Size matters when it comes to bailout funds

Louisa Bojesen
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EUROPEAN leaders still have their work cut out for them. Even though we now know they’re not (officially) moving towards introducing a Eurobond, this is still the direction many in the market argue makes the most sense. Even if it would once again mean the richer European countries underwriting the debts of the poorer ones.

Merkel and Sarkozy also said they wouldn’t increase the value of the European Financial Stability Facility (EFSF) – but why not?

Some analysts would like to see funds available to the EFSF increased from the current €440bn to more than €2 trillion.

Size does matter when it comes to stabilising large economies. The US, for example, threw a big pile of money at the problem from the word go with the introduction of the Troubled Asset Relief Program (TARP), which allowed the US Treasury to buy or insure around $700bn of troubled assets.

But by increasing the value of the EFSF you would also be adding to the long-term debt pile, so it’s important to ensure that the money would be put to good use to help spur growth. Especially in the midst of ongoing worries about bank liquidity.

Just because you increase the value of the EFSF, that doesn’t necessarily mean that markets will stabilise if the money isn’t being put to use in the right way.

Satish Pulle, a portfolio manager at European Credit Management, says that the recent concerns about the French banks have been overblown, and that while some may need capital to strengthen their balance sheets from good to very strong, liquidity is not as big a concern as markets have recently assumed.

Interestingly, Pulle suggests that one solution to the European sovereign bank situation could be to use EFSF funding as capital for the banks. This would prevent escalating concerns over bank capital and funding.

Pulle believes that if you strengthen the banks directly, they could then help with sovereign issuance over the next few months – exactly how the US used the TARP program. This approach, says Pulle, would eventually end up greatly reducing the total amount of bailout funds required.

With some questioning whether we’re headed towards a double-dip recession, Pulle thinks that the European sovereign debt and banking crises are bigger issues for global markets than the rising probability of a US recession.

Louisa Bojesen is a CNBC anchor followe me on Twitter @louisabojesen