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Europe’s Troubled Economies Join the Rescue Team

Can a bailout fund whose backers include some of the countries it may be called upon to bail out really succeed?

Protestors escape tear gas fired by policemen in Athens.
Louisa Gouliamaki | AFP | Getty Images
Protestors escape tear gas fired by policemen in Athens.

That’s the question being asked by skeptical investors about the European Financial Stability Facility — the rescue fund of 440 billion euros, or $632 billion, that is being given new, amplified powers to help the euro zone end the sovereign debt crisis.

Under an agreement clinched on Thursday, the fund will be able to buy distressed government bonds on the open market and lend money to countries to recapitalize their banks.

The initial reaction by surprised investors bordered on the effusive. But details were scant and a devil lurked amid them — an inconsistency that skeptical analysts and hedge fund investors had begun to latch onto by the end of the trading day Friday.

The potential problem is that, after Germany and France, the facility’s next largest guarantors are Italy and Spain. And they happen to be the two countries that, with their fragile banking systems and high financing requirements, may be next in line for a bailout if the crisis deepens.

In the afterglow of last week’s summit meeting, the rescue fund, known as the E.F.S.F., was quickly labeled an embryonic European monetary fund.

In fact, with Europe and the International Monetary Fund having committed close to $1 trillion to the crisis since it flared early last year, the extent to which the new European fund is seen as credible will go a long way toward determining whether the markets will accept Europe’s broader strategy in addressing its economic ills.

Already, hard questions are being asked.

“The creditors are becoming the debtors — that is the problem,” said Stephen Jen, a currency strategist and former economist for the monetary fund who runs SLJ Macro Partners, a hedge fund based in London. “The burden of support in the euro zone will become even more concentrated on Germany and France.”

In a note to investors on Friday, analysts at Merrill Lynch echoed this theme, pointing out that it might take close to 300 billion euros for the stability fund to make a meaningful impact if it were called upon to buy discounted Italian and Spanish bonds in the secondary market.

“Given that the E.F.S.F. has already committed 145 billion euros for Portugal and Ireland and 73 billion euros for the second Greek package, the E.F.S.F. would only be able to use 220 billion euros out of the 440 billion euros, which might err on the tight side,” Merrill’s analysts wrote.

And these calculations do not include the capital needs for Europe’s weak banks, the other new area of responsibility for the fund.

Some economists say that figure could go as high as 250 billion euros.

Adding to the uncertainty was a statement Friday from Chancellor Angela Merkel of Germany that the necessary legal changes to the fund’s structure — its size, its financing and its decision-making, to name just a few — would not be taken up by the German Parliament until the second half of September, after Europe’s summer break.

With signs of anxiety resurfacing late Friday — a rally by Spanish bonds fizzled at the market’s close — the idea that investors would wait patiently for two months for Europe’s leaders to provide the fine print on their grand proposal was met with disbelief in some quarters.

“I would suggest that if the eurocrats want to go on vacation that they bring their cellphones,” added Mr. Jen.

Based in Luxembourg and overseen by Klaus Regling, a German economist and former top official in the European Commission’s financial division, the E.F.S.F. was conceived in May 2010 during Europe’s first attempt to quell market fears over Greece and other debt-burdened nations in the euro zone.

But unlike the Troubled Asset Relief Program that invested billions of dollars in American banks, the stability fund has not been handed a pot of cash to disburse as it sees fit.

Instead, every time it wants to put money to work, it has to issue a bond — backed by the guarantees of euro zone economies.

Because Germany is its largest backer, the fund carries a triple-A rating, which allows it to raise money relatively inexpensively (3.3 percent for 10 years, for one recent offering).

In June and July, for example, the stability fund raised 8 billion euros in two auctions, and it has said that it plans to come to market an additional four times this year in support of bailout programs in Ireland and Portugal.

As it stands now, Italy’s and Spain’s guarantees make up 30 percent of the facility’s backing.

If those two countries were to require a rescue, they would no longer be listed as guarantors to the fund, but instead would join Portugal, Ireland and Greece as bailout recipients — thus heaping more of the borrowing burden on France and Germany.

For Germany, Europe’s cash cow, this might be bearable. But for France, which has a budget deficit of 7 percent of gross domestic product — higher than Italy’s — and an emerging problem of competitiveness reflected in its record trade deficit, such a burden may be more than its triple-A credit rating can bear.

A spokesman for the fund declined to comment. And while European officials concede that the fund is not large enough to support both Spain and Italy, they also argue that these countries have made changes to keep them from needing a bailout.

The stability fund would still be able to raise money, analysts say, but the interest costs would inevitably increase.

It is also worth noting that if the fund had to raise money for Spain or Italy, the market conditions would, by definition, be quite difficult.

There are also questions regarding its management that have to be addressed. Currently, Europe’s new buyer of last resort is a special-purpose vehicle with a pure and simple mission to raise money when it is needed.

How the fund is transformed into Europe’s largest purchaser of bonds has not yet been explained, although a news release last week said that this would be done in tandem with the European Central Bank.

And do not forget domestic politics. National parliaments must approve any changes to the stability fund’s structure.

For the weaker economies on the receiving end of its largess, that may not be a problem.

But certain members of the German Parliament, already upset about the cost to taxpayers, may not be so accommodating.

For the time being, these questions are for another day.

Until then, the euro zone’s leaders can only hope that investors will take them at their word.

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