The Strategist

ESM: Eurozone's Rescue Team

07/15/2015 - 19:07

July 13, Eurozone leaders summit has approved in general terms the third program of financial aid to Greece - this time at the expense of the European Stability Mechanism.

After 17 hours of tortuous negotiations, Heads of State and Government of the Eurozone countries have agreed in principle on the following the third in a row program of financial aid to Greece. Athens - in exchange for radical economic and administrative reforms – were promised loans at the rate of 82 to 86 billion euros over the next three years.

This time, the creditor of Greece is European Stability Mechanism (ESM), which has never operated on such sums before.

For the first time, financial assistance to Greece in the amount of 73 billion euros was provided in 2010. Then the Eurozone countries allocated 52.9 billion. The remaining 20.1 billion were added up by the International Monetary Fund (IMF).

At that time, skeptics already predicted that this money was not enough to overcome an acute debt crisis in Greece. Later, the country took a second financial aid package. The helping hand was given by European Financial Stability Facility fund, which allocated EUR 130.9 billion, and again the IMF - 11.8 billion.

The validity of this program finally expired on 30 June this year. Notably, Athens has received not all the funds, as Greece has not implemented all the reforms prescribed by the creditors.

Now it’s turn ESM turn - a permanent fund established by Eurozone countries in 2012, when it became clear that the budgetary problems of states, switched to a single currency, are going to last long enough. The total size of the fund – once Lithuania joined it - reached 705 billion euros. ESM has the right to allocate 500 billion of them to euro-zone countries on the verge of default, the other money must be kept as a kind of reserve stock.

The biggest share in ESM - about 27 percent, that is 190 billion – has Germany. The second largest share in the ESM relates to France - 16 percent, the third - Italy, the fourth - Spain.

ESM founders primarily counted on its psychological effect. The fund was intended to increase the confidence of private lenders to the euro by its impressive amount, as well as to convince them that there is no risk in buying the euro area government bonds and thereby create for the monetary union states preferential credit conditions in global financial markets.

In practice, the ESM plays the role of a ‘fire brigade’, whose mission is to extinguish the center of the debt crisis for the ‘fire’ not to spread to other parts of the euro area. Until now, ESM rescue team responced on call only twice. Once in Spain, to blanket the debt crisis with 41.3 billion euros, and the second - to Cyprus, 9 billion program of financial assistance to which has been not finished yet.

As for the loans to Ireland, Portugal and the Greek second package, they were allocated from ESM precursor - EFSM, which is virtually completed its work. ESM headquarters in Luxembourg, and is headed by Klaus Regling. But the decision on the allocation of loans is made not by him but all the Eurozone finance ministers. At the same time, the German Minister has a special status.
Against his will - as a representative of a country with the most significant share in the capital of the ESM - can not be taken any decision. And the Minister of Finance of Germany, in turn, must obtain two approvals of the Bundestag, even two - to negotiate with the country that asked to ESM financial assistance and approval to provide it.

The deputies of the Bundestag are obliged to provide, or at least take into account, the interests of the voters, that is, German taxpayers, who risk to lose their the money allocated to Greece in the form of loans.

The German share in the current Greek debt (313 billion euros estimated by Athens itself) currently stands at about 85 billion. The new program of financial aid to Greece will further increase the risks for the German budget.

In order to reduce such risks, ESM provides loans only under certain conditions, including, in particular, assessment of the client’s future solvency of the "client", implementation of already prescribed reforms and austerity measures, as well as the threat to financial instability for the entire Eurozone.

In the case of Greece, which accounts for only a couple of percent of Eurozone economic potential, the last of these conditions appear to be at least debatable. But the threat is a loose concept and cannot be purely mathematical calculations.