The euro zone is struggling to design a fired-up bailout fund capable of protecting Italy and Spain nearly a month after European leaders agreed on the plan, adding to concerns that the crisis has escalated too far for the fund to have an impact.
Finance ministers are expected to finalise details on how to extend the lending reach of the European Financial Stability Facility (EFSF) to as much as 1 trillion euros ($1.6 trillion) when they meet in Brussels next Tuesday, but the fund itself may not be operational for several weeks more.
"It is difficult to say today when the fund will be ready," said a senior euro zone official with direct knowledge of the negotiations. "Before Christmas would be an optimistic target from a technical point of view."
Another official said the leveraged fund should be working from January. "We need to take into account what investors want and what the politicians want," the official said.
January may already be too late, with evidence growing by the day of the crisis seeping into the heart of the euro zone. France's bond market is under pressure and Germany on Wednesday failed to sell a large chunk of 10-year bonds at an auction.
Euro zone leaders agreed on Oct. 27 that the EFSF, set up in May 2010, should be leveraged to raise its firepower, focusing on a two-pronged scheme to provide bond insurance and attract outside funds to invest in euro zone bonds.
With Germany rigidly opposed to the idea of the European Central Bank providing liquidity to the EFSF or acting as a lender of last resort, the euro zone needs a way of calming markets, where yields on Spanish, Italian and French government benchmark bonds have all been pushed to euro lifetime highs.
Once fully leveraged and operational, it is hoped the EFSF will be sufficiently large to provide emergency loans to Italy and Spain, should they find themselves unable to raise funds in the market, as others have done.
The EFSF currently has a capacity of 440 billion euros, but it is already committed to providing assistance to Ireland, Portugal and Greece, and needs to set aside money in case it needs to help recapitalise European banks as well.
As a result, it only has about 250 billion euros available, not enough to help Italy and Spain, which together need to raise 570 billion euros next year in short and long term financing, according to ABN Amro.
Even as policymakers work to design a way of bolstering the EFSF, the crisis is worsening, making it ever harder to get on top of the problem.
As problems expand, the probability that one of the euro zone's 17 member states will be forced to default on its debts increases. That in turn is likely to increase the demand from investors for EFSF guarantees on euro zone bonds.
The head of the fund, Klaus Regling, has already warned that the EFSF may not reach the 1 trillion euro level and scepticism is growing about the ability to achieve the leverage.
"No one's coming out and say 'let's abandon this' but I don't think at this point there are many investors who think this stuff is going to fly," said Malcolm Barr, an economist at JP Morgan in London.
"The failures of these mechanisms leaves the ECB as the last man standing and it is highly likely that the pressure will come on for the bank to do more to stabilise the situation."
"INCOMPREHENSIBLE"
At the same time, the EU is trying to convince investors from outside Europe to put money into co-investment vehicles that would buy euro zone bonds. Largely because of legal issues, that process is slow and complex.
Russia's central bank chairman, Sergei Ignatyev, said this month that the co-investment idea was "incomprehensible" and said he would not invest until things were clearer.
Reserves-rich China has shown little more enthusiasm.
The EFSF must decide if each co-investment fund is to be dedicated to buy bonds of a single euro zone country, or whether it could service several countries. It must then build the fund, decide where to register it, and draft documents to comply with local regulations.
The fund must also decide how to design the bond insurance scheme without playing into the hands of speculators.
The current idea is to provide 'first-loss' insurance on a portion, possibly 20-30 percent, of new primary debt issuance. The debt would be sold with an insurance certificate attached, but the certificate could be detached and traded separately.
"We need to create a certificate that would provide a guarantee that is eventually detachable and negotiable in the market," the euro zone official said. "But we want the owner of the certificate to own the bonds. This has to be engineered, it is not so obvious."
The International Monetary Fund, which can only lend to governments and is not directly involved in the leveraging, is anxious that too much time is elapsing and says the crisis threatens the global economy. ECB President Mario Draghi has also urged the EFSF to get its plan operational quickly.
"They need to act to prevent the euro crisis from spinning out of control," said Luc Everaert, the International Monetary Fund's assistant director for the euro area and EU policies.
"It's clear they need to have enough real money available to inspire confidence in the markets," he told Reuters.
