November 30, 2011
The past 24 hours have seen a flurry of action around the world, in response to growing concern about the euro zone's sovereign-debt crisis. The story begins in Europe, where finance ministers meeting to discuss the future of the European Financial Stability Facility seem to have taken some key decisions regarding the fund. The EFSF will be able to lever its meagre €440 billion in capital (less amounts already committed to rescues for Greece, Ireland, and Portugal) in two different ways. First, by using its resources to guarantee 20% to 30% of the bond issues of struggling peripheral economies and, second, by creating "co-investment funds" that (it is hoped) will attract money from other investors and which can be deployed to buy bonds.
The trouble is that the total firepower of the EFSF is likely to fall short of expectations and well short of what will probably be necessary. It may amount to €1 trillion, but that's far too little to manage serious trouble for, say, Italian bonds. The ministers are increasingly eyeing the IMF for assistance, but its capital is also limited; the IMF has under $400 billion available to lend. There are hints that leaders are exploring the idea of channeling loans from the European Central Bank through the IMF, but it isn't clear that this will fly with the ECB's conservative, German contingent. There is an element of collective breath-holding, as everyone waits to see what will emerge from a meeting of euro-zone heads of state on December 9th—quite possibly a make-or-break gathering.
Against the backdrop of these disappointing outcomes and the deteriorating financial situation in Europe, central banks have once more ridden to the rescue. The Federal Reserve, Bank of England, European Central Bank, Bank of Japan, Bank of Canada, and Swiss National Bank announced today their intention to coordinate action to ease liquidity conditions in financial markets. The Fed will increase its dollar lending to other central banks who will do the same to other financial institutions, and all will reduce the cost of dollar borrowing. The aim is to defuse the growing trouble banks have had borrowing to finance their operations.