The rising costs of eurozone rescues

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The eurozone has two bailout funds of any size at all: the European Financial Stability Facility, which exists now, and the European Stability Mechanism, which is supposed to be launched in July.

They exist (mainly) to lend to governments deemed to be solvent but which can't borrow from investors.

Even before Friday's downgrades by Standard & Poor's of nine eurozone governments, there were already concerns that the bailout funds' resources were inadequate to rescue a state with huge debts, such as Italy.

So a particularly damaging consequence of S&P's decision to strip Austria and France of their AAA ratings is that the two bailout funds will have even less to lend, if the funds themselves want to retain their own AAA ratings.

The reason (slightly simplifying) is that any lending by the bailout funds is backed by eurozone countries - and if fewer eurozone countries have a AAA badge, then a much smaller amount of lending by those funds would be underpinned by support from AAA governments.

That is one reason why the Chancellor, George Osborne, is concerned that eurozone countries aren't doing enough to prevent a breakup of their currency union. This is what he told the Today Programme this morning:

"I think what the euro needs to do is show convincingly that it can stand behind its currency. We haven't actually seen much evidence of the pooled resources needed by the euro to actually provide confidence to the market that they will stand by their own currency."

Eurozone leaders face a tricky choice.

They can abandon the idea that the bailout funds need a AAA rating. The German chancellor Angela Merkel suggested over the weekend that this may be the better way to proceed.

But were the bailout funds to go AA or AA plus, the costs for the bailout funds of borrowing would probably rise.

And the funds might have difficulty raising money from some high profile investors, such as China, whose participation would have huge symbolic value.

The alternative of asking eurozone governments to increase their financial backing for the funds to sustain both their AAA and their lending capacity would however place quite a strain on the balance sheets of eurozone governments, especially that of Europe's biggest economy, Germany.

According to new research by Royal Bank of Scotland, if eurozone leaders wanted to do what Mr Osborne implies they should do and double the lending capacity of the European Stability Mechanism from what it was prior to the S&P downgrade, eurozone countries would have to provide capital equivalent to 2.6 trillion euros, or 27% of euro area GDP.

All of which is a long-winded way of saying that the downgrades of France and Austria have dealt a hefty blow to the eurozone's ambitions of establishing bailout funds with sufficient liquid resources to douse whatever fires erupt in the currency union.

And that matters more than ever, with Greece teetering on the brink of default because of an impasse in debt-reduction talks between the Greek government and its private-sector creditors.

If Greece were to default, investors would only be persuadable that Portugal, Ireland and even Italy and Spain won't be next in the queue to renege on what they owe, if the two bailout funds have access to an ocean of emergency money.

Following the S&P downgrades, the bailout funds are endowed with what looks like a puddle or pond, rather than a great sea of money stretching beyond the horizon.

UPDATE 18:48

S&P has tonight downgraded the European Financial Stability Facility, Europe's rescue fund, by one notch to AA plus from AAA.

It warned there could be further downgrades if the finances of eurozone members were to weaken further.

Eurozone members now have to decide whether to reconstruct the bailout fund to restore the AAA or whether to take the downgrade on the chin, with the possible consequences I mentioned earlier.

Robert Peston Article written by Robert Peston Robert Peston Economics editor

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  • rate this

    Comment number 17. very deep hole with optional steel roof..any offers?

    (or are they all taken) .

  • rate this

    Comment number 16.

    Rob, why is everyone still applying for more money
    borrowing has gone crazy and has become unsustainable
    building up a brand new debt balloon ready to pop again


  • rate this

    Comment number 15.

    Equity investors started week slowly, waiting to see how France & Greece handle economic problems, after much of EZ was slapped with S&P downgrade. Britain's FTSE 100 was flat; France's CAC 40 dipped 0.2 per cent; Germany's DAX rose 0.3 per cent. US stock markets closed - Martin Luther King, Jr. Day. EU said it would decide shortly whether to downgrade the EZ's bailout fund from triple-A.

  • rate this

    Comment number 14.

