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Officials Working on a Sovereign Debt TARP for Europe?

Monday, 26 Sep 2011 | 3:21 PM ET

European officials are working on a detailed plan aimed at shoring up European bank stability, according to an official who spoke with CNBC’s Steve Liesman.

The plan appears to have a lot of moving parts. It would involve money from the European Financial Stability Facility (EFSF), a bailout vehicle created in 2010 to alleviate the sovereign debtcrisis in Europe, to capitalize a special purpose vehicle that would be created by the European Investment Bank, a bank owned by the member states of the European Union.

The special purpose vehicle would issue bonds to investors and use the proceeds to purchase sovereign debt of distressed European states.

The hope is that this would alleviate the pressure on the distressed states and on the European banks that hold a lot of the distressed sovereign debt.

The bonds issued by the special purpose vehicle could then be used as collateral for borrowing from the European Central Bank (ECB), allowing the central bank to make loans to banks faced with liquidity shortages.

To put it more simply, banks loaded down with distressed sovereign debt would be able to sell the debt to the special purpose vehicle.

They would buy bonds of the special purpose vehicle, and those bonds could be used to access liquidity facilities from the ECB.

Although the structure is complex, the underlying result is relatively simple. Banks would essentially be allowed to exchange their sovereign debt for debt issued by a special purpose vehicle created by the European Investment Bank capitalized with funds from the EFSF.

In some ways, this resembles the original plan for the Troubled Asset Relief Program (TARP). As originally conceived, the TARP would have purchased "toxic securities" from banks. (This plan was abandoned when U.S. regulators concluded that it was too difficult to price the securities and that the plan would take too long to implement.) In this case, the "toxic securities" would be sovereign debt rather than mortgage bonds.

One question is whether this will require an expansion of the EFSF. The fund has already committed to providing emergency loans to Ireland, Portugal and Greece. It is expected to provide over 100 billion euros ($134.9 billion) in additional funding for a Greek bailout.

After those loans, the fund will be down to about 298 billion euros ($402 billion), according to some estimates. German Finance Minister Wolfgang Schaeuble on Monday said that there is no plan to expand the EFSF.

This is likely why the plan appears to make the new vehicle a levered fund, which borrows far more than it has in equity capital provided by European governments.

No official plans have been released. Details may change as European officials work on the structure.

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