Europe's Idea for Maximizing the Backstop Fund

Spiegel
October 20, 2011

How can the reach of the euro backstop fund be maximized without forcing governments to throw more money at it? European leaders are considering a finance tool that would attract private investors and greatly expand the reach of the fund. SPIEGEL ONLINE explains how the "leveraging" would work.

It is already an immense sum of money: Euro-zone countries have provided guarantees worth €780 billion to the currency backstop fund known as the European Financial Stability Facility. It has a lending capacity of €440 billion, with which it is to help out deeply indebted members of the currency union.

As large as it is, though, it already appears that the EFSF could in fact be too small. Ten percent of the fund is already guaranteed to Ireland and Portugal. A second bailout package for Greece, currently under negotiation, is also to be funded by the EFSF. In addition, the fund is to buy sovereign bonds from crisis-stricken countries in order to keep their borrowing costs low. But should the euro-crisis contagion spread to a large country like Italy or Spain, the EFSF wouldn't stand a chance.

But euro-zone countries are not prepared to pledge yet more money to the fund. Germany is already on the hook for €211 billion, and parliamentarians in Berlin made it clear in September that they would not back any further increases. Other euro-zone parliaments would likewise block requests for additional funding.

What, then, is a currency union to do? The magic word is "leveraging." Euro-zone leaders are looking for a finance tool which could make the impact of the EFSF as large as possible.

Politicians and finance experts are currently examining a solution which would turn the EFSF into a kind of first-loss insurance. Instead of buying sovereign bonds itself, the plan foresees the EFSF attracting private investors to buy debt from countries such as Greece, Ireland and Portugal. In return, the fund would insure a certain portion of the investment against losses in the event of a partial insolvency.

According to a Reuters report, each country that profits from its bonds being insured would then be required to pay a fee to the EFSF. If all goes well, and the countries are able to pay off their debts themselves, the EFSF could even turn a profit.

More