Eurozone toolbox

Around a dozen people work for Europe's latest saving grace, a rescue fund called the European Financial Stability Facility, headed by the German EU official Klaus Regling. The fund is located on an office floor above a shopping facility in central Luxembourg and is privately owned by the EU member states that use the euro currency, save Estonia which joined the 17-member eurozone at the beginning of this year.

These 16 states have equipped the EFSF with state loan guarantees, with which the fund provides credit to financial markets. This money is then made available to struggling eurozone members - like Portugal and Ireland - to keep their interest rates from ballooning and to free them from normal financial markets.

Ireland and Portugal are currently the only two states utilizing the EFSF; together, they have received 7.5 billion euros ($10.3 billion). The fund has already received a triple-A rating from leading US agencies, mainly because it both possesses loan guarantees from the solvent eurozone members and keeps some 30 percent of this capital on reserve as security.

In practical terms: If a 5-billion-euro loan is issued to Ireland, for instance, only 3.6 billion euros is actually paid out; the rest of the rescue installment is kept in Luxembourg with the EFSF as guarantees.

EFSF gets pumped up

This technicality has led to the fund only being able to pay out 250 billion euros, as opposed to the 440 billion originally planned last summer. Due to the rising speculation that Italy and Spain will soon encounter solvency issues, eurozone leaders have decided to enlarge the EFSF so that it can pay out 440 billion euros.

Government guarantees to the tune of 660 billion euros will be needed to hit that mark, and Germany's contribution - dependent on the comparison of its economic force in Europe - will thus be raised to 211 billion euros. It is this rise that the Bundestag voted for in Berlin on Thursday.

An extra 60 billion euros will be provided by the budget of the European Commission, money that has already been loaned to Greece, Ireland and Portugal. In addition, the International Monetary Fund (IMF) in Washington has issued a supplemental loan of half the entire fund, that is, 330 billion euros.

All in all, the EFSF comprises some 1 trillion euros; the amount that can be paid out is somewhere around 750 billion euros.

Real tools

According to financial experts, the most important part of the EFSF is not its loan guarantees, but rather its ability to buy government bonds from eurozone states, either directly or on the free market.

At the moment, the European Central Bank (ECB) is involved in this process of buying up the bonds of struggling states on capital markets, which is a divergence from its actual duty and something that poses a potentially devastating risk to the bank.

The ECB is thus looking to give this task to the EFSF, which will also take direct part in the rescue of struggling banks and the issuing of loans in a bid to prevent near-bankrupt states from paying exorbitant rates for bonds on financial markets.

The Bundestag also voted to provide the EFSF with this extra toolbox, in addition to the enlargement of the fund. The new fund will be used to finance a new rescue package for Greece, and Estonia will also belong to the 17 paying members.

Greece in a class of its own

Until now, Greece has received its bailout loans from a specially created fund, which has nothing to do with the EFSF and is administered by the European Commission.

The fund was created last March by the then 16 members of the eurozone and gave Greece direct credit of up to 80 billion euros without having to make the detour around state guarantees and financial markets. In addition, the International Monetary Fund provided an extra 30 billion euros. So far, of the fund's 100 billion euros, around 60 billion have been paid out, on condition that Athens pass and implement severe austerity measures.

After it became clear this summer that the first rescue package would be unable to save Greece from bankruptcy, eurozone leaders put together a proposal for a second set of emergency loans. This package contained 109 billion euros, but this time private creditors - mostly European banks - were called upon to participate. The extent to which they are engaged in this second bailout, however, remains unclear.

Europe's contribution is to come from EFSF funds. The Bundestag will be voting on this second package for Greece in the near future.

Permanent monetary fund

In the summer of 2013, the EFSF will be replaced permanently by another stability fund, the European Stability Mechanism (ESM), which will function more like the International Monetary Fund.

The 17 eurozone states will be the sole stockholders and provide the fund with capital to the tune of 80 billion euros, with which it can invest in financial markets. This money will be offered - under strict guidelines - to struggling eurozone members, and it will also be used to buy government bonds and bailout out bankrupt banks.

The ESM will be designed to have the capability to help any eurozone member file for insolvency, giving it the choice of incorporating the bankrupt state's creditors in any debt consolidation.

In contrast to the EFSF, the ESM will no longer be a private firm, but rather an official EU institution. Thus, the bloc's rule-book, the Lisbon Treaty, will have to be reformed before the fund can be created, and the Bundestag is scheduled to vote on this amendment next spring.

Leverage for the EFSF

Even before the enlarged EFSF was accepted by eurozone countries, discussion arose as to whether the fund was too small to provide any real financial stability. US financial experts, meanwhile, have calculated that its volume can be increased eight-fold, if the European Central Bank is incorporated.

However, European finance ministers are rather skeptical of, if not opposed to, invoking such financial "leverage." In essence, it would force the European Central Bank to print more money and could potentially cause inflation. German central bank chief Jens Weidmann is categorically against any ECB involvement, which he has described as "state financing achieved with a money printer."

The USA, China and a host of developing countries have urged the Europeans to do more and act faster to solve the euro's crisis. In response, Germany's finance minister, Wolfgang Schäuble, has said he could imagine the ESM being implemented already in 2012, ahead of the proposed 2013 start date.

Author: Bernd Riegert (glb)
Editor: Nancy Isenson