26 September 2011

FT: Europe thinks the unthinkable to solve crisis

A rescue fund with extra tools

The most immediate task facing European leaders has been on the front burner for more than two months: getting all 17 eurozone parliaments to approve the overhaul of the European Financial Stability Facility, the bloc’s rescue fund. Once resisted by Germany and the Netherlands, among others, they are now seen as essential to dealing with the two things that most threaten the survival of the eurozone: a meltdown of the banking system, perhaps starting in France, and a run on Italian and Spanish bonds.

Although six parliaments have approved the measures, Finland  is to vote on Wednesday, and passage is not assured. All eyes then turn to Thursday’s vote in Germany, where Angela Merkel, the chancellor, has the support of opposition parties but faces a revolt from within her own coalition. Then there is Slovakia, where political opposition is strongest. If Slovakia fails to approve the deal, it may not be fatal but it is likely to increase calls from other sceptical nations looking for opt-outs.

Boosting the rescue fund’s firepower

For the EFSF to perform effectively its new duties, eurozone leaders have finally acknowledged that the fund – originally set up as a temporary facility to deal with small peripheral economies – is no longer big enough for its new tasks. Bail-outs for Ireland, Portugal and Greece have reduced usable EFSF guarantees to about €250 billion.

Instead, leaders are debating at least five different proposals on how to make EFSF money go further, mostly by leveraging the available remaining cash. One proposal is for the EFSF to guarantee losses of up to 20 per cent on sovereign bonds, for example of Spain and Italy, rather than buying the bonds outright. Such insurance would increase the value of EFSF support by five times and avoid upfront payments. Another variant would speed up by a year the creation of the EFSF’s replacement, the permanent European Stability Mechanism, which was originally to come into place in mid-2013.

Closer economic integration and moves towards fiscal union

Eurozone leaders will also start debating wider-ranging reforms to establish more centralised EU authority over national economies. Although collectively backed “eurobonds” are expected to be included in the debate, several officials noted that any move to pool risk would implicitly rely on Germany’s strong economy and credit rating – in return giving Berlin unparalleled authority to push for tough new treaty rules in exchange.

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