Germany Set to Approve Bailout Fund Purchases of Sovereign Debt

In a reversal that was bound to come sooner or later, German Chancellor Angela Merkel is reportedly ready to agree to allow the Eurozone’s European Financial Stability Fund (EFSF) and the European Stability Mechanism (ESM) to use their combined €750 billion to purchase sovereign bonds. The dramatic rise in Spanish bond yields to more than 7% is the most likely driver of Merkel’s capitulation on the issue.

Spain is set to auction medium-term debt later this week, and there has been every indication that yields on that debt would rise above 7% as well. Sovereign debt interest rates above 7% are considered to be unsustainable.

In some ways, agreeing to allow the EFSF and the ESM to purchase sovereign bonds could turn out to be very much like an agreement among nations to release crude oil from strategic reserves. The mere threat acts as a brake on bond yields. If EFSF/ESM funds are actually used to buy Spanish debt, it will be the first time that has Eurozone bailout funds have been used to purchase sovereign debt.

Another effect of Merkel’s change of heart could be a widespread belief that Germany will acquiesce (eventually) to the issuance of eurobonds. Many observers think that until the richer Eurozone nations agree to stand behind the debts of their distressed neighbors no real solution to the continent’s financial crisis is in sight.

Paul Ausick