Critical vote for eurozone bailout fund
02:45 - Source: CNN

Story highlights

European leaders are voting to increase powers of Europe's bailout fund

Increased powers likely to be ratified by the end of October

Tthere are still doubts the fund will have enough firepower to halt the crisis

Other measures are already under discussion

London CNN  — 

What is happening with the eurozone bailout fund?

European leaders are voting to increase powers of the European Financial Stability Facility – Europe’s bailout fund – so it can increase its lending capacity from around €250 billion ($341 billion) to €440 billion ($600 billion). The new powers will also allow it to buy sovereign bonds in the capital markets, a strategy designed to prop up debt prices and help struggling eurozone countries fund themselves.

The bailout fund is being increased after the initial pot of cash, which was put in place after Greece’s €110 billion bail out last May, was tapped by Ireland and Portugal, before Greece returned for more help.

The original fund was meant to stem the crisis but this has not happened. Instead, the crisis has intensified, feeding global instability and driving the eurozone to the edge of recession.

A key vote for ratification – from Germany – took place Thursday, following votes in favor this week from Austria and Finland. German lawmakers voted in favor of the measures by a large majority.

Why was Germany’s vote so important?

Germany is the eurozone’s biggest economy, and the country’s Chancellor, Angela Merkel, is a key figure in attempts to pull the bloc out of its crisis.

Merkel is facing rebellion from the streets due to the country’s effective underwriting of the eurozone’s weaker economies. She is also facing fractures within her own coalition, with the Free Democratic Party’s Philipp Roesler – leader of the coalition’s junior party – sending shockwaves through the markets by saying an orderly insolvency for Greece could not be ruled out.

However, Germany’s lower house of parliament, the Bundestag, passed Thursday’s vote with a significant margin - 523 in favor to 85 against, with three abstentions.

Why are the bailout fund’s powers being expanded?

The fund’s expansion is meant to calm investors who are worried countries like Greece will be unable to emerge from their financial problems while others like Italy and Spain – deemed too big to fail – may need financial assistance.

Increased powers of the fund are likely to be ratified by the end of October, once all countries have approved it.

However, the eurozone debt crisis has continued to deepen since the proposal was made public. Greece is now teetering on the brink of default and in desperate negotiations to access a €8 billion tranche of funds, without which it could run out of money next month.

Can the fund pull the eurozone out of its crisis?

Europe’s leaders are desperate to stem the crisis, which is now casting its shadow across the global stage. It has prompted warnings from U.S. Treasury Secretary Tim Geithner that it is the “most serious risk now confronting the world economy.”

However, there are doubts the fund, even once strengthened, will have enough firepower to halt the crisis.

Investors are becoming less and less willing to buy the debt of eurozone countries, and concerns are increasing around the strength of some European banks exposed to Greek debt.

This week, markets were buoyed by reports there were plans to strengthen the fund even more by leveraging its assets to enable access to around $2.7 trillion in funds. The reports were denied by European leaders, but many market participants argue the fund will need to be restructured in some form to contain the contagion effect should Greece default.

However, political differences within Europe and an increasing reluctance to fund the eurozone’s troubled countries means any more significant changes to the fund could take some time to implement.

But could other measures be implemented?

It’s not yet clear, but with Greece heading toward likely default the pressure for a response that will calm the markets is intense. Jacques Cailloux, an analyst with the Royal Bank of Scotland, says a significant policy response at this stage remains “sketchy,” but appear to include some of the “game changing elements” needed to stabilize the bloc.

Ideas floated so far are “likely the beginning of a flurry of new proposals that will filter through over the coming weeks,” he says.

Pavan Wadhwa, global fixed income strategist at JP Morgan, believes European leaders need to look at alternative ways to fix the crisis, including turning the fund into a bank with funding support by the European Central Bank.

He also believes European countries need to set up structures similar to the U.S. Troubled Asset Relief Program, which would allow recapitalization of the banks through government funds if needed.

What do changes to the bailout fund mean for Europe?

Apart from attempting to stem the crisis, changes such as this can be seen as shifting the bloc toward greater fiscal integration. The eurozone is currently a monetary bloc – with interest rates dictated by the European Central Bank – but each country retains its own tax policies, budgets and banks, and issue their own bonds.

Shifting toward a more integrated structure would be a huge political change for the eurozone, and will most likely meet massive resistance.

But, no matter what changes are made, the bloc appears set to hit even stormier waters. According to Wadhwa: “The sovereign debt crisis is going to get worse before it gets better.”