E.U. Develops $2 Trillion Firewall
The E.U. may be avoiding crisis by providing bailouts, but these bailouts are proving to be increasingly expensive. To date, the costs have been divided between the E.U. members and IMF, which is funded by countries like the U.S. But in the latest G20 meeting in Mexico City, world leaders pressured the E.U. into boosting their own funds before the IMF steps in again.
The E.U. is planning a 500 billion euro firewall – dubbed the European Stability Mechanism – that will act as a permanent bailout fund that supplements the existing and temporary European Financial Stability Facility (EFSF) and the European Financial Stability Mechanism (EFSM). Combined, the new measures would boost total commitments to nearly $1 trillion.
SEE: 5 Eurozone Acronyms Explained
When this is in place, the IMF is likely to seek to raise $500-600 billion in additional capital that will bring the total European funding to nearly $2 trillion. European leaders are hoping that this will be enough to discourage traders from betting against larger sovereign entities, like Spain or Italy, which would be far more disastrous than Greece.
LTRO and Germany Provide Further Stabilization
The ECB is expected to announce its second LTRO right before the beginning of March. With the last LTRO delivering 489 billion euros in cheap loans to more than 500 banks, there are high expectations for the second upcoming LTRO. In fact, some forecasts suggest that over 1 trillion euros may be drawn from the new facility.
The ECB believes that the LTRO operations help reduce the fear of systemic risk, since banks have the ability to borrow cheaply, regardless of sovereign performance. And many analysts see the recent loans to struggling banks as one of the reasons that the European bond markets have stabilized over the past few months.
SEE: What Is The Difference Between Systemic Risk And Systematic Risk?
Finally, Germany has also proven to be a bright spot in the E.U. Business confidence rose to its highest levels in seven months, helping the country to continue evading a recession. In particular, the largest member of the European Union has been helped by historically low interest rates and robust domestic demand that helped drive businesses forward.
Many Risks Could Derail Recent Efforts
Despite this optimism, investors would be wise to exercise caution. Germany's Wolfgang Schaeuble warned that there are no guarantees that the path being taken will lead to success. And the ECB's Jens Weidmann warned that Europe must prepare for a potential worsening of the region's sovereign debt crisis, which remains very much on the table.
Some economists have raised concerns that the Greek deal – that brings its total bailout funds to 237 billion euros – only postpones the inevitable. The deal comes with strict conditions and many of the funds are going to finance swaps with private investors rather than addressing the country's real financial problems. And worse, Germany's Wolfgang Schauble admitted that Greece is likely to require a third bailout before the crisis is over.
|Figure 1: Eurozone GDP Breakout|
Portugal is another major concern that began to reemerge over the past few weeks. After receiving a bailout package last May, some economists now believe that the country may need to seek emergency funding amid the worst recession in decades. Growth to overcome that need may be hard to come by, with the government slashing spending and raising taxes to meet bailout requirements.
In the end, there is still a significant risk of contagion until the E.U. acts in a strong and unified way, or unless a day of reckoning takes place for troubled members like Greece. While there are many positive plans in place now, the recovery in the Eurozone remains decidedly fragile.
SEE: The History Of Greek Sovereign Debt Defaults Investopedia's Forex Outlook For March 2012: U.S. Economy News
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