“We are barely halfway through the current crisis in the euro zone.”
- Paul Donovan, Deputy Head of Global Economics at UBS, November 30, 2010
According to recent reports, U.S. officials have expressed support for plans to commit additional U.S. money to the $980 billion European bailout fund created by the European Union (EU) and the International Monetary Fund (IMF). 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. 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.
The European Bailout Fund: In May 2010, the IMF and the EU announced the creation of the European Stabilization Mechanism (ESM), a 750 billion euro ($980 billion) lending facility to provide lines of credit to insolvent European countries. Under the agreement, the IMF agreed to provide approximately one-third of the contributions to the fund or 250 billion euro ($327 billion). The fund’s main lending facility, the European Financial Stability Facility (EFSF), was authorized to provide up to 440 billion euro ($557 billion) in loan guarantees through the European Commission. Since the establishment of the fund, fears of European contagion have grown, and along with them, rumors that the size of the bailout fund should be vastly expanded. Last week, EU officials debated doubling the size of the EFSF. On December 1, 2010, Reuters reported that “The United States would be ready to support the extension of the European Financial Stability Facility via an extra commitment of money from the International Monetary Fund, a U.S. official told Reuters.”
The Greek Bailout: On May 2, 2010, the IMF and the EU announced that they had agreed to terms on a 110 billion euro ($145 billion) assistance package to bail out Greece before it defaulted on its debt obligations. Under the arrangement, the IMF provided Greece with a 30 billion euro ($40 billion) loan through an IMF Stand-By Arrangement (SBA). Greece was initially to have completely repaid the IMF loan by 2015; however, it was recently announced that EU and IMF officials are expected offer an extension of the repayment schedule until 2024 due to Greece’s inability to repay the loans in the agreed upon timeframe.
The Irish Bailout: On November 28, 2010, the IMF announced that it had reached an agreement with Ireland and the EU to participate in an 85 billion euro ($113 billion) package to cover bank debts which were assumed by the Irish government. Under the deal, 22.5 billion euro ($30.1 billion) would be provided by the IMF and 45 billion euro ($60 billion) would be provided by the EU, while Irish authorities would be responsible for 17.5 billion euro ($23 billion). Ireland would have 10 years to pay off its IMF loans, and the first repayment would not be required until 4 1/2 years after an initial drawdown.
European Contagion and the Elephant in the Room: While speculation about the size, scope, and viability of the bailouts for Greece, Ireland, and possibly Portugal continues to swirl, the real impetus for expanding the size of the EFSF is likely the fear that Spain, Europe’s fourth largest economy, could fall prey to contagion and seek a massive bailout of its own. According to a Bloomberg report, “The risk for Europe is that Spain’s economy is twice as big as that of Greece, Ireland and Portugal combined, meaning the euro region’s 750 billion-euro bailout fund may not be big enough if the country resorts to aid.”