Skip to main content

The Globe and Mail

€1-trillion worth of reasons to hope for European stability

Demonstrators stand between protest banners underneath the euro sign in front of the European Central Bank in Frankfurt, central Germany, Monday, Oct. 17, 2011. Protestors gathered at many major European cities last Saturday to join in demonstrations against corporate greed and inequality and to support the US movement ' Occupy Wall Street'. About 150 protestors in Frankfurt remained at that place , some with tents.

Thomas Lohnes/Thomas Lohnes/Associated Press

The euro zone has bought itself a few weeks to work a little bit of financial magic, making each of the remaining euros left in the continent's bailout fund do the work of four or five.

As part of the package of measures that buoyed markets Thursday, euro zone governments said they want to leverage the continent's dwindling bailout fund to provide as much as €1-trillion ($1.4-trillion) in support to governments in need of cash. But like much in the plan, the two-part proposal was sketchy on details.

The market clearly signalled it's open to the ideas, sending most every risky asset higher in value on Thursday on optimism that at last a fix may be at hand for the European problem that has bedevilled investors for months. Stocks surged across the globe – the S&P 500 climbed 3.4 per cent and Toronto's S&P/TSX composite 2.3 per cent – and commodities such as oil and copper gained.

Story continues below advertisement

However, without more details, analysts said there's no way to know if the leverage plan will really work. Details aren't expected until next month, and the market could still turn on the European plan if the workings are found wanting.

The problem Europe has to solve is one of scale. A year ago, the 17 governments in the monetary union agreed to a €440-million bailout package known as the European Financial Stability Fund. But payments to Greece, Ireland and Portugal have eaten up almost half the money. Amid concerns that bigger countries like Italy and Spain could be next in line, Europe needs to magnify the power of what's left to reassure markets that there's enough money available.

Simply going back and asking the governments for more money isn't going to work given the fractious situation in Europe, so the policy makers need to find a way to increase the firepower of each euro they do have, particularly with attention turning to Italy, the euro zone's third-largest economy and the most heavily indebted.

"The plan will certainly buy the euro zone some time and the market has been in a forgiving mood of late," Gavan Nolan, director of credit research at Markit, a bond market research firm, said in a note. "But the lack of detail is a concern and headline risk could rear its ugly head in the forthcoming weeks."

There are also questions about whether €1-trillion is enough, and what would happen if the fund were to run dry, given that getting 17 countries to agree on more money is so tough. That has resulted in continuing calls for the European Central Bank to step up and signal that it would be willing to backstop the fund in that event.

"If you had €1-trillion and you had the ECB on board, that would be enough," Credit Suisse equity strategist Damien Boey told Reuters. "But there's been no announcement that the ECB's on board so far. If the ECB is not actually willing to use its own money to prop up the bailout fund ... then there's a problem. This plan actually doesn't work."

The plan unveiled Thursday contemplates two possible ways of beefing up the rescue fund, both of which had been widely expected to be part of the fix. One is by using the money to fund insurance, rather than straight bailouts. The other is to invite private investors to partner in bailouts.

Story continues below advertisement

"There is nothing secret in all this, it is not easy to explain but we are going to do more with our available money, it is not that spectacular," Herman Van Rompuy, the president of the European Council, said after the agreement was struck. "Banks have been doing this for centuries, it has been their core business, with certain limits."

The insurance idea is designed to allow countries that have been shut out of bond markets, or forced to pay sky-high interest rates, to borrow at more reasonable costs. Investors who were leery of buying bonds from a country like Italy should be comforted by the knowledge that if the country struggles to repay, the fund will be there to cover some of the losses.

Many Canadian homeowners will have experience with a similar program through Canada Mortgage and Housing Corp. mortgage insurance. Because mortgages are insured by the government, banks are more willing to lend to borderline borrowers.

Managed correctly, a small insurance fund can create a lot of extra lending. That only works, though, if lenders trust the insurer to have enough cash to cover all claims.

The second method is to bring in private money from sources such as sovereign wealth funds to invest in funds known as special-purpose vehicles that would have the money to buy bonds, recapitalize banks and make loans.

One possible model is the Public Private Investment Program that the U.S. created as part of the TARP plan. The program, known as PPIP, was designed to lure investors to buy assets off bank balance sheets by lending them some of the money to do it.

Story continues below advertisement

The idea of a partnership has champions such as Laurence Fink, the head of BlackRock Inc., the world's largest asset manager.

"We'd all run in, invest side-by-side and I think this problem could be fixed really rapidly," Mr. Fink said last month.

With files from Reuters and Bloomberg.

Report an error Editorial code of conduct Licensing Options
As of December 20, 2017, we have temporarily removed commenting from our articles as we switch to a new provider. We are behind schedule, but we are still working hard to bring you a new commenting system as soon as possible. If you are looking to give feedback on our new site, please send it along to If you want to write a letter to the editor, please forward to