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Friday, March 30, 2012

Who's afraid of the big bad bailout fund?

Update - 12:10: Eurozone finance ministers have already reached an agreement and put out a statement. It's pretty much exactly as we expected, with all assigned funds being rolled into the headline lending volume to give the €800bn.

The fact remains though that, even combined, the funds will not be able to introduce more than €500bn in fresh lending. This was the aim all along. In fact, all eurozone finance ministers have done is correct a previous mistake which would have limited the combined lending capacity to €300bn (as originally the treaty essentially specified that only €500bn in loans could be outstanding at any one time). There should be no illusions that this changes almost nothing (we expect not even the markets which have been reacting to every piece of news will be moved much by this). One thing is for certain though this is a clear win for Germany.


Eurozone finance ministers are meeting today, in what looks to be the most chilled get-together of this group in recent time. They’re set to sign off on an agreement that will see the combination of the eurozone’s temporary and permanent bailout funds, the EFSF and ESM. On paper, the funds have the potential to produce a combined firewall of €940bn. Still far too little if Italy and Spain went, but an impressive sum nonetheless. That is, on paper. In reality they won’t even come close to this.

In an interview with Bild this morning, German Finance Minister Wolfgang Schauble said he didn’t want to “unnerve markets with numbers”, but in a speech in Copenhagen he did just that, saying,
"We have 500 billion euros in fresh money available, together with the programs already agreed for Ireland, Portugal and the new program for Greece. It is about 800 billion (euros). I think it's enough."
Apparently, Schauble reached this number by adding €500bn from the ESM, €200bn from the EFSF, €56bn in bilateral loans to Greece and €60 billion from the third bailout fund, the European Financial Stability Mechanism (EFSM) – which is underwritten by all 27 member states via the EU budget. But much of this cash has already been spent, i.e. the EFSM only has €11bn left, and some of the other money can’t actually be lent out. In addition, the remaining €240bn in unused EFSF capacity will be held back for ‘exceptional circumstances’ until mid-2013.

As we’ve been reminded of time and again, the only thing that matters is effective lending capacity. The real amount of cash that is still available to back stop struggling states, should it come to that, is only around €500bn. Here’s the lending capacity math (courtesy of some excellent analysis by the WSJ):
  • Mid-2012 – The ESM will be limited to €210bn (as it will only have €32bn in paid-in capital). Along with the €240bn in ‘exceptional’ funds, this gives a total potential lending of €450bn. (The money which is already out the door should be ignored)
  • Mid-2013 – Following a second instalment of capital the ESM will be able to lend €420bn. The ‘exceptional’ funds will be wound down around this point.
  • Mid-2014 – All ESM capital paid-in, reaches total lending capacity of €500bn.
(There is one caveat to these figures, in that the eurozone could decide to speed up the paying in of ESM capital if the funds were needed. However, this would likely face significant opposition from the likes of Germany and Finland, and is therefore most certainly a last resort).

So despite Schauble’s comment, euro finance ministers continue to throw various different numbers around, which bear few resemblances to reality. We also note that the French Finance Minister, François Baroin, yesterday floated an unfortunate analogy. He said,
"The bailout fund is a bit like the nuclear weapon in the military domain…It is not intended to be used but to act as a deterrent."
The problem here is that if it’s too big and terrible to ever be used, it’s likely that it won’t ever be used. Even jittery markets will be able to figure out that a large fund which would damage French and German credit ratings if ever extended will never be fully tapped. So clearly some circular logic at play. And let's not forget that it’s still far too small to save Italy and Spain should if worse come to worse.

But at least eurozone ministers can look forward to a quieter Friday than usual...


Anonymous said...

The problem with these loan amounts is that they're reactive. If we have a problem down the road that requires more money or the propsect of financial annihilation, you can be assured that this lending limit will be revised upwards yet again.


Anonymous said...

Another problem is that these rescue funds have to raise the money. They do not have money ready to help out so they have to raise it before they can help. No-one but a fool would design a fire-bigade like that!

Here is an anlysis of the recent fund raising of the EFSF by the economist blogger Shaun Richards.

"On the other side of the coin let us look at the money raised by the EFSF recently. If we ignore the short-term borrowing we see that it raised the grand sum of 1.5 billion Euros with a twenty-year bond on the 19th of March and 4 billion Euros on the 21st. This looks rather thin compared to its actual and intended liabilities but let me give you the biggest implied criticism of it. It also raised just under 2 billion Euros of short-term borrowing on the 20th of March. So it lends long and borrows short! Ahem. In fact as its liabilities look even longer it finds itself having borrowed on an ever shorter basis in a travesty of how to manage a risk."

As you can see such borrowing falls way short of all the promises.Remember the billions it has laready promised Greece?

Denis Cooper said...

The EFSF started out with negligible capital, and looking at how much it has borrowed so far:


I find that to be about €71 billion in total.

While looking it how much it has disbursed so far:


I find that to be about €85 billion in total.

So rather than having many billions at its immediate disposal for illegal eurozone bail-outs, it presently seems to be overdrawn by about €14 billion.

It will have to borrow that money, plus the €138 billion "pending disbursement", which could mean that it will end up borrowing directly or indirectly from the ECB rather than from "global investors" in the free market.

Similarly although the ESM would start out with substantial paid-in capital, probably €80 billion, and could call in the additional capital as required, all of this is money which has to be borrowed, in this case by the eurozone governments rather than by the ESM itself.

Erecting a painted canvas screen with the word "FIREWALL" stencilled on it in large red letters could pass muster for a theatrical production, where the audience willingly suspends disbelief, but if it ever got to the point where it was actually needed to contain a fire then it wouldn't work.

Open Europe blog team said...

Thanks for the comments.
@Anonymous: Yes, very good point about the mismatch in short term borrowing and long term lending. The EFSF will not have the cash to repay these short term bills and bonds so will probably have to keep rolling them over for decades. Indeed, lets not forget that this is the sort of mismatch that got the likes of Dexia into trouble:


Looks unlikely that short term funding for the EFSF will dry up, but given the timescale upon which it needs to be rolled over it is far from prudent.

@Denis: There are definitely questions over how quickly this money can be raised on the markets. As we noted in our commentary of the second Greek bailout, the huge amount which needs to be raised this year to help fund the banks will create a flood of EFSF bills and bonds onto the market. Whether sentiment is positive enough to fund all this at low rates is certainly questionable. We would note that on the level funds dispersed vs. raised, the money for the PSI and ECB collateral was simply issued as EFSF bonds, meaning cash did not need to be raised on the market. So the EFSF could just create these bonds (backed by its guarantees) and then put them to the desired use.

Denis Cooper said...


So presumably the two €15 billion bond issues listed for March 8th, which unlike the others have no launch information attached, correspond to the €30 billion PSI, and the €5.5 billion short term bond the same day with no bid/cover information corresponds to the "accrued interest"?