Bundesbank chief worried bailout will harm fiscal policy

Bundesbank President Jens Weidmann said Greece?s second bailout package may weaken incentives for governments to implement solid fiscal policies.

?By transferring sizeable additional risks to aid-granting countries and their taxpayers, the euro area made a large step toward a collectivization of risks in case of unsolid public finances and economic mistakes,? Weidmann said in an e-mailed statement. ?That?s weakening the foundations of a monetary union founded on fiscal self-responsibility. In the future, it will be even more difficult to maintain incentives for solid fiscal policies.?

European leaders agreed on a 159 billion-euro ($228 billion) plan to stem Greece?s debt crisis and contain a spillover into larger countries such as Spain and Italy late on July 21. The package empowers the region?s 440-billion euro rescue fund to buy debt of distressed euro nations, aid troubled banks and offer credit-lines to repel speculators. Financial institutions will contribute 50 billion euros to the proposal.

Weidmann ?makes it very clear that he?s not happy with the outcome,? said Juergen Michels, chief euro-region economist at Citigroup Inc. in London. ?This suggests that he will try to prevent the ECB from taking additional action by re-activating? its bond-purchase program.

Greek two-year notes soared the most in 14 months yesterday, pushing the yield down 617 basis points to 27.64 percent in London. Irish two-year note yields fell below 15 percent for the first time since July 6.

?Overall, acute tensions in financial markets could ease with the program,? said Weidmann, who took over the helm of the Frankfurt-based central bank from Axel Weber in May.

Fitch Ratings said yesterday Greece faces a ?restricted default? if the plan includes getting bondholders to assume part of the cost. The ratings company will assign post-default ratings, likely ?low speculative grade,? to Greece after new securities are issues to investors, it said.

?The Bundesbank was one of the strongest opponents of a default, and now there?s a default,? said Christian Schulz, an economist at Berenberg Bank in London, who used to work at the ECB. ?That means the concerns have in a way been waived and the risks have been transferred to the taxpayer.?

European Central Bank President Jean-Claude Trichet indicated late July 21 that European leaders will guarantee Greek bonds in money market operations should a bailout agreement trigger a default, telling reporters after a summit in Brussels that he won?t ?prejudge? whether Greek securities will be classified as being in default.

?The protection of the integrity of the central bank is non-negotiable,? Trichet said yesterday in an interview with Germany?s Sueddeutsche Zeitung. Greece must ?rigorously and comprehensively? implement its adjustment program, he said.

Weidmann, who is also ECB council member, echoed Trichet?s remarks, saying it?s ?decisive for monetary policy? not to transfer additional risks to the Eurosystem and that the ?dividing line between monetary and fiscal policy isn?t blurred any further.?

?Solvent counterparties and adequate collateral are indispensable for the refinancing operations of the euro zone,? he said. ?The position of the European council, to assure sufficient collateral and adequately capitalized banks, in the framework of a new aid program for Greece, is to be very welcomed.?