The euro zone is considering allowing the European Financial Stability Facility to buy back the bonds of member states in trouble as part of a broader response to the sovereign debt crisis, a euro zone source said.
The EFSF is a special purpose vehicle that can borrow money against government guarantees and lend it to a euro zone country cut off from market financing, in exchange for a tough programme of fiscal consolidation and structural reform.
The 17 countries that share the euro are in discussions about raising the EFSF's effective lending capacity, from around 250 billion euros closer to its 440 billion euro ceiling, while also broadening how the funds can be used.
The changes are part of a package of new measures that the euro zone is expected to announce by mid-March as it tries to draw a line under the sovereign debt crisis, which has forced Greece and Ireland to seek EU and IMF financial help.
Under the proposal being discussed, the EFSF would be able to buy the bonds of a distressed country in the secondary market, which could help stabilise that country's bond market.
"This option has always been on the table as a part of the 'comprehensive package'," a euro zone source with knowledge of the discussions told Reuters on Thursday.
"It was discussed only in general under the heading of 'broadening the scope of EFSF activities', not in relation to any specific country," the source said.
The source said the potential buy-backs would not be a stand-alone measure, but part of a broader programme of consolidation and reform agreed with the troubled country.
"The buy-backs could be provided in combination with a loan or recapitalisation of banks in the recipient country, for example," the source said.
While no decisions have been taken so far and more technical talks are likely over the coming weeks on various options, there was some support for the idea among euro zone officials.
"It was one of the options more seriously considered. Some people were quite pushing this. I think technically it would be the EFSF buying back the bonds and then somehow swapping them against new issuance," the source said.
The source said the idea was discussed separately from a proposal to allow the EFSF to buy bonds of countries experiencing market stress on the secondary market, as the European Central Bank is currently doing.
"I think the bond buying programme is something else, at least purchases on the secondary market and buybacks were discussed as a separate point," the source said.
The source said the Commission had argued that under present financing conditions countries under market stress would not benefit that much from such an ECB-style bond buy-back programme.
But the source also said opposition to this idea could be rooted in concern about the potential losses it could mean for euro zone banks which have invested heavily in, for example, Greek or Irish paper and would lose money selling those assets more cheaply via buy-backs at current market rates.
"I think it is politically easier to say we are saving the euro than to give a lot of money to banks at the time when budgets are being tightened," the source said.
"Although the amounts needed to recapitalise them would probably be much smaller than the money needed to bail out everyone against whom these banks have an exposure," the source said.
