Front row left to right, European Commission President Jose Manuel Barroso, French President Nicolas Sarkozy, and Lithuania's President Dalia Grybauskaite. Back row left to right, Portugal's Prime Minister Jose Socrates and German Chancellor Angela Merkel at the EU summit in Brussels Photo: AP
Germany has agreed to give the EU's €440bn (£383bn) bail-out fund permanent status rather than letting it expire in 2013 as planned, but only as part of a "Crisis Resolution Mechanism" that forces bondholders to share losses from any future bail-outs. The fund must be anchored in EU law through changes to the Treaties in order to head off legal challenges at Germany's constitutional court.
A draft proposal from Berlin – now serving as a working text for the European Commission – calls for "orderly insolvency" by eurozone countries in trouble. Details are sketchy but this "Chapter 11" for sovereign states would include an extension of debt maturities, a "holiday" on interest payments for as long as needed to let debtors recover, and a suspension of bondholder rights. The blueprint is akin to debt-restucturing schemes used by the International Monetary Fund.
Under a Finnish proposal, there are likely to be "Collective Action Clauses" in all new bond issues to prevent minority bondholders blocking a default deal.
European President Herman van Rompuy will be tasked to draw up a blueprint for the crisis mechanism. There may also be a Sovereign Debt Restructuring Mechanism (SDRM).
Berlin is determined to avoid a repeat of the €110bn bailout for Greece when banks were shielded from losses, leaving eurozone taxpayers facing the full cost.
Silvio Peruzzo, Europe economist at RBS, said talk of "haircuts" for bondholder at this delicate juncture could backfire. "The debt crisis in the eurozone periphery has not been sorted out. These countries need markets to keep buying the bonds, but investors are going to stay away if you open the door to private sector pain," he said.
It is unclear whether the latest bond jitters in Greece, Ireland, and Portugal is linked to growing awareness of the German plans. Each country has its own troubles. Yields on Ireland's 10-year bonds briefly rose to a post-EMU high above 7pc on Thursday, partly due to a stand-off between Dublin and angry funds facing losses on the junior debt of Anglo Irish Bank.
However, EU officials fear that the proposals could make it harder for high-debt states to tap debt markets, risking a self-fulfilling crisis.
Germany is likely to win backing in principle at Friday's EU summit in Brussels since it has already struck a deal with France, and Britain has dropped its opposition to treaty changes.
Brussels believes it is possible to invoke Article 48.6, which allows changes to the Lisbon Treaty without the political trauma of referenda or full ratification in all 27 states. This "simplified revision" can be used to cover matters in Part III of the Treaty, but the EU risks a political backlash if it tries to push through such a controversial plan by these means. Viviane Reding, the EU justice commissioner, said it was "suicidal" to tinker with the treaties so soon after the Lisbon storm.
German Chancellor Angela Merkel is also demanding EU powers to strip countries of their voting rights if they breach eurozone rules, but this has been dismissed by Brussels as "totally unacceptable" and will be blocked by other states.
The summit was intended to endorse plans by an EU taskforce for a beefed-up Stability Pact, but as so often at EU meetings France and Germany have run away with the agenda.
The German proposals have a logic since they let struggling states claw their way out crisis by reducing debt. Greece's rescue risks failure because it will leave the country with public debt of 150pc of GDP, near the point of no return
http://www.telegraph.co.uk/finance/economics/8094324/EU-haircut-plans-rattle-bondholders.html
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