Euro Stability Fund Is A Mirage

28 Sep

The European economies are continuing to be a source of much speculation and worry in American financial sectors. The Greek default, potential bailouts, and more all effect the global economy and with it US interests. There has been some minor successes such as the creation of the European Financial Stability Facility, but now it looks like the €440 billion fund might not be large enough to cushion some of the larger European economies. The article below details exactly what a European default would mean and how far reaching its effects might go as well as discusses the specifics of proposed European bailout measures.

By Ben Rooney

As a proposed overhaul of the European bailout fund inches its way toward approval, investors and economists are already calling for more aggressive measures to contain the eurozone debt crisis.

European leaders agreed in July to expand the powers of the European Financial Stability Facility, which was set up in the wake of the 2008 financial crisis.

The goal is to give the fund more flexibility to stabilize shaky government finances and provide money for banks that need to raise capital.

So far, the plan has been ratified by eight of the 17 nations that use the euro. On Thursday, the German Parliament is expected to narrowly approve the measure, which is politically unpopular in many northern European nations.

Euro area officials said last week that they plan to implement the proposed changes by mid-October, assuming the overhaul is approved by the remaining eurozone nations.

But there is now widespread agreement among economists and investors that the €440 billion fund is not big enough to be effective if some of the larger euro area economies fail.

Some economists have estimated that the fund would need up to €2 trillion to bail out Spain or Italy. Both nations are struggling with unsustainable levels of debt and dim economic prospects.

“Even an enhanced EFSF will have barely €100 billion to throw at the bond market…minus, of course, any new commitments made to Greece” said Carl Weinberg, chief economist at High Frequency Economics, in a note to clients.

More recently, European officials have been discussing ways to increase the fund’s ability to absorb bad sovereign debt by leveraging its assets in some way. However, experts say the fund is unlikely to see an increase in the amount of money it is able to deploy.

José Manual Barroso, president of the European Commission, said Wednesday that the stability fund “must immediately be made both stronger and more flexible.” After the overhaul of the fund is official, he added, “we should make the most efficient use of its financial envelope.”

There is no shortage of theories on how the fund could be used more effectively.

Under one of many scenarios, the EFSF could buy €440 billion worth of bonds issued by distressed euro area governments and use those securities as collateral to borrow from banks in the private sector. The proceeds could then be used to buy even more government bonds.

Greek finance minister promises ‘no default’

Another scheme being debated involves using the fund’s €440 billion to guarantee the first 20% of any losses the private sector may suffer on bonds issued by troubled sovereigns. The goal is to encourage investors to buy newly issued bonds and lower borrowing costs for governments struggling with massive debts.

There has also been talk about using EFSF funds to guarantee purchases of government debt by the European Central Bank, which has been buying up billions of euros worth of bonds issued by Spain and Italy, among others.

The euro will survive (That’s not a typo)

However, the emergency bond buying program has already caused a major rift within the ECB’s management and many analysts say the bank may be reluctant to take on more bad debt.

Overall, many experts say increasing the stability fund’s price tag to €2 trillion is highly unlikely given the political headwinds.

“Emerging details about the recent proposal to supersize the eurozone’s bail-out fund suggest that, at best, the plan is simply to use existing funds more imaginatively,” said Jennifer McKeown, senior European economist at Capital Economics.

In addition, she noted that the proposals seem to have more support outside the eurozone than within it, “suggesting that the region’s policymakers are still a million miles away from resolving the crisis.”

Read the full article here

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