Amidst all the talk of a Euro 1 trillion fund to bail out ailing Euro countries, it might help to look at what they done so far.
They set up the European Financial Stabilisation Fund as a Luxembourg regulated Special Purpose Vehicle or company on 9 May 2010. It is owned by the Euro area member states. It has to rely on borrowing to carry out its purposes. So far it has borrowed just 13 billion euros, and lent 9.5 bn euros to Portugal and Ireland. It uses the EU Commission to help perform its duties.
The owners were very keen that the fund should be able to borrow at an AAA credit rating, and wanted it to be able to lend up to 440bn euros. To achieve this they had to make each member state in the company guarantee up to 165% of their share of the 440 billion euros, so that the AAA rated states always covered the full amount at risk. The members have had to agree to guarantee up to 780 bn euros. The German share is 29% and the French share 22%.
The legal base used to set up the EFSM and EFSF was stated as “Article 122.2 and an intergovernmental agreement of Euro area states”. The use of the intergovernmental agreement will become a popular way for the Euro area to move quickly without the legal restrictions of the EU. The legal base of the EFSM, the money provided by all EU states, is the one that has been questioned.
It’s going to take some magic to pump a 13 billion fund into a 1 trillion one. If the fund is to expand to Euro 1 trillion there are several ways it could do this. It could first of all issue the full 440 bn of euro debt, adding 427 billion to the current total. It has already pledged 34.2 bn euros in additional loans to Portugal and Ireland which it needs to cover by new borrowing.
It can offer to guarantee slices of a country’s borrowing to help that country carry on borrowing in the normal way. Thus, if Italy needed help to borrow at a cheaper rate, the EFSF could guarantee the top one fifth of Italy’s new debt issues, protecting bond buyers from a 20% haircut or partial default. This would enable them to say they had 5 euros of firepower or capacity to borrow for every one euro of guarantee committed. It might help keep Italian interest rates down.
The company could set up further funds or special purpose vehicles to channel other investors’ money into Euro area debt. That is why they are now asking China if she would like to contribute. They may also ask other sovereign wealth funds in the Middle East and elsewhere if they fancy such an investment. Token contributions or tough terms are the likely result of such requests. If they could raise 100 to 200 bn euros extra, that gets them closer to their trillion objective.
The EU is trying a little spinning and praying for a little magic. Today they have a 13 bn euro company. Tomorrow they want to impress the markets with the possibility of a 1 trillion one. There are ways of getting there. They draw on techniques used by investment banks and others in the run up to the Credit Crunch. The very politicians who have spent so much time condemning the bankers for the ways they behaved in 2005-7 now seem to be copying their techniques to gear the EFSF.
The bottom line is the strong states are being drawn more and more into subsidising and propping up the weaker states.