Euro Bailout Will U.S. Have to Step Up to the Plate?
If efforts to stem the current bleeding in Europe fail; if Portugal, then Spain, and perhaps others need outside assistance, existing European bailout funds may be stretched too thin. Europe may be forced to look for more help from the International Monetary Fund (and by extension the U.S. Treasury), the U.S. Federal Reserve and China. How Washington reacts could have grave foreign policy and economic consequences.
In May, the 16 countries that use the euro established the European Financial Stability Facility, which amassed roughly $579 billion in pledges that can be used in conjunction with $79 billion backed by the EU budget and $329 billion from the International Monetary Fund, creating a $1 trillion pot of money available for lending to beleaguered European states.
The question now is whether this financial safety net will be sufficient. Both the Greek rescue package late last year and the recent Irish bailout cost more than first advertised. Some initial estimates put Dublin’s needs at $100 billion. Its final price tag was $112 billion.
And Europe’s costs may continue to grow. The repayment schedule for Greece’s $145 billion loan may be extended, effectively raising the cost to lenders.
Assumptions about future demands could be too optimistic or too pessimistic. But Nomura, the Japanese investment bank, estimates that bailouts of Portugal and Spain could total more than $660 billion, leaving no cushion for other contingencies.
“You can never use your last dollar, or euro … Markets would immediately come to the conclusion that there was no money left,” warned Kenneth Courtis, founding partner of Themes Investment Management. “Markets would then riot.”
“The more countries need access to it, the less capital is available, because every time a country is a recipient of funds, it drops out of the pool that contributes to the loan guarantees.”
The adequacy of the European safety net to deal even with Spain assumes that the European Financial Stability Facility could lend up to or near its limit and still maintain its triple-A bond rating. In reality, it would likely lose that rating and the ability to lend at reasonable rates before it ran out of funds.
Pledges backing Europe’s current pot of bailout money come from some governments, such as Spain and Italy, that could soon become borrowers themselves, effectively depleting available resources. “There is an imbedded contradiction in the way the EFSF has been structured,” said one international financial official.
“The more countries need access to it, the less capital is available,
because every time a country is a recipient of funds, it drops out of the pool
that contributes to the loan guarantees.”
“The more countries need access to it, the less capital is available, because every time a country is a recipient of funds, it drops out of the pool that contributes to the loan guarantees.”
It could get worse. “If Spain and Italy have to be bailed out,” said Courtis, “immediately France and Germany would be on the firing line. They do not have the type of resources required to bail out Spain and Italy without themselves getting into very, very serious financial trouble.” In the face of such demands, Europe’s bailout fund could prove woefully inadequate.
European economists are now speculating about ways to give their financial authorities more ammunition. Klaus Zimmerman, president of the German Institute for Economic Research in Berlin, has suggested doubling available resources to $2 trillion. Axel Weber, the German member of the European Central Bank’s Governing Council, has said that if available funds prove insufficient, “I am convinced euro zone states will do what is necessary to protect the euro.
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