EU bailout fund: Europe’s bailout fund is no longer fit for its purpose. As the euro zone’s sovereign debt crisis has spread to Spain and Italy, the euro 440-billion fund looks increasingly puny. Expanding it is politically tricky. But using the European Financial Stability Facility’s (EFSF) remaining firepower to guarantee new sovereign debt would give it more clout and buy some time.
The euro zone overhauled the EFSF at its July summit. But, it has already been overtaken by events. After subtracting the sums it has agreed to lend to Ireland, Portugal and Greece, EFSF probably has about euro 300 billion left. That might just pay for a Spanish bailout, but is nowhere near enough to help Italy. And, if EFSF bought government bonds in the market at the same rate as the European Central Bank is currently doing, it would run out of cash in five months.
Expanding the fund’s capacity, or leveraging it up by turning it into a bank — an idea touted by US treasury secretary Tim Geithner — would require another round of government approvals. That’s a political non-starter.
A more feasible idea being actively discussed by European policymakers is for the EFSF to guarantee new issues of sovereign debt. For example, the fund could indemnify investors against losses on the first 20 cents of every euro of new debt. That would allow it to guarantee debt worth five times its current capacity, or euro 1.5 trillion. Assuming the yield on the insured bonds was similar to EFSF’s current borrowing costs, the scheme would allow Spain and Italy to borrow at well below current market rates — even after adding a chunky fee.
The scheme is not fool-proof. Investors might conclude the guarantee wasn’t big enough to prevent losses, and that other governments might not be able to come up with the cash in the event of a default. Providing guarantees would make EFSF’s funds more risky, which might undermine its credit rating. However, of all the ideas that have been put forward to bolster EFSF, the guarantee scheme is one of the few that could actually be implemented soon. For that reason alone, it is worth a try.