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Fears remain enhanced EU fund still not big enough

Taxi drivers are silhouetted in front of the parliament during a rally calling for the government to rescind a new taxi deregulation law Athens September 29, 2011. The Socialist government decided on unpopular pension cuts, lay-offs and taxes last week to lure back the so-called troika of European Commission, European Central Bank and International Monetary Fund officials, who suspended talks earlier this month after disagreements on the steps needed to plug fiscal gaps.


The German parliament handed Chancellor Angela Merkel a crucial victory in her campaign to keep the embattled euro zone intact, but her win failed to calm fears that the Greek debt crisis could still infect larger countries.

On Thursday, a parliamentary vote went overwhelmingly in favour of expanding the powers of the main debt-crisis fighting tool, the European Financial Stability Facility. While its approval was never it doubt, Ms. Merkel had feared a rebellion within her ruling coalition, one that never materialized: The vote tally was 523 to 85.

Ms. Merkel and her allies argued that keeping the 17-country euro zone intact would be less costly than letting it fall apart as the threat of cascading defaults looms ever larger. "We have an existential national interest in the stability of Europe and the euro," Volker Kauder, a member of Ms. Merkel's centre-right Christian Democratic Union (CDU), said from the floor of the parliament.

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But investors and some economists, strategists and politicians were not convinced that the enhanced EFSF, which will be able to provide liquidity loans to troubled governments and buy their bonds in the secondary market, would halt the debt crisis in its tracks.The fund's size, at €440-billion ($620-billion), is considered insufficient to prevent the Greek crisis from hitting Italy, Spain and perhaps even France.

The German vote provided some relief to investors as it was a critical step in the fund's approval process, which has been marked by battles between political leaders, populist anger and turbulence on financial markets. Still, many observers say Thursday's action was nothing more than a Band-Aid on economic wounds that will take years to heal.

Frank Schäffler of the Free Democrats, the CDU's junior partners, said he doubted the EFSF would improve Greece's health. "Despite all arguments, the first bailout did not make the situation for Greece better, but worse," he said.

The markets failed to take a strong view on Ms. Merkel's victory. In London, the FTSE-100 index fell 0.4 per cent while Germany's benchmark Dax index rose 1.1 per cent. The euro climbed slightly against the dollar.

Yields on the bonds of some of the euro zone's most indebted countries fell somewhat Thursday, but the German decision did not do any favours for Italy, the region's third biggest economy. The yield paid Thursday on new treasury notes, due in 2022, rose to a hefty 5.86 per cent from 5.22 per cent at the previous auction a month ago, and demand was tepid.

Meanwhile, dangers of a Greek default in no way disappeared. On Wednesday, the day before the parliamentary vote, Ms. Merkel told Greek TV channel ERT that her government was "naturally disappointed" by Greece's September budget deficit figures and warned that the country's second rescue package, worth €109-billion, might have to be reviewed if Athens fails to meet its aggressive deficit-reduction targets. According to Germany's Bild newspaper, Ms. Merkel told her CDU members that "We are trying to avoid a Greek insolvency. But I cannot rule it out."

Leveraging the EFSF to give it "shock and awe" crisis-stopping power is considered essential if the fund is to work. The consensus is that boosting the effective size of the fund to about €2-trillion, by allowing it to borrow, should be the goal. Economists at the French banking giant Société Générale said the EFSF's current firepower "would be insufficient to rescue Italy or Spain."

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But there is no agreement on how the EFSF should receive extra financial power. Additional guarantees from euro zone countries, notably Germany, are one option, though German Finance Minister Wolfgang Shauble has made it clear he would not bump up Germany's guarantees if it meant jeopardizing the country's top credit rating. Borrowing from the European Central Bank is another option, though the ECB is highly reluctant to expand its already costly firefighting roles.

Still another option is to use the EFSF to guarantee the capital at maturity, though not the interest payments, of any new bonds sold by troubled countries such as Italy. The guarantee would translate into lower yields. Société Générale favours this option because "it may help keep the secondary markets open and thus keep private investors in the markets."

The bank, however, acknowledges that any effort to increase the size of the EFSF will be difficult because it would have to be made "politically palatable" to national parliaments, some of which are leery of funding more bailouts.

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About the Author
European Columnist

Eric Reguly is the European columnist for The Globe and Mail and is based in Rome. Since 2007, when he moved to Europe, he has primarily covered economic and financial stories, ranging from the euro zone crisis and the bank bailouts to the rise and fall of Russia's oligarchs and the merger of Fiat and Chrysler. More

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