Analysis: Euro zone eyes EFSF changes in response to debt crisis

By Jan Strupczewski

BRUSSELS (BestGrowthStock) – Euro zone policymakers are toying with a number of ideas to fall back on if moves to create a permanent European Stability Mechanism for solving debt crises fail to calm financial markets next year.

European Union leaders are expected to agree at a two-day summit starting on Thursday to tweak the EU treaty to create the ESM, which they hope will go into force in 2013.

Most of the fallback options being considered involve boosting the euro area’s firepower to help governments cut off from market financing, notably by making more money available to the European Financial Stability Facility (EFSF) — the euro zone rescue fund to be replaced by the ESM.

None of the ideas is subject to formal discussion or set out in any formal proposal, but policymakers are talking about them informally on the sidelines of meetings, euro zone sources say.

Ideas could take more concrete shape next year if markets put pressure on Portugal to follow Greece and Ireland by seeking financial help. The euro zone would then want to ringfence the next potential aid candidate, Spain, whose size would stretch available EU funds.

“Early next year, when we will see many euro zone countries going into the markets to get new funding in the markets, then tension could come up,” ING economist Carsten Brzeski told Reuters Television.

“And the tensions can only really calm down if politicians give us a structural solution. They think the ECB can solve the job by purchasing bonds in the markets right now but there will be a moment … and this could come very soon, in which they really have to address the structural problems in the near future and not only after 2013,” he said.

European Commission President Jose Manuel Barroso said on Wednesday that if a stronger response to the crisis was needed, it should be by “improving and adapting” the existing EFSF.

Below are details of some of the options being discussed.


The EFSF is a lending vehicle of up to 440 billion euros which is backed by euro zone government guarantees.

But its effective lending capacity is smaller because when its raises money on the market, its bonds have to be either backed by countries with a ‘AAA’ rating, or by cash, to be rated triple A themselves.

BNP Paribas said in a research note that because only six euro zone countries now have a triple A rating and together account for just over 58 percent of the guarantees for the EFSF, the effective lending capacity is just 255 billion euros.

One of the ideas is therefore to increase the effective lending capacity of the EFSF by raising the guarantee amount by each government from the current 120 percent of their share of contribution to the fund.

EFSF loans are diminished by a one-off fee of 0.5 percent of the loan and by the net present value of the anticipated margin that would accrue on each loan to its scheduled maturity. If the fee or the margin were to be smaller, more cash could be disbursed to the country.

“You can play around with the margin. But that’s politically controversial because you are relaxing the lending conditions. They would still be strict but not as strict as today,” a euro zone source said.


The EFSF can now act when a government has been effectively cut off from market financing. One idea could be for the EFSF to extend stand-by loans to a country which is experiencing financing problems to modeled on the IMF flexible credit lines given to Poland and Mexico in the past.

The very existence of such a credit line would help ease market pressure, for example for Spain, a senior euro zone source said.


European Central Bank President Jean-Claude Trichet called on Monday for euro zone governments to give the EFSF maximum flexibility in both size and scope.

A euro zone central bank source told Reuters last week that the ECB would like to see its resources at least doubled.

“A lot of people are pushing for an increased amount,” a euro zone source, not connected to the ECB, said.

Belgian Finance Minister Didier Reynders and the International Monetary Fund have backed raising the EFSF size, as have several ECB Governing council members. Germany said the discussion was premature and there was no need to increase it at this time, leaving the door open to discussing it later.

Economists have talked about doubling or even tripling the EFSF, not because so much money would be needed, but to shock markets with its size and show there was money for any action.

“If nothing works and the markets do not calm down, then eventually we will have to do something and we can either raise the effective amount, or raise the actual amount of the EFSF,” the euro zone source said.

Asked about the chances of boosting the EFSF’s size, the source said: “It depends on what the alternative is.”

“Raising the guarantee amount from 120 percent to something would be easier than raising the 440 billion to 880 billion and that would be simpler than a euro bond, which in turn would be simpler than buying Irish bonds outright in the market.”


Because both changing the parameters of the EFSF as well as increasing its size could be difficult politically — notably in Germany, where public opinion is opposed to bailing out others — another idea is to lend more money to the IMF and increase the IMF’s share in bailouts of euro zone countries.

The IMF now provides a third of the total amount of euro zone bailouts — a proportion that could be increased. In April 2009, G20 leaders agreed to quadruple the financial capacity of the IMF with a $1 trillion commitment.

“The 1 trillion was raised globally and some countries are already grumpy that a lot of it is going to Europe,” the euro zone source said.

“The IMF has this formula that they cover a third of a program, so if Europe would like to have more from them they would just say: ‘Give us more money’. It might be politically easier for governments to give money to the IMF than to the EFSF.”


The chairman of euro zone finance ministers Jean-Claude Juncker and Italian Finance Minister Giulio Tremonti called last week for the issuance of joint European sovereign bonds, so-called “E-bonds.”

The call quickly ran into opposition from Germany, which said there were legal and economic hindrances that would require fundamental changes to the European Union’s underlying treaty.

But a senior euro zone source said the idea was unlikely to go away and more talks could be expected next year.

Barroso called the idea of a euro zone bond interesting, but noted it would require time to develop and put into action and a discussion on it should be therefore left for later.

(Additional reporting by Paul Taylor in Paris, editing by Mike Peacock)

Analysis: Euro zone eyes EFSF changes in response to debt crisis