30th September 2010
The European Financial Stability Facility (EFSF) hopes to provide a financial safety net for those Eurozone members being hammered by markets unconvinced that they can deal with the problem of high budget deficits and debt.
Countries the markets are most concerned about include Spain, Greece, Portugal, Italy, and, increasingly, Ireland. The seriousness of their situation was underlined earlier this week by the wave of anti-austerity demonstrations and strikes across Europe.
The idea is that the Euro €440 billion facility can be tapped at low cost by a eurozone member, via the European Central Bank, if that country’s borrowing costs rise to unfeasible levels because of the market’s wariness over its ability to deal effectively with high deficits and debt.
The EFSF, comprising funds raised through a bond issue, was awarded a triple A rating “with stable outlook” by rating agencies Fitch, Standard & Poor's and Moody’s last week.
Jamie Stuttard, head of European and Fixed Income at Schroders, however, is unconvinced by the rating, adding that the “stable outlook” conclusion reached by the agencies is “incongruous” with the fundamental data on the creditworthiness of each of the guarantor countries.
Stuttard says all eurozone countries are on track to breach the Stability and Growth Pact this year. The Pact, agreed in 1997, aims to enforce fiscal discipline among eurozone members through agreed criteria such as an annual budget deficit of no more than 3% of GDP.
The breaching of the Pact will be a “poor result” for 2010, says Stuttard, adding: “We have a situation in which every single country is borrowing more – not only more than was borrowed in total debt stock last year, but more than has been enshrined in eurozone treaties. How can that possibly be called stable?”
The eurozone members' guarantees for the EFSF are in proportion to their contribution to the paid-up capital of the European Central Bank, plus a further 20% to ensure that the fund will be able to repay creditors if one euro-zone government cannot honour its guarantee.
Stuttard is concerned about the guarantee structure for the EFSF, with the creditworthiness of issues particularly sensitive to changes in the triple A ratings of countries like Germany, France and Netherlands.
In this respect he believes France is the potential Achilles heel over the next few years, pointing out that the European Commission has forecast France’s annual deficit to be higher than Portugal, Italy or Malta in 2010 and that the country has not balanced its books since 1974.
Moreover, President Sarkozy’s attempts to engineer Thatcher-style structural reforms have met with overwhelming popular resistance and studies suggest post-retirement obligations facing the French state put the country’s finances in one of the worst consolidated positions in Europe.
The EFSF is seen by eurozone politicians and ratings agencies as the solution to their problems, a means of drawing a line under the eurozone debt crisis. Indeed S&P says it considers the facility to be the “cornerstone’ to the EU’s strategy to restore financial stability to the eurozone sovereign debt market. “Yikes!” retorts Stuttard. “How about improving the fundamentals as a cornerstone of restoring financial stability!?”
More broadly, Stuttard is worried about some of the conceptual implications of the EFSF. He feels markets should have learnt by now that the era of implicit guarantees – the buying of bonds of failed bond issuers because the bank, company, country in question is in some way too big to fail – is over as an investment thesis: “There is no longer the financial appetite or political appetite to bail-out every failed issuer.”
Indeed the underlying operational premise of the EFSF, the idea of issuing debt to bail out debt is “clearly circular” and conjures up for him the spectre of Charles Ponzi, one of the greatest swindlers in American history.
The term ‘Ponzi scheme’ is attributed to his activities and describes any scam that pays early investors returns from the investments of later investors.