by Lorenzo Metrangolo
At the beginning of the 2008 economic and financial downturn, the Eurozone and the whole European Union was clearly in lack of a tool available to provide financial assistance to the Member States in need. The trust in the fiscal and budgetary rules set up in the previous thirty years – starting with the Maastricht Treaty in 1992, and the establishment of the Stability and Growth Pact in 1997 – was the main reason why European institutions did not consider building a financial safety net that would help during the hardest times. When the financial crisis hit the European Union in 2008, no one was willing to even consider the bankruptcy of a eurozone Member State as an option on the table. The growing pressure on financial markets, in particular on the secondary market regarding the yields of government bonds with maturities of close to ten years, started to change dramatically the situation.
From financial assistance “ad hoc” packages to the European Stability Mechanism
The very first attempt from the European Union to establish a bailout mechanism to provide ad hoc financial assistance can be traced to the set-up of the Greek Loan Facility in 2010. It was a significant disbursement of resources, approximately 110 billion of euros, divided between the European Union Member States bilateral loans (80 billion euros) and the resources of the International Monetary Fund (30 billion euros). Attached to the Greek Loan Facility loans there was a political conditionality concerning the budgetary and fiscal policies that the Greek government should have been implemented in exchange for the loans itself. All the related fiscal and budgetary policies were contained in a Memorandum of Understanding agreed and signed between the parties involved.
The financial assistance packages of Greece have been always conducted in a bilateral manner and not in an institutionalized way due to the lack of a permanent bailout mechanism in the Eurozone. This trend started to change with the birth in 2010 of the European Financial Stabilisation Mechanism (EFSM) and the European Financial Stability Facility (EFSF). Both of these institutions can be considered as a predecessor of the following European Stability Mechanism. Indeed, they are both bailout mechanisms able to provide financial assistance to the Member States that have submitted an official request.
The EFSM was created in 2010 with the aim and scope of providing financial assistance “to a Member State which is experiencing, or is seriously threatened with, a severe economic of financial disturbance caused by exceptional occurrences beyond its control”. Its limited financial envelope consisting in only 60 billion of euros and its limited time of action, were the two main reasons why the European Union decided to create the EFSF in 2010.
The EFSF clearly presented some positive elements if compared with the EFSM. For instance, if we look at the financial envelope, the EFSF had a significant number of resources available consisting in 440 billion of euros. The way in which it finances itself is through the issuing of bonds on financial markets and through Member States’ guarantees. Nonetheless, the EFSF itself had some drawbacks when it comes to the time of action; indeed, the instrument was set-up and functioning until the expiring date foreseen by the recital 11 of the EFSF Framework Agreement, which reported the 30 June 2013 as ending date of the operational working.
The necessity of a permanent bailout mechanism was finally undertaken with the rise of the European Stability Mechanism as an international organization outside the EU framework but still highly intertwined. The establishment of the ESM happened also due to the revision of the EU treaties and the European Council Decision 2011/199/EU that allowed to modify article 136 TFEU adding a crucial sentence:
The Member States whose currency is the euro may establish a stability mechanism to be activated if indis pensable to safeguard the stability of the euro area as a whole. The granting of any required financial assistance under the mechanism will be made subject to strict conditionality.
The ESM financial envelope is about 700 billion euros, in which 80 of them are already available and disposable because are subscribed by each Member States according to its percentage share of the European Central Bank capital.
The ESM lending toolkit is wider and much better Member States-tailored if compared with the EFSM and EFSF lending toolkit. Included as tools at the ESM disposal are a various number of options, such as loans within a macroeconomic adjustment programme, primary market purchases, secondary market purchases, precautionary credit line, loans for indirect bank recapitalization and direct recapitalization of institutions.
Another important difference with the previous financial facilities regards the fact that the ESM has gained much more influence and importance if we consider the number of Member States that requested financial assistance to the ESM itself: Spain, Portugal, Ireland, Greece, and Cyprus.
What to expect from the ESM in the future?
The ESM has demonstrated several times in the recent years to be a flexible and adaptable instrument, ready to deploy its firepower in all the asymmetric shocks occurred in the European Union.
Starting from the Covid-19 pandemic the ESM has played a role in providing financial assistance with favorable interest rates in order to finance the rising and urgent demands upcoming from the national healthcare system. With this reasoning, a new credit line called Pandemic Crisis Support was settled. Its aim was – and still is – to finance the direct and indirect costs emerged due to the outbreak of the Covid-19 pandemic, which stressed with variable intensity and degree national healthcare systems across Europe.
The credit line was conceived as one of three safety nets initiative for workers, businesses, and sovereigns alongside the European Investment Bank’s (EIB) loans and the instrument to Support to mitigate Unemployment Risks in an Emergency (SURE).
With this new credit line, the only conditions attached concern the fact that beneficiary Members States shall commit the resources to support domestic financing of direct and indirect healthcare, cure, and prevention-related costs due to the Covid-19 crisis. Each Member State can obtain a loan consisting in a maximum of 2% of its 2019 Gross Domestic Product (GDP) taken as a benchmark for a maximum of 240 billion euros overall if all the Member States apply for the newest credit line.
Another important aspect that should be underlined is the fact that the recent revision of the ESM treaty has brought new competences and powers to the ESM. The revision of the ESM treaty started in 2019 when an agreement was reached on the final text. Among the new competences of the ESM, it is truly worth mentioning the “backstop” i.e., the possibility for the ESM to use its funds in order to guarantee the financial stability in case of a systemic bank crisis, such as the one occurred between 2011 and 2014. Furthermore, the new reform package has not entered into force yet due to the missing ratification law from some national parliaments (above all, Italy, and Germany).
This new role has clearly shown how the ESM can possibly assume new crucial and relevant functions inside the European Union economic framework. The link between the ESM with the European Union and, in particular, with the European Banking Union, can open a new way for the old bailout mechanism, and perhaps dissipate the old fears that encircle the European Stability Mechanism.