The European Financial Stability Facility (EFSF) was created by the euro area Member States in May of 2010 as a temporary response mechanism to the growing EZ credit crisis. It’s mandate is to safeguard financial stability in Europe by providing financial assistance to euro area Member States.

EFSF is authorised to use the following instruments to help stabilize the credit markets:

• Provide loans to countries in financial difficulties
• Intervene in the debt primary and secondary markets. Intervention in the secondary market will be only on the basis of an ECB analysis recognising the existence of exceptional financial market circumstances and risks to financial stability
• Act on the basis of a precautionary program
• Finance recapitalisations of financial institutions through loans to governments

The EFSF is backed by guarantee commitments from the euro area Member States for a total of €780 billion and has a lending capacity of €440 billion. It has been assigned the best possible credit rating by Moody’s (Aaa) and Fitch Ratings (AAA). EFSF has been assigned a AA+ rating by Standard & Poor’s. EFSF is a Luxembourg-registered company owned by Euro Area Member States. It is headed by Klaus Regling, former Director-General for economic and financial affairs at the European Commission.

On December 16 2010 the European Council agreed a two line amendment to its charter allowing for the creation a permanent rescue facility called ESM (The European Stability Mechanism) The amendment states, “The member states whose currency is the euro may establish a stability mechanism to be activated if indispensable 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 will be governed by the European Council and individual countries have no veto power over its authority. However, the ESM faces a series of problems such as the fact that it may not be big enough to rescue larger Southern European nations like Italy and Spain, that it may face funding problems just like EFSF did and that it may have to honor commitments of EFSF which would reduce its capital markedly. Nevertheless, for now the ESM remains the only pan-European institution designed to deal with the EZ credit crisis and as such will be the primary policy tool of EZ fiscal authorities as the year proceeds.