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4 reasons why the European Stability Mechanism will not work

May 15, 2012 by Forex Market

Before we begin, let me address the question in his mind: What the hell is the European stability mechanism (ESM)

The ESM program is the bailout fund to replace the European Financial Stability Fund (EFSF) in 2013. It is designed to provide financial assistance to EU members who have been bad. It plans to do this primarily through the granting of loans, but you can also buy government bonds in the primary market in exceptional cases.

Sounds like a noble effort, right? It’s like the bank from their parents let you make money when you’re out the dough to buy candy in the ice-cream man! But believe it or not, this fund has been a lot of fire lately. What with European debt issues coming to light again, it seems that not everyone is convinced of the ESM will do the trick.

Let me talk about some of the shortcomings of the environmentally sound management of over-scrupulous readers have been pointing out:

Error # 1: Time and again the cycle of insolvency will …

Under the SEA, the European Commission will first assess whether the euro zone country is insolvent or not. It means to be insolvent does not have enough assets to cover its financial obligations. In other words, if you’re insolvent, you can not pay the bills yo!

So what if the European Commission states that a country is insolvent? Naturally, because its government was considered not able to pay its debt, lenders demand higher returns on funds that the government loans. That means the government eventually will have to pay higher interest rates to holders of sovereign bonds, but what if you do not have sufficient funds by then

And so the cycle begins insolvency. Government bond yields of insolvent countries rise, making it harder for them to refinance its debt further and bury them deeper into insolvency.

Error # 2: Therefore, the funds are you?

Did you know that European economies are not even cough fund all cash ESM

In simple agreement, European leaders decided that the ESM would have a total capital of 700 million euros, with a lending capacity of 500 million euros, but only 80 billion euros in reality would be paid in advance. The remaining 620 billion euros to be allocated as “callable capital,” or funds that finance the euro zone economies guarantees instead of real money, at least until the initial 80 million euros is exhausted.

Let me tell you what bothers me the installation of two ways. The first is the fairness of the agreement. Word on the street is that the ESM only need strong guarantees of euro zone economies such as France and Germany, but the economies with low bond ratings would have to pay if they start to dry thoroughly. Talk about preferential treatment!

Another problem with the funding system is the reliability of collateral. It is a business based on trust after all. If investors willing to take the handshake promise of weak economies in the euro area as PIIGS would pay up when needed? Remember that public sector debt in Italy is already running at a whopping 120% of its GDP. Where would find the money to contribute to the fund

Mistake # 3: Vote must be unanimous or else …

Unlike the voting process for the king and queen in high school graduation, the finance ministers of the euro area can not simply abandon their vows in a box. You see, each of the finance ministers is given veto power in the Council, making it more difficult to reach a unanimous decision on issues such as interest rates on loans ESM.

What if a finance minister wakes up one day and decides to act like an idiot to veto any suggestions made by other leaders? Or in a more realistic scenario, so if a finance minister of a fairly stable economy changes his vote in exchange for minor trade policies in less stable countries in the euro zone

Given the reputation of Europe’s leading “for slapping and fighting (well maybe not slap, but close!) At its meetings, it is not difficult to imagine that there would be problems with the current voting system.

Mistake # 4: It is a little small and a little later, friend!

The Doo Doo has already hit the fan for some of most nations with debt problems of the union. Just two days ago, Portugal became the third country to seek financial assistance from the European Commission, joining Ireland and Greece in the rescue of the counter.
To make matters worse, 502 million-worth of debt maturing PIIGS this year. Compare this figure with the ability of millions of euros of loans 500 of the ESM, and is easy to see how the RAF is too little, too late.

Yes, it is true that the nations of the euro area have the option to accelerate their contributions and pool together their funds earlier in the event of financial disaster before 2013, but it is unlikely that these nations want to speed the process of separating from their money.

If this is what the European leaders in practice means “whatever it takes” to keep the euro area, then I worry that the region could be in grave danger. While saying that the RAF is aimed at making the euro area strong enough to weather the challenges ahead, the defects of the mechanism may do the opposite and expose them to an even greater crisis.

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