The Globe and Mail

There’s very good reason for bond markets to be nervous about the scale of the Ireland bailout – and it’s not just because of the tough talk it has inspired in German Chancellor Angela Merkel.

While markets were indeed shaken this week by Ms. Merkel’s worrisome musings about a possible end to bailouts and, just maybe, to the euro itself, there may be a more concrete threat to euro-zone sovereign debt than political posturing. Indeed, the bigger problem is that Ireland’s rescue plan, far from removing a major risk to the government bond market, may have greatly increased the risk to other European countries teetering of the edge of insolvency – because there suddenly might not be much left for the rest of them.

Beware the Promise of the PIIGS

Brockhouse Cooper economists Pierre Lapointe and Alex Bellefleur noted in a report this week that Ireland’s €85-billion ($114.8-billion) rescue package would take a major bite out of the European Financial Stability Facility (EFSF) – a fund created last June that, on paper, currently has about €440-billion in loan guarantees available to euro-zone members in need. (Not all of the Ireland bailout funds would be drawn from the EFSF; some would come from another fund, the €60-billion European Financial Stabilization Mechanism, or EFSM, and some likely from the International Monetary Fund. But safe to assume the EFSF is going to take a significant hit.)

A portion of €85-billion out of a €440-billion fund sounds manageable, but the economists argued that the size of the EFSF is deceptive. It has not actually been funded to that amount, but rather represents guarantees to provide funds from the euro-zone member countries. and that’s all the member countries – even the so-called PIIGS (Portugal, Ireland, Italy, Greece and Spain) that are in such deep debt trouble themselves that their guarantees may not be worth the paper they’re written on.

“These countries accounted for 37 per cent of the guarantees under the initial [EFSF] framework,” they wrote.

If you remove the funds guaranteed to the EFSF by the PIIGS countries, they said, funding for the facility is just €278-billion. After Ireland’s expected drawdown, the fund would be somewhere under €250-billion.

The Drain from Spain?

That would put the fund in serious difficulty if an even bigger at-risk nation were to come to the EU seeking help – like, say, Spain.

“Spain’s funding needs are much larger than those of Ireland or Greece,” Mr. Lapointe and Mr. Bellefleur wrote.

Indeed, a bailout covering Spain’s borrowing needs to 2013 – similar to the Ireland package – would run north of €350-billion. After Ireland’s bailout, that would be more than the remaining EFSM and EFSF funds put together.

“We do not believe that the European debt crisis is over yet,” they said.