It Doesn't Matter What Slovakia Does: the EU Bailout Fund Cannot Succeed

The European financial stability fund is going to fail no matter what Slovakia (or any other country) decides to do. It will not have and cannot get sufficient funds to do what the EU wants.

To recap:

• In July, European leaders crafted the fund (technically, the European Financial Stability Facility or EFSF) as a $588 billion rescue fund to prop up Greece and other nations that are bankrupt in reality -- if not in public.
• Of course, it isn't just the governments which will need rescuing. It is also all the other institutions that made loans to Greece & Co.
• When (not if) the default happens, a lot of already shaky banks will have much more debt than they do assets. Investors and depositors will then act on the fact that those institutions are not a good place to keep their money.
• The banks that loaned to the banks that loaned to Greece will also have more debt and people will worry about those banks.
• This will worry the banks that loaned to the banks that loaned to the banks to fund the mess that Greece built.

"Recapitalizing" European banks (the preferred euphemism for bailout, apparently) in order to stabilize them in the face of "haircuts" on sovereign debt (the preferred euphemism for losses, obviously) through a facility like the EFSF risks a spiral that will make the bailouts more difficult to fund.

The EU finance ministers have done the same basic math you have and realize that at best they are still $1.75 trillion short of paying the rent. So they are now saying the EU/IMF money will serve as "equity" which they will then "leverage" into a lot more money by borrowing from the European Central Bank.

Two problems here.

1. It assumes a lot of people in a lot of EU nations will be willing to take on all this debt in the name of preserving the EU.
2. Even if they do, the EU is then incurring more debt in order to pay off debt. This can work only if income is increased enough to pay for the new amount of total debt. That requires higher taxes AND no more debt being incurred for a good amount of time.

Because the resources for recapitalization will surely not come from private investors, but rather states would ultimately have to raise the funds themselves, thereby worsening their debt levels. The key to the problem therefore lies with governments to restore trust in the solidity of state finances.Greece is hemorrhaging money. Italy is already borrowing money to make payments on its debt. Spain? Portugal? Ireland?