How Europe can get more bang for its bailout buck
By Peter Thal Larsen.
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.
Europe’s bailout fund is no longer fit for purpose. As the euro zone’s sovereign debt crisis has spread to Spain and Italy, the 440 billion euro fund looks increasingly puny. Expanding it is politically tricky. But using the EFSF’s 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, the EFSF probably has about 300 billion euros left. That might just pay for a Spanish bailout, but is nowhere near enough to help Italy. And if the 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 Tim Geithner, the U.S. Treasury Secretary — would require another round of government approvals. That’s a political non-starter.
A more feasible idea, which is 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 the EFSF to guarantee debt worth five times its current capacity — or 1.5 trillion euros. Assuming the yield on the insured bonds was similar to the 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 the EFSF’s funds more risky, which might undermine its credit rating. However, of all the ideas that have been put forward to bolster the EFSF, the guarantee scheme is one of the few that could actually be implemented soon. For that reason alone, it is worth a try.