Can Europe’s Bailout Fund Save Europe?
January 5, 2012
Ron DeLegge, Co-Founder & Editor
Ever since the first sale of bonds for Europe’s bailout fund back in January 2011, the appetite to invest in the rescue vehicle has swiftly declined.
Clear evidence is the latest sale of bonds for the bailout fund that was just 4 billion euros or roughly three to four times short of what it could call a successful capital raising round. Does Europe’s bailout fund have the firepower to save Europe?
A Rescue Fund that Needs to be Rescued
The European Financial Stability Facility’s (EFSF) was established to give countries that run into liquidity problems, emergency cash. Yet, the ability of the EFSF to help troubled countries like Italy is being undermined because the emergency fund’s very backers have been swept into the crisis.
France’s credit outlook was lowered by Fitch Ratings and the country is on a short list of EFSF sponsors with a top credit rating that is at risk of being cut. Both Moody’s Investor Service and S&P have issued similar warnings, saying that eurozone governments face possible credit downgrades.
A credit downgrade for the backers of EFSF would mean a downgrade for the EFSF itself. As of now, the EFSF has guarantees of 726 billion euros from eurozone governments.
Are Euro Bonds the Answer?
Another idea that’s been floated is sovereign bonds backed by multiple eurozone nations, also known as “euro bonds.”
Although euro bonds have been promoted as the panacea to fixing Europe’s debt crisis, it’s difficult to understand how increasing already excessive debt loads with even more debt would provide lasting benefits. Euro bonds may buy troubled countries more time, but would it really be a permanent fix?
Euro bonds would also require greater integration of fiscal policies among its participants along with strict fiscal standards that certain countries like Greece (NYSE: GREK), Italy (NYSEArca: EWI), Portugal, and Ireland (NYSEArca: EIRL) would not likely satisfy.
The Italian Stallion
Over the past two years, Greece or Portugal each had their 15-minutes of fame, which has lasted 14 minutes and 58 seconds too long. In contrast to them, Italy plays a key role in the euro’s survival or demise. Italy has the third largest economy in the region but it also has the dubious title of the second most indebted eurozone country, after Greece. Around 53 billion euros in Italian debt must be repaid in the first quarter of 2012.
The plan to dig Italy out of its 1.9 trillion euro sinkhole has angered its citizens. Reductions in pension benefits and tax increases are seen as the solution by politicians. We don’t know if they’re right or wrong, but we do know that upset citizens aren’t a good formula for economic productivity. Just ask Greece.
The Italian government projects a 0.4% pullback in its economy for 2012, a figure that will likely be higher by year end.
Another Unwilling Back Stop
If the EFSF doesn’t have the fire power to save Europe from collapse, what about the European Central Bank (ECB)?
Unfortunately, this illustrious institution has strongly resisted overtures to become the lender of last resort. The U.K. (NYSEArca: EWU) has the Bank of England and the U.S. (NYSEArca: VTI) has the Federal Reserve to play this reluctant role if either one of their respective countries runs into liquidity issues.
True to the ECB’s charter, its primary responsibility isn’t to buy the national debt of financial drunkards. And at least for now, they should be commended for sticking to that main job.
Last year when the euro (NYSEArca: FXE) was sailing along and analysts were bullish, here’s what ETFguide’s ETF Picks said about the eurozone:
“From the very beginning of Europe’s crisis circa January 2010, its leading voices (from Europe’s Central Bank to its heads of state) have been consistent in one regard: They’ve continually underestimated the severity of the crisis each step of the way. They were wrong about Greece, Ireland and Portugal not needing bailouts – and they were badly wrong on the actual size of the bailout required. Is there any reason to believe they’ll be wrong (again) about the alleged soundness of Europe’s banking system? What about their authoritative statements that a euro breakup won’t happen? Europe’s crisis is the same story it’s always been – financial contagion.”
What’s next for the euro and where will the big move be?
The January 2012 ETF Profit Strategy Newsletter and Weekly Picks highlights a short list of mega investment themes, including trading spots for the beleaguered euro.