Before the end of this month, the 27 leaders of the European Council will convene once again in Brussels to increase the ‘firepower’ of the European Financial Stability Facility and its heir, the European Stability Mechanism (EFSF/ESM), with the ESM set to succeed the EFSF in July. The question, however, is with how much more firepower are the EFSF/ESM financial support mechanisms going to be provided?
In any case, the EFSF is expected to be recapitalised during the first semester of 2012 by Eurozone countries. Then, towards mid-summer, it will be absorbed by the permanent financial support facility the European Stability Mechanism (ESM), which will assist any Eurozone country in distress in future.
The ESM's functioning will financially resemble the International Monetary Fund (IMF) but without its infrastructure. For this reason, the Eurozone countries have also decided to request that the IMF work with the EFSF/ESM mechanisms in bailing out Eurozone countries.
The financial means devoted by the Eurozone to the EFSF/ESM mechanisms will be around €750 billion for the EFSF/ESM and another €200bn to be provided by Europeans and non-Europeans to the IMF, to secure its involvement in operations concerning Eurozone countries in distress.
Non-EU countries, such as Japan and Russia, have stated that they will support the Eurozone's efforts to address its problems, either by investing directly in the EFSF/ESM or by lending money to the IMF.
Official sources state: “To fulfil its mission, the EFSF is backed by guarantee commitments from the Eurozone member states for a total of €780bn and has a lending capacity of €440bn. The EFSF has been assigned the best possible credit rating by Moody’s (Aaa) and Fitch Ratings (AAA)…and an AA+ rating by Standard & Poor’s. EFSF is a Luxembourg-registered company owned by Eurozone member states.”
However, this mechanism must finance the Greek deal at a cost of around €130bn, by supporting the Private Sector Involvement (PSI) exercise, the recapitalisation of the Greek commercial banks and guaranteeing the new Greek bonds to be handed to private sector creditors in exchange for the debt paper they now hold.
The PSI involves a 53.5% ‘haircut’ to the Greek debt held by the private sector, which began last week and will be complete by 8-9 March. After this, its exact cost to the EFSF mechanism will be known.
As for the ESM, the Treaty establishing it provides that: “The European Council agreed on 17 December 2010 on the need for Eurozone member states to establish a permanent stability mechanism. This European Stability Mechanism (ESM) will assume the tasks currently fulfilled by the European Financial Stability Facility "EFSF) and the European Financial Stabilisation Mechanism ("EFSM") in providing, where needed, financial assistance to Eurozone member states. Given the strong interrelation within the Eurozone, severe risks to the financial stability of member states whose currency is the euro may put at risk the financial stability of the Eurozone as a whole. The ESM may therefore provide stability support on the basis of a strict conditionality, appropriate to the financial assistance instrument chosen if indispensable to safeguard the financial stability of the Eurozone as a whole and of its member states. The initial maximum lending volume of the ESM is set at €500bn, including the outstanding EFSF stability support. The adequacy of the consolidated ESM and EFSF maximum lending volume will, however, be reassessed prior to the entry into force of this Treaty. If appropriate, it will be increased by the Board of Governors of the ESM, in accordance with Article 10, upon entry into force of this Treaty.”
After the Greek deal is completed, however, the EFSF/ESM firepower will be drastically reduced, so there is an obvious need to increase it. This was supposed to be done during the EU Summit of 1-2 March, but Germany, which is paying the larger part of these contributions, pressed for a postponement, until after the exact cost of the PSI exercise is known.
According to information from various sources, the combined firepower of the EFSF/ESM mechanisms should be maintained around the €750bn benchmark and this will be decided some time before the end of March. However one should add to that the IMF's special account of at least €200bn so the Fund can continue to support Eurozone countries in distress, which will be financed by EU and non-EU countries. As a result, the whole package of EFSF/ESM/IMF to be used in future to support Eurozone countries in distress will be of the order of €1 trillion.
In addition, on 1 March the ECB released €529.5bn to 800 Eurozone banks in a Long Term Refinancing Operation (LTRO), through three-year loans at an interest rate of 1%. This should be added to a similar LTRO of €489.2bn in favour of 500 Eurozone banks released on 22 December 2011.
Obviously, those two LTROs are not of the usual liquidity support kind favouring the banking system – their three-year maturities, negligible interest cost of 1% and the full coverage of the amounts that all the banks requested constitute a huge subsidy to the Eurozone banking industry. It will help Eurozone's financial sector to amply and easily recapitalise itself and fulfil the Basel criteria for own capital requirements.
At the same time, those funds will be used by Eurozone banks to buy sovereign debt in their home capital markets, thus also solving the liquidity problem of the respective governments.
The €2 trillion
In total, the Eurozone's central bank has put €1tn on the table in order to solve the governments and banks’ liquidity problems. At the same time, the EFSF/ESM/IMF mechanisms are expected to amass a dowry of another trillion to be used not only to support Eurozone governments in distress, but also support the banking sector's recapitalisation. In short, the Eurozone has created a firewall of €2tn to solve its twofold problem, the sovereign-debt crisis and recapitalisation of the banks.