Our occasional series on financial institutions turns its attention to the EFSF (with a quick look at the EFSM too).
The European Financial Stability Facility, or EFSF, has been in the news recently, especially regarding the latest round of attempts to prevent Greece drowning in debt.
But what actually is it and how does it work?
Well, it's a temporary facility that was set up as recently as May 2010, and its purpose is to raise loans by the issue of bonds and other debt instruments, in order to lend on to help support eurozone member states in times of economic difficulty -- and although the first round of Greek bailouts happened before the genesis of the EFSF, it is currently heavily involved in the latest around.
The EFSF is not actually a fund, and members do not have to cough up the billions up front to lend directly. Instead, the cash itself is raised on the open investment market, and what the member states do is provide guarantees.
After all, would you lend money to someone to lend on to Greece in the hope that Greece will be able to pay you back, without charging the high interest rates that would be needed in order to compensate for the risks associated with a possible (many would say probable) default?
If you buy bonds from the EFSF, you wont be taking that risk, because it's not just Greece that's promising to repay you -- it's all of the eurozone members, each proportional to its share of ownership of the European Central Bank (ECB).
A complex web
The EFSF has its headquarters in Luxembourg, and management facilities are provided by the European Investment Bank -- the EU's central lending bank set up in 1958, and co-owned by the member states.
To complicate the interlinked web of organisations further, the EFSF's activities can be augmented by loans from the European Financial Stabilisation Mechanism (EFSM) of up to €60 billion and IMF money of up to €250 billion.
The EFSM is yet another body charged with raising cash for emergency funding, again through financial markets. But this time it is backed by the European Commission using the EU budget as a guarantee.
So the EFSF raises cash guaranteed by individual members of the eurozone, and the EFSM raises cash guaranteed by the EU's coffers, which are in turn filled by the individual members of the EU. Confused? You're surely not alone.
Spreading the risk
The total currently guaranteed amounts to €440 billion, and at the moment the rules mean that Germany shoulders the largest share of the burden, of 27%, closely followed by France on 20%, Italy on 18%, and Spain on 12%. Greece has to guarantee only 3% of the total.
So you will be effectively lending to Greece, with Germany, France, Italy and Spain guaranteeing your repayments -- though fears are that the debt contagion could spread to Italy and Spain too, so not all of those guarantees are as golden as the bold rescuers might hope.
Partly for that reason, and partly to bolster the latest attempts to put the shine back on the euro, the EU has asked the member states to increase their commitments to €780 billion, with most of the additional risk being borne by the group's AAA-rated economies.
So lend Greece more money, on the expectations that the Germans and the French will repay it if Greece can't -- isn't that how we got into this sorry mess in the first place? Still, at least this time round the austerity conditions on Greece are far more onerous than back in the days when the country was able to freely borrow money on the strength of the eurozone without having to demonstrate sound fiscal management itself.
A reliable saviour?
The major credit rating agencies are impressed enough by both the EFSF and the EFSM to give them AAA ratings, so you can't go wrong lending them money -- oh, hang on, aren't these the same agencies who gave AAA ratings to all those junk mortgage bonds that helped precipitate the crisis in the first place?
So is the EFSF the latest knight in shining armour riding to the rescue of the embattled EU? Will its efforts pull the PIIGS back from the brink and halt any further contagion? Or will it be throwing good money after bad, and will Greece (as many believe) still have to default on at least some of its debt?
All these questions, and more, will be answered in the next enthralling episode of "I'm a eurozone investor, get me out of here".
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