    GO - markets not being provided with enough confidence by the EZ

    Could be because EZ & rest of world has worked out the AngloUS markets can't be sated whatever the rest of us do from here

    Mass sovereign debt write off, nationalised banks & start again, killed AngloUS markets

    Athens already has medical charities usually in 3rd world. Price for EZ default too high

    Always the last to know eh GO

  • rate this

    Comment number 13.

    It seems to me that 'leadership' falls under one of three categories: 1) Those who make things happen...2) Those who watch things happen....3) Those who wonder what the hell just happened.

  • rate this

    Comment number 12.


    Absolutely right. That is why the Euro is a dog's dinner and won't be fixed until the PIIGS default unless German bites the bullets and says that the ECB is the lender of last resort. You'll be dealing with some interesting numbers then!!

  • rate this

    Comment number 11.

    Once the indebtedness was exposed, the core problem was (and remains) a lack of time to correct a decade of indulgence. There is no quick-fix - no enduring financial engineering solution. The euro project has hit the buffers.

    I thought the events of 2008 would convince the establishment that the old ways of doing business were over. Denial replaced by decisive action.

    It seems I was wrong...

  • rate this

    Comment number 10.

    These funds, so Eurozone governments borrow now (ish) and increase their debt to pay into a fund that they might need to borrow from in the future should their debts become too high.

    Who cares about what the credit agencies say, is anyone fooled that this is anything other than a pup?

  • rate this

    Comment number 9.

    The Euro is a political creation and this crisis can only be solved by politicians, if serious economic damage is to be avoided.

  • rate this

    Comment number 8.

    This story has been in the pipeline since the fund was started - good of you to finally join us Robert

    Tip - read ZH first....

    This is why the great unveiling of the EFSF was met with the sound of a broken trumpet down at ZH - but the MSM had the full brass band out

    How often will the BBC and others mislead the public by failing to analyse claims made by politicians about 'fixes'?

  • rate this

    Comment number 7.

    The UK is a great example for the Eurozone of what can happen in the current crisis if your central bank starts printing to hose near-bankrupt entities (banks in our case, sovereigns in EZ's case) with a torrent of cash together with a policy of austerity:
    - The near-bankrupt entities keep doing the same things that got them into trouble, unemployment up, real incomes down, economic stagnation

  • rate this

    Comment number 6.

    Simon Ward of Henderson says that ( "Sovereign credit ratings are pretty meaningless - at least for countries borrowing in their own currency with their own central bank. Such countries will always print money rather than "default", about the possibility of a UK downgrade, but what will the cost be for eurozone countries? They can't just print money!

  • rate this

    Comment number 5.

    Moody's have not down graded France and the evaluation of risk is probably already factored in. It is all very well Osborne lecturing from the sidelines but it may not be too long before these rating agencies turn their red pens on to UK which in debt terms is not the best placed in Europe but nevertheless continues to bulldoze austerity across the economy.

  • rate this

    Comment number 4.

    Question is in what currency is stability bail out mechanisms to be piad in?

    If they're proposing to pay in Euros - Yikes!

    Need to devalue Euro hard & fast and get those Euros printed before "events" dictate the agenda.

    Waiting to see what happens is a very dangerous thing here - We know what's going to happen if the EU/EZ/ECB keep waiting to see 'what happens' next?

    Watch it happen!

  • rate this

    Comment number 3.

    Economists and Governments are in denial.

    One of the things that happens, that has to happen, is that interest rates will rise & rise substantially like it or not. This always happens at this time in a depression, on the way down.

    This will force the market driven debt deflation (and down pricing of assets) of private debt. It will hurt. It has to hurt, but without it there can be no recovery!

  • rate this

    Comment number 2.

    Say that Germany relents, the ECBs printing machines go full-on and the ESM and ESFS have access to an "ocean of emergency money", enough to cover the needs of all of the PIIGS.

    What then?

    The "If only we can gain ourselves a couple of months, we'll start growing again and everything will be allright" theory hasn't worked - things got worse, not better.

    The fundamentals are not being fixed!

  • rate this

    Comment number 1.

    EFSF bonds are currently priced at about AA (and have been for about two months), so the market has already built this in.


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