The EFSF was created as a remedy to this structural flaw of the Eurozone. After realising that its size was insufficient, its capacity was enlarged. A new idea came out of the European summit, namely to extend its scope, concentrating the resources of the EFSF in order to partially guarantee newly issued debt of countries at risk. This would allow both Italy and Spain to issue debt which would be partially guaranteed until the end of 2013.
The next failure
There are reasons to believe that this remedy – like the innovations of the past – will fail to restore market confidence.
- First, the resources of the EFSF will be exhausted in a few years – but confidence cannot have an expiration date.
Knowing that there could be a confidence crisis in a couple of years, why should one trust the solution today?
- Second, without guarantees, the debt that has already been issued would be penalized, making European banks even more fragile.
This would worsen the vicious spiral we are seeing at work, namely distrust towards debt and banks, higher cost of capital, lower investments and growth, and further slippage towards debt unsustainability.
To cope with this problem, the summit agreed to rely on a special purpose vehicle that would buy sovereign debt in the secondary market. But it is not clear whether its resources would be sufficient for the task, nor where they would be coming from.
- Third, the guarantees that have been proposed – which cover the losses only up to 20% – are modest.
Experience teaches that, when debt is really restructured, losses are much higher – on average around 50%.
via www.voxeu.org
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