"We have done nothing more than to buy time until we have brought order to these competitive differences and to the budget deficits of individual euro countries."
-German Chancellor Angela Merkel, May 16, 2010
On May 9, 2010, the IMF and the EU announced the creation of the European Stabilization Mechanism (ESM), a 750 billion euro (roughly $925 billion) lending facility to provide lines of credit to European countries. Under the agreement, the IMF will provide approximately one-third of the contributions to the ESM or $310 billion. With the U.S. being the largest contributor to the IMF, American taxpayers will be liable for up to 17 percent of the IMF's loan contribution. The following is background on the European bailout fund and potential concerns for American taxpayers.
The European Debt Crisis: The EU's collective growth pact, which was agreed to by all 27 member nations, places a ceiling on deficits of 3 percent of GDP and a total debt limit of no more than 60 percent of GDP. Many EU nations however, have violated these ceilings because of years of out of control spending on welfare programs. Italy's debt, for example is 117 percent of GDP, while Greece (which just accepted a $145 billion EU and IMF bailout) has a debt to GDP ratio of 113 percent. Other EU nations with dangerously high debt-to-GDP ratios include Portugal with a ratio of 75 percent and the United Kingdom with a ratio of 68 percent. In all, 11 EU nations have levels of debt that exceed the EU's growth pact. These high levels of debt ultimately make those who have purchased these nations' debt weary that they may not be repaid. In the case of Greece, for instance, those fears were realized when the Greek government announced that it was going to default on its loans in mid-May. Thus, these EU nations, and indeed the public and private investors who hold their debt are clamoring for foreign countries to bailout these indebted nations.
The U.S. Burden: Currently, the IMF receives its primary financing through a member quota system which requires members to contribute to the fund based on the proportion of the world economy which they represent. The U.S. has by far the largest single quota contributor burden with a quota requirement equal to 17 percent of all members' contributions. As a comparison, the next largest supporter, Japan, provides 6 percent of the total contributions. Regardless of their support level, all members that provide contributions to the IMF are entitled to a claim on the overall balance sheet, not on specific loan arrangements with countries, such as Greece. If, however, the $310 billion from the IMF's quota resources and bilateral agreements for Europe were looked at proportionally, the U.S.'s 17 percent contribution would be equivalent to $53 billion. While the U.S. would also bear a larger risk as the largest quota member, the IMF points out that in its history no participating member has experienced a loss from contributing to the fund. However, the fact remains that contributions from the U.S. quota will be used to bail out independent nations that-by no fault of the U.S. or the IMF-behaved in a fiscally irresponsible manner and created a sovereign debt crisis. If EU nations default despite these loans, American taxpayers will be responsible for billions.
The Expanding Fiscal Crisis: Other European nations such as Portugal, Spain, Italy and Ireland could all be in a similar situation as Greece soon, unable to pay their debtors. Recently, Portugal's credit rating was lowered from A+ to A- and Spain's rating dropped from AA+ to AA. If a larger economy like Spain were to need a similar rescue, it is estimated that it would need hundreds of billions more than Greece. Now that a larger bailout fund including the other most likely countries to need assistance has been agreed to, some experts believe that even $1 trillion may not be enough. The IMF's support of the Greek bailout has already had the effect of setting a new precedent for bailouts in Europe. But despite the bailout, the unrest in Greece and fears of contagion in Europe caused large scale market disruptions around the world. Since late in 2009, the euro has lost far more than 10 percent of its value. Markets in both the U.S. and Europe have experienced sharp drops as a result of the Greek bailout and fears of more crises in other countries with high debt risks. Some argue that the European bailout is merely a backdoor handout to EU creditors, whose fears of default may be contributing to the market downturns.
Moral Hazard on a Global Scale: The fact remains that each EU nation currently facing a debt crisis which they arrived at because of their own reckless spending, deficits, and borrowing. By providing billions in taxpayer dollars to bailout the profligate spending habits of European nations, the U.S. will send the message that the cycle of reckless borrowing and international bailouts can go on. While both the EU and IMF have referred to "economic measures" that need to take place to decrease deficits and stabilize EU markets once and for all, there are no concrete requirements or benchmarks, leaving the actual requirements for receiving a bailout to the determination of those controlling the fund. Without serious benchmarks from the outset, the U.S. is committing to a plan that has no parameters and could very well need repeating in the coming years. Europe needs to put its own fiscal house in order with spending restrictions, entitlement reform and pro-growth economic policies instead of looking to the American taxpayer to bear the risk for one more government bailout.
America's Own Fiscal Crisis: The debt crisis in Europe was brought on by reckless borrowing to fund welfare programs. While the U.S. is putting itself on the hook for the Greek bailout (and likely more bailouts across Europe), Democrats in Washington are following the Greek model and refusing to learn any lessons from the crisis. In FY 2009, the deficit in the U.S. reached a record high of $1.4 trillion or 9.9 percent of GDP. In the first seven months of FY 2010, the U.S. government has already racked up a deficit of $800 billion. Under the President's budget, the average deficit as a percentage of GDP between 2009 and 2019 will be more than the average deficits over the past decade that brought Greece to its current crisis. According to CBO, under the President's proposed budget, the debt held by the public in the U.S. will jump dramatically from 53 percent of GDP to 63 percent between FY 2009 and FY 2010. By 2020, CBO estimates that the public debt in the U.S. will be $22.5 trillion, an amount equal to 90 percent of GDP. These levels of debt are unprecedented in U.S. history and are dangerously unsustainable. Europe provides a stark illustration of what will happen in the U.S. if our fiscal house is not put in order. Instead of putting taxpayers and future generations at further risk by bailing out European nations, the U.S. should be tending to its own fiscal mess. If the U.S. does not act to dramatically cut spending soon, this nation will run out of time. If that happens, who will be there to bail out the U.S., and at what cost?