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Tuesday, December 14, 2010

Many questions - no answers

Open Europe has today published a briefing looking ahead to the EU summit this week, identifying the crucial, inevitable questions on the future of the eurozone that EU leaders have to find the answers to. The small problem that EU leaders are facing is: there aren't really any good answers and any that there are, in turn, throw up a series of new questions.

One of the big questions is whether the current euro bail-out package will need to be increased to ensure market stability in the New Year, when eurozone governments and banks will face record targets of refinancing.

A very simple calculation shows that the current bail-out package looks worryingly insufficient to deal with Greece, Ireland, Portugal and then - the nightmare - Spain all at once. A conservative estimate from Goldman Sachs puts the cost of taking Spain, Ireland and Portugal off the debt markets for two years at up to €450 billion (other estimates put the cost of bailing out Spain alone closer to €500 billion).

And as has been widely documented by now, while the size of the EU/IMF bail-out package on paper is €750 billion, in reality, it's far lower than that.

First, the contributions from Greece and Ireland have to be subtracted (€19bn between them), as they themselves are receiving aid and are therefore exempt from contributing. Secondly, to ensure a ‘triple A’ credit rating – and therefore low borrowing costs – eurozone governments are guaranteeing 120 percent of each bond raised (allowing for a reserve that can never be used). In addition, as the credit rating agencies like to point out, the share of eurozone governments without a triple A rating must also be discounted, if the triple A rating of the EFSF is to be
guaranteed.

When adding up the figures then - and there are a few estimates flying around - the real size of the European Financial Stability Facility becomes more like €213 billion, with another €60 billion added through the European Stabilisation Fund. The final twist is that under the agreement struck in May, the IMF would only add 50 percent of the sum the EU provides, meaning €136 billion as opposed to the original €250 billion.

This leaves a total of €409 billion - as opposed to the official €750 billion.

Pew! Not very helpful, we know, but this amount is cutting it worryingly close. Although no one is saying it out loud, there will probably be plenty of whispers in the corridors of Justus Lipsius this week (where the Council meeting is held) on how to increase the package should the smelly stuff hit the fan in the New Year.

There are, of course, steps that eurozone leaders could take to ease the pain, including restructuring the debts of Greece, Ireland and Portugal in some way (though that would not deal with the underlying competitiveness problem these countries are facing). In addition, banks, not least Spanish ones, should come clean on their loan losses, so that we can flush out Europe's over-leveraged banking system once and for all (here real, rigorous stress tests could help). And, subsequently, the ECB must stop acting as a rubbish dump for bad government and bank debt and become a solid, independent central bank again - its current role is simply unsustainable.

So many questions, so little time...

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