February 3, 2011

German Advisor to Merkel Says Banks Should Hold Bond Equity

Low-rated euro zone bonds should be backed by equity against bailouts

Economist Wolfgang Wiegard said Thursday that banks should be required to guard against the possibility of bond restructuring for any bonds they hold from lower-rated euro zone countries by holding equities against such investments.

This would ward off the possibility of banks calling for taxpayer-financed bailouts in the event of such restructuring, he said. He added that the more risky the bond, the higher the equity reserve should be. In that way, he explained, the banks could absorb losses themselves.

Reuters reported that Wiegard, one of German Chancellor Angela Merkel’s advisors, known as the "wise men," made the assertion in an interview that was published in Die Welt. "A basic requirement for aid must be that private creditors always participate," he said, adding that such equity holdings would lower the risk that banks subject to haircuts on any bonds to be restructured would then insist on being bailed out of their losses by taxpayers.

"Not if banks must hold capital for their risky sovereign bonds—the worse the rating, the higher the amount of equity that banks should set aside," he said in the interview, adding that such a move would keep "the German taxpayer ... for the most part out of the woods."

Currently there is no requirement that German banks hold equity against investments in bonds from Ireland, Portugal, or Greece, although holdings of bonds from similarly rated countries that are not a part of the European Economic Area (EEA) would carry such a requirement.

Wiegard currently teaches economics at the Universityof Regensburg. In March his "wise man" position will be assumed by Lars Feld, who will succeed him after Wiegard’s 10-year stint on the economic advisory panel to the German government.

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