The European Money Jar: The EFSF

Every article and news report on the European crisis seemed to mention the ‘EFSF’ – the European Financial Stability Fund. What is it and why is it important?

First things first, what is it?

Officially,  Its a triple A-rated eurozone private company run by the European Commission, European Central Bank, IMF and the Eurogroup (eurozone finance ministers). It is backed by guarantees from all 17 eurozone countries (but really, its the guarantees of the 6 AAA ones that matter).  It sells debt/bonds to raise money for bailout funds for countries in need and help them pay their short term debts  (keeping the default wolf from the door). It can also be used by a country to fix their banking sector (as in Ireland). But it cant just intervene. Countries must apply for funds and be accepted (so you better be in trouble because ‘applying’ is enough to make investors run for the hills). So it’s a means to an end – only to be used after euro-using countries cant borrow in the normal way from the markets.

How much is it?

Before reform proposals made in July are agreed, it has a ceiling of €250bn. Of this, €100-€135bn has been pledged to Greece (€25bn for 1st bailout + €72bn-€110bn for 2nd bailout), Ireland (€17.7bn) and Portugal (€26bn).  The July 21 reforms will see its lending ceiling grow to €440bn. Even if the reforms are passed by October across the EU, the pot is already reduced to between €260-€300bn after PIG deductions. If you want to get technical, because EFSF bonds are guaranteed up to 165% of their size, the EFSF crutch  (on remaining funds) is technically between €429-€495bn. In cold hard cash, the overall bailout fund, adding the EU’s €60bn and IMF’s €250bn is now between €570-€610bn.

Isn’t this enough?

At first it was – when it looked like it was only needed for Greece, Ireland and Portugal. Now, with Italy and Spain (the eurozones 3rd and 4th biggest economies) looking shaky with combined debts of around €2.2 trillion – its thought a much bigger fund is needn’t to convince investors in the market that the eurozone has the muscle to prevent members defaulting on their debts. Italy and Spain will soon have to raise a combined €390bn just to cover their immediate problems – which is nearly 90% of a capacity of EFSF even before the money for Greece, Ireland and Portugal is considered. Conservative estimates suggest a bailout for Spain could cost €290bn, with Italy around €500bn. This looks like a bridge too far.

The Changes to EFSF

Following the June 24 EU Council meeting and the July 21 ‘Crisis Summit’, some changes were announced to the EFSF to give it a bit more (pre-emptive) bite and to help the eurozone/ECB to get ahead of the crisis for the first time. Heres the summary:

Commission President Barossa hailed the July Summit has being a ‘bold step’ to tackle the concern over debt levels in the eurozone but that they were not having the desired effect. The 21 July proposals significantly underwhelmed investors who saw it was tinkering around with the existing fund rather than beefing up its size. Instead of giving it real teeth to take action, it can only act on advice of the ECB, to try make it as a-political as possible.  And even then it needs everyone to unanimously agree meaning it takes a lot of time to get the cogs moving.  All these changes have to ratified by all EU-27 parliaments by late September/early October. Easy? Nope.

Beefing Up the EFSF?

How big is big enough for the EFSF? Although the weakest link is Greece, the biggest weakening link is Italy with over a €1tn of bonds and €1.8tn of sovereign debt. Analysts say a reformed EFSF should be therefore between double and triple (€880bn-€1.3tn) …for now. Even this, at the most optimistic, remains a cloudy issue.

The inescapable fact is that now the EFSF has be made a bit looser to be used by countries in need, it still needs more money. Constant crises mean more EFSF money is needed. In effect, politicians across the EU have agreed to create a brand new weapon but are going to really use the same old bullets. This is hugely contentious. Politicians at EU level are strongly in favour of an expansion including Commission President Barosso. When its gets down to the national level, things are far murkier.

Opposition to beefing up the EFSF in parts of the eurozone hinges on three reasons:

  1. They don’t want to pay more to the ‘reckless’ PIIGS
  2. They risk losing their AAA ratings (and it mightn’t even solve the problem)
  3. Domestic politics

Based on these reasons, the following countries have shown some worries:

  • Germany will vote on September 23 on the changes which are deeply disliked by large sections of Chancellor Merkel’s two-legged coalition but favoured by the opposition Social Democrats and Greens. The reason is simple – they’re sick of bailing out high spending countries who appear to be giving Europe the two fingers – all the while risking investors questioning the German ability to pay its debts. As Germany provides 27% of the EFSF funding, the largest share, a ‘no’ vote could be an economic and political earthquake in Europe. If changes which are seen as pretty minimal are proving very difficult to muster support for, the likelihood of passing a bill to expand EFSF (a far bigger deal) seems next to impossible.
  • In Finland, where the euro-sceptic anti-bailout True Finn Party excelled above expectations in recent elections (and was promptly left out of the now ruling coalition), the mood is no more chirper. Their success has seen some Social Democrat and Leftist Alliance MPs within the ruling coalition uncertain to support the reforms. Its likely that recently elected Prime Minister Jyrki Katainen might need to adopt a hard line approach afterward making any proposal to put more money into the EFSF certain to be an uphill battle.
  • In the Netherlands, it’s a similar situation with worries over the Dutch AAA rating and the stability of the government as the ruling minority coalition relies on the Freedom Party, which opposes any bailouts. Although the July 21 reforms are expected to pass, opinion polls suggest that 55% of the Dutch people oppose paying any more money into the EFSF.
  • For France, while the July reforms are expected to pass the French parliament easily, the outlook is worsening. While eager to assume a ‘European Monetary Fund’ role for the EFSF/ESM which should include more money, France in the same breath wants to protect its own credit rating fearing expanding the fund would ultimately lead to a domino effect ruining the French banks. Early August saw speculation about Frances ability to pay its debt hit fever pitch. If France has to now fork out for an expanded EFSF, it will have to borrow to pay for it, making a credit downgrade a real possibility.  If France was to be downgraded, then the remaining 5 AAA nations would have to take up the slack (a very costly task).
  • Slovakia, like the Netherlands, has domestic political problems with a party in the ruling coalition (SaS) led by the Parliaments Speaker threatening to vote against. Like Germany, the passage of the EFSF reforms might require opposition support which could bring the government down. As this is contentious, extra EFSF funding seems dead on arrival.

And so, onward to September!

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