Even if euro-area leaders agree to leverage the temporary 440 billion-euro ($609 billion) European Financial Stability Facility by using it to insure a portion of national bond sales, it may not have enough capacity to provide loans to countries and support banks.
Turning the fund into a “bond insurer is not enough unless it’s well capitalized in advance, so markets understand that EU governments are ready and willing to take losses and make good on obligations of either Greece or of the banks that will be impaired when Greece et al default,” Phillip Swagel, assistant U.S. Treasury secretary for economic policy in the George W. Bush administration, said by e-mail late yesterday.
As EU leaders prepare for an Oct. 23 summit, momentum has gathered around a proposal for the EFSF to guarantee a portion of new borrowing by countries under pressure and for bondholders to take bigger losses on Greece. European Economic and Monetary Affairs Commissioner Olli Rehn said yesterday that Greek bondholders need to play a bigger role. German Finance Minister Wolfgang Schaeuble, who has consistently opposed expanding the fund’s resources, has told lawmakers that its leverage should be increased, according to Financial Times Deutschland.
‘Insufficient Firepower’
Both ideas represent deviations from plans set at a July 21 summit, when EU leaders agreed to give the rescue fund more flexibility and to work with banks and other investors on a Greek debt swap. Group of 20 finance ministers and central bankers last week set this weekend’s summit as a deadline for the EU to come up with an expanded crisis-fighting strategy.
“It seems clear that, even with leverage, there is insufficient firepower to meet all the potential liquidity needs,” David Mackie, chief European economist at JPMorgan Chase & Co., wrote in a note to clients yesterday.
The EFSF might be allowed to insure 20 percent to 30 percent of new bonds sold by distressed euro-area governments, a person familiar with the deliberations said.
The upgraded facility may still prove too small to deter investors from targeting the bigger economies, according to Mackie, who calculates that given its existing commitments, the fund has about 270 billion euros left. His figures suggest that with Italy, Spain and Belgium facing funding needs of more than 1 trillion euros over the next three years, guaranteeing the first 20 percent of losses would leave less than 100 billion euros for other fire-fighting tasks.
New Issuance
“This might be sufficient, but it is not exactly a bazooka,” Mackie said, referring to former U.S. Treasury Secretary Henry Paulson’s 2008 request for “bazooka”-like powers to take over Fannie Mae and Freddie Mac, the two government-backed companies that dominate the U.S. mortgage market.
As a bond insurer, the EFSF would focus on new issuance rather than taking advantage of its new powers to buy debt on the secondary market, said Marc Chandler, chief currency strategist at Brown Brothers Harriman in New York. This means it won’t be able to relieve the burden on the European Central Bank, which had hoped to pass on some of its crisis-fighting duties and return to its focus on monetary policy.
“The insurance model likely means that it will not be able to buy sovereign bonds in the secondary market as some have proposed,” Chandler said. “While some at the ECB may not be pleased, its continued involvement is an important element of support the financial system.”
Capital Shortfall
The EFSF might not have the resources to help recapitalize Europe’s banks, another issue that European leaders have pledged to address. And it would face highly concentrated and correlated risks by insuring the debt of multiple European countries with high debt levels like Italy, Spain and Belgium, said Jacques Cailloux, the chief European economist at Royal Bank of Scotland Group Plc (RBS) in London, in a research note.
Some requirements under consideration would lead to a 220 billion-euro capital shortfall at 66 of the participating banks, with the biggest gaps at Edinburgh-based RBS, Deutsche Bank and Paris-based BNP Paribas SA, according to a note published by Credit Suisse Group AG analysts on Oct. 13.
“We believe it is very risky for euro-area policy makers to rush out some quick deal on leverage or insurance schemes given the risks associated with such mechanisms and the limited actual firepower of the EFSF,” Cailloux said. “There are more downsides than upsides” and “ultimately a fuller involvement of the ECB will be needed.” source: www.bloomberg.com
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