalue their currencies and must impose growth-sapping economic measures to regain competitiveness, their bonds have traded if their economies are near insolvent. Meanwhile, the securities of debt-racked Britain, for example, are snapped up abandon.

It is a paradox that lies the heart of the European debt crisis. On Friday its most recent summit meeting, Brussels a halting first step to addressing this issue on a permanent . Euro zone leaders proposed that Europe’s current and future rescue facilities might buy Italian and Spanish bonds as as these countries fulfilled Germany’s austerity demands and debt and deficit targets. The market, expecting more waffling, jumped and the yields 10-year Spanish and Italian bonds dropped sharply investors celebrated the prospect that Europe might become a buyer of resort of its beaten-down bonds.

Still, Friday’s euphoria , economists and market participants remain doubtful the bond market fears can be permanently assuaged the European Central Bank intervenes with the force and conviction shown its peers in the United States and Britain.

Paul De Grauwe, a Belgian economist the London School of Economics, says he believes that the latest step will be enough. Mr. De Grauwe has written extensively how the cycle of fear and panic in the bond markets is pushing countries that may not need a bailout to ask for .

The euro zone’s temporary bailout fund, the European Financial Stability Facility, has only 248 billion euros at its and must first raise the money the bond market, does not have the firepower to convince skittish investors Europe is serious, he said. Italy and Spain have a total of nearly 2.5 trillion euros sovereign bonds outstanding.

Mr. De Grauwe proposes instead, that the European Central Bank announce that it will be aggressive buyer of Spanish or Italian bonds the spread — or the difference the yields on these bonds and benchmark German bonds — reaches a certain level, say 300 basis points, compared the recent level of 500 basis points and above.

“You would then have a floor bond prices and it would be attractive investors to buy Spanish bonds again,” said Mr. De Grauwe.

His most recent paper claims the Spanish and Italian bond rout has been driven by the psychology of fear than hard and economic numbers.

“The E.F.S.F. does not have the credibility its resources,” Mr. De Grauwe said. “What you need are the unlimited resources of a central bank.”

Such a forceful approach been resisted by Germany, the bank’s largest shareholder, on the that countries would not proceed with necessary reforms. It is also that the E.C.B. has intervened in the markets before and is said own close to 150 billion euros weak euro zone country bonds.

The buying has had little effect, , because the numbers have been relatively small and because the operations have done mostly secret, largely mitigating their effect.

If the bank were to set open target, in the same vein that Switzerland’s central bank last year when it shocked markets by declaring that it would limit the increase of Swiss franc by intervening a certain level, then perhaps bond investors would take heed.

, after the Greek debt restructuring and the Spanish bank bailout, foreign investors have been sellers of Spanish and Italian bonds, fearing as the yields increase to near 7 percent and above, so the risk that these countries will run of money — even the raw numbers would argue the opposite.


Adapted and abridged from: The New York Times, June 29, 2012.