One by one, European parliaments are blessing a $600 billion bailout fund considered an important step in solving the region’s financial crisis.
But there is an unspoken problem: The fund may not be big enough to do a job that involves backing such major countries as Italy and Spain and boosting capital levels in the region’s financial system.
Germany’s parliament delivered an important vote of approval Thursday for the European Financial Stability Facility. But even if other governments follow suit, officials will need to pivot quickly into a contentious debate about how to boost the size of the fund to perhaps several trillion dollars.
That’s what many analysts feel is needed for the 17-nation euro zone to prove its commitment to standing behind weakened euro-zone governments and the region’s financial system. But taxpayers in stronger countries are tiring of bailouts provided to weaker ones, so it won’t be an easy sell.
Whether and how to supersize the bailout fund “is a very important question,” Erkki Liikanen, governor of Finland’s central bank, said in Washington this week, but it needs to be set aside until all the parliamentary approvals are in place. To open the debate while parliaments are voting, he said, might derail the whole program.
“We have a particular challenge at home. We need to fix it, agree on everything, put it in place, and any discussions on the future, we will come back to that…I don’t want to distract the focus now,” Liikanen said.
Throughout the euro zone’s lingering crisis, politics have constrained officials from moving to the sort of quick and dramatic solutions that some market analysts and U.S. leaders have urged.
Euro-zone leaders spent months in early 2010 denying the extent of the problem represented by Greece’s massive budget deficits. The response, when it came, was limited in scope to make it politically palatable, but it was followed by more than a year of continued turbulence, with bailouts in Portugal and Ireland and threats to the financial standing of Italy and Spain.
The underlying tension has been political: Fiscally conservative countries such as Finland and Germany are not eager to risk their cash and credit on others. But there is also a philosophical divide between the urge to meet the demands of the crisis and the desire to not let Greek officials or other politicians off the hook for past decisions.
Responding more forcefully to Greece’s problems — and with more money — a year and a half ago might have reassured markets about the euro zone as a whole. But within the region it would have been viewed as giving Greek and other leaders no incentive to change.
The result has been a merry-go-round of trouble and response in which Greece starts to run out of money and Europe and the International Monetary Fund lean on Athens to promise further cuts or economic reforms in return for more loans. The process has kept the pressure on Greek officials, outside analysts say. But it has done little to rebuild confidence in the euro region’s governments, banks or ability to put the problems to rest.
The same dynamic is at work in the debate over the EFSF, which is billed for public relations and parliamentary purposes as an essential response to the crisis but which is also widely acknowledged as incomplete. Established in May 2010 as part of the initial response to Greece’s crisis, the fund quickly proved inadequate. The changes being considered would allow the fund to buy bonds of any euro zone country as a way to help keep government borrowing rates at manageable levels. The fund would also be able to lend to governments preemptively, to head off problems, and it could provide financing to recapitalize euro-zone banks.
A recent IMF report hinted at the potential size of the problems the EFSF faces, among them: about $4 trillion in outstanding bonds of a half-dozen countries now regarded as heightened credit risks; perhaps $400 billion in losses faced by banks as a result of investments in government bonds and other financial institutions; and $200 billion in government bonds that the European Central Bank bought as a stopgap and may be eager to unload.
During the IMF’s recent annual meetings, euro-zone officials promised to develop a comprehensive plan to “maximize the impact” of the EFSF. They are to have it ready to present by a November meeting in France of the Group of 20 major economic powers.
But the options involve the same conflicts that have prevented more forceful action all along: the fear of encouraging bad behavior vs. the need to show that the region’s governments and central bank stand behind one another.
The size of the fund could be boosted, for example, by simply upping the amount each country contributes through loan guarantees. But the direct hit to public accounts in Germany, Austria and elsewhere has led officials in those countries to oppose such an outright increase.
Its effective size could also be multiplied by using the available $600 billion to encourage the central bank to buy more bonds. That approach would bring the ECB’s theoretically unlimited supply of euros to the table but also require a fundamental change in the bank’s mission, something Germany in particular is likely to oppose.
Other in-between options suffer from either providing too little money or providing so much that they’ll be opposed by the region’s fiscal hawks, analysts at Capital Economics, an economic research consulting firm, reported in a recent analysis of the EFSF.
“The region’s policymakers are still a million miles away from resolving the crisis,” wrote Jennifer McKeown, the company’s senior European economist.