For Brussels the situation is clear: The rescue fund for the heavily indebted euro states is too small. No more than 250 billion euros is allegedly available to protect Ireland, Portugal and Spain for the next three years. Since this will not suffice to cover the refinancing requirements of these countries, the fund should urgently be enlarged to be able to fulfil its tasks. But is this really the case? Let’s do the math.
It is true that Germany and France, both with impeccable credit ratings, will guarantee 258.1 billion euros between them via the Luxembourg special purpose vehicle, the European Financial Stability Facility (EFSF). However, Luxembourg, Finland, Austria and the Netherlands are guarantors as well. These countries also have AAA ratings. Adding their liability coverage, we have 315.4 billion euros. Only if the unproved and implausible assertion were true that the rating agencies are demanding that one-sixth be subtracted from this amount do we come close to the above 250 billion euros – 263 billion euros, to be exact.
The 250 billion euros in help from the International Monetary Fund (IMF) and 60 billion euros from the EU credit facility, which was approved in May 2010, must also not be ignored nor the fact that the European Central Bank (ECB) is continuously purchasing government bonds of the troubled countries – so far to the tune of more than 76 billion euros. Even if this ECB help is not included and we deduct the one-sixth that some are allegedly calling for and the IMF aid is calculated at only 161 billion euros, which corresponds to the AAA-ensured share of 323 billion of the nominal EU rescue sum of 500 billion, we have at least 484 billion euros for rescue loans. This is more than sufficient.
According to information on the refinancing requirements of Portugal, Ireland and Spain published by the national debt administrations, the three countries will need only 159 billion, 75 billion and 76 billion euros, respectively, in the coming three years – totalling 310 billion euros, no more than over half of the money available.
Let us assume that the three countries are not yet willing to save, which is what they really must do in the medium term in light of their declining economic strength. Let us allow them, as permitted by the Stability and Growth Pact, to take on additional debt of up to three percent of their present GDP, which would amount to 124 billion euros. Of the 484 billion euros in the rescue fund, we would then need 434 billion euros, but there would still be some 50 billion euros left for other purposes. It is simply not true that the rescue funds are insufficient for coping with a larger liquidity crisis in Spain.
Those who call for topping up the fund must have something else in mind than just providing liquidity assistance to the troubled countries. Evidently with their loans the Community is also meant to assume a part of the existing debts that have not yet reached maturity. One idea being voiced in Brussels is that the Luxembourg special purpose vehicle should buy up existing debts, as the ECB is already doing. It would be even more attractive for the debtor countries if they received additional loans from the special purpose vehicle so that they could buy back their outstanding debts themselves. This would be an opportune time since 10-year Greek and Irish bonds are now only worth about 70 percent of their nominal value. This would amount to a valuation adjustment (“haircut”) for private creditors – as even members of the German government are claiming – without really hurting anyone. This of course is not the case because the taxpayers of the countries with good credit standing would now be liable also for the existing debts of the affected countries. If the loans granted as a substitute are not serviced, the taxpayers would have to meet the claims of the special purpose vehicle.
Under no circumstances should Germany accept this approach. It amounts to making the debts the responsibility of the Community via eurobonds – a policy that the German federal government has strictly refused, and rightfully so. This is a cunning way of introducing eurobonds, using incorrect figures and new semantics.
There is no objection to countries’ buying back their own debts on the favourable conditions that market uncertainty has created. But they should not be given Community loans for this purpose. Instead, they could make use of the loans with Collective Action Clauses that were introduced in December. The Community could make these loans attractive by coupling them with the right to convert them, in the case of payment problems and after a “haircut”, into replacement bonds partially guaranteed by the Community. Since the investors would then only bear a known and limited risk, they would be content with a limited interest premium over the German benchmark and would grant the troubled countries new credit, with which they would be able to buy back their outstanding debts.
Professor for Economics and Public Finance
President of the Ifo Institute
Revised Version. Published in WirtschaftsWoche as “Falsche Zahlen, neue Semantik”, no. 4, 24 January 2011, p 38.