You've heard George Soros talk about it. You've heard it talked about on CNN, FOX, MSNBC, etc. You've also read about it on The Blaze, Drudge Report and countless other websites. By now you probably have a couple of questions:
What exactly can the European Financial Stability Facility (EFSF) do to stabilize Europe? Can they do anything at all?
For answers to these questions, we can turn to the writers at Zero Hedge. In an article titled Everything You Wanted To Know About EFSF (But Should Be Afraid To Ask), they highlight an interesting report from Nomura (a financial services group and global investment bank) that discusses possible courses of action that the EFSF can take to try to cure Europe’s financial ills.
They break down various scenarios, which include:
- The structural weaknesses of EFSF 2.0
- Proposals for an EFSF 3.0 (and their variants)
- Leverage-based options
- EFSF 2.0 as TARP
The study then goes on to say that most (if not all) of these options can only end in one of three outcomes:
- Fiscal union
- Major restructurings which risk ending of the euro
In the words of the Nomura report:
While the most elegant solutions have no official sanction, we think the necessary political resolve is yet to be forthcoming, and the technical issues are challenging if not insurmountable for many of the legal workarounds, resulting in the need for yet another round of parliamentary approvals. Consequently, we see a significant risk that the market, looking for large headlines and enhanced flexibility, will be disappointed at least in the short run [emphasis added].
Well, they don't sound like they have much confidence in the ability of European leadership to adequately deal with the crisis. In fact, it sounds downright bleak.
The report then proceeds to walk through each of the "steady state solutions" (defined as the market no longer being concerned about future default risks on government debt – at least over a time-frame that is meaningful to immediate asset allocation decisions) and their economic implications:
1. Full fiscal union and the issuance of Eurobonds with a joint and several liability structure or at least unconditional credit risk transfers to stronger countries for a extensive period of time (for sustainability to be reestablished).
2. Aggressive policy reflation, whereby the ECB [European Central Bank] significantly expands its balance sheet and its SMP [single market] program. (Given the requirement of EU governments to recapitalize the ECB, this option ultimately begins to blend into option 1.)
3. Default and debt restructuring in selected non-core countries and possible end of the euro area.
The report then proceeds outline the dangers and implications involved with each of these options:
Option 1: [It] is not under consideration at this juncture since all forms of recent fiscal or credit transfer appear to come with strict conditionality. As for the possibility of Eurobonds, it has been dismissed by the AAA countries and the German Constitutional Court's ruling that uncapped liabilities accruing to the German state from its participation in the EU is unconstitutional.
Option 2: May be a possible solution to the crisis, albeit with drawbacks, but our economics research team does not believe that the ECB is close to accepting the significant increase in credit risk on its balance sheet and the distorting influence on its monetary policy that this option would entail. The ECB is not programmed for full-blown monetization and the bar is extremely high for any major steps in this direction.
Option 3: For [the above] reasons, the possibility of further debt restructuring in selected countries has become increasingly likely and in recent weeks has underpinned investor risk allocation decisions. The consequences would depend on the ability of EU politicians to isolate other periphery countries and European banks. This may prove virtually impossible without significant credit risk transfers, so ultimately European politicians will need to pick one of the three outcomes: fiscal union, monetization or major restructurings risking the end of the euro area.
As mentioned in the headline, these seem to be the only realistic choices for the eurozone. The first two options do not seem feasible which leaves us with option 3: restructuring.
Also, as mentioned in the headline, none of these options are any good.