John Paulson: Europe Needs ECB "Firewall"

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, Billionaire hedge fund manager John Paulson argues that the ECB should guarantee European sovereign debt in order to stabilize markets and allow distressed countries time to restructure their budgets. Like many others, Paulson is clearly frustrated with the effect that the European debt crisis has had on financial markets over the last year. In fact, it is possible that no one has lost more money as a result of the less-than-optimal investing atmosphere that has been driven in part by the crisis. Paulson, who solidified his reputation as an elite money manager during the mortgage crisis when he made billions betting against shaky subprime credit instruments, has had an absolutely abysmal year after betting big on a robust recovery in the United States. A number of his hedge funds have fallen more than 40% year-to-date according to investors. Paulson writes that “It is clear that existing, piecemeal efforts by European leaders have been ineffective. Even after the ECB bought €208bn of European debt, Greece, Portugal and Ireland all still required bail-outs. Italian and Spanish yields, meanwhile, remain stubbornly high.” Paulson's idea, which is not exactly unique, is to basically rout the markets via the ECB in what has basically become a game of chicken between the EU and investors. The ECB would fully guarantee all sovereign debt in return for a 1% annual guarantee fee and compliance with ECB/IMF structural reform mandates. He argues that such a program would allow large, troubled countries such as Italy and Spain to refinance their debt at below current market costs which are unsustainable. Paulson believes that these countries "all-in-financing" costs would be in the 4% range. Furthermore, such a measure would allow countries time to implement much needed reforms. The other argument that Paulson makes is that the guarantees would never likely need to be used. The simple mechanism of an "all-in" ECB backstop would drive interest rates down to manageable levels. Paulson clearly views the current situation as untenable. “Time is running out for the euro. “A comprehensive firewall is needed now, before the crisis gets worse.” The problem with Paulson's plan is that it basically has been rejected repeatedly - primarily by Germany. Without German support, such a liquidity "bazooka" is not going to happen. It also would require the ECB to totally distort its mandate, which is price stability. In order for Paulson's "firewall" to be implemented, the Europeans would to have to agree to basically scrap the ECB's mandate and let the central bank engage in unlimited bond buying with printed money, or at least signal to the markets that it is willing to do this. The burden of such a move would fall, in large part, on the back of German productivity and could spark inflation.