By December 2011, euro area leaders figured they had put together enough euros to reach the symbolic figure of $1 trillion in backstop resources. They hoped that amount would calm markets concerned that Spain or even Italy might represent Europe’s next weak link. Not only did they agree to reinforce the EFSF’s guarantee structure and add new leverage tools, they also pulled forward the ESM’s entry into force to mid-2012, so the euro area would soon have a robust and capital-backed firewall instead of the EFSF’s temporary guarantees.

When they met on 9 December, the leaders added some finishing touches aimed at making the promise of $1 trillion more credible^[1].

For the total commitment to hold up, a number of factors would need to come together. As IMF members themselves, they would lobby for the fund to receive a €200 billion temporary increase from euro area member states. And they pledged to review the capacity question again in March 2012.

Unfortunately, the headline number’s foundations were not completely sturdy. Former ECB President Trichet put the problem succinctly: ‘The amount of money that was really mobilised was significantly more meagre than what was promised and, in my view, was one of the reasons why the Europeans lacked the level of credibility that would have been necessary given the circumstances.’

First, the IMF assertion materialised at less than initially announced. In a mid-December meeting, finance ministers heralded only a €150 billion increase in the IMF, to be funded by currency union members. While a few EU Member States that were not in the euro area were willing to take part, the UK resisted^[2] so the initial €200 billion figure became unworkable.

Meanwhile, the speedier ESM debut raised many questions. Now that the permanent firewall would be running in parallel to the EFSF, was there any chance the capacity of the two funds could be combined? This in turn raised the stakes for the March capacity review, as EFSF CEO Regling acknowledged in a 17 December interview with Al Jazeera, where he tried to quiet the drumbeat of questioning whether or not Europe was willing to act.

‘Markets will understand that there is enough “firepower” – i.e., immediately available financial assistance to any euro area country – if needed,’ Regling said, specifying that this would include any country, not just the three that were already seeking aid^[3]. ‘Firepower is increasing, and also, importantly, the summit decided to review the availability of firepower, if that is necessary, by March 2012. By then we will know whether more is needed. At the moment I think we have more than enough.’

In the interview, Regling pushed back against the idea that resources were insufficient to stand behind the euro with both Italy and Spain in the market’s crosshairs. Even in a worst-case scenario, the fears of actually needing a trillion euros in a short timeframe were unfounded, he said. ‘It’s not correct to look at the total outstanding debt,’ Regling told the news channel. ‘When we look at firepower, the question is what may be needed over the next 12 months, maybe the next 24 months, but no more than that,’ he explained. ‘We know, for instance, that Italy and Spain have about €600 billion in maturing debt over the next two years. So that’s the appropriate figure for the comparison with the firepower of the EFSF.’

Doubts remained. Euro area authorities were quietly mulling over Italy’s situation. The Italian economy had been relatively stagnant for most of the 2000s, with banks struggling and the country’s debt high. The crisis had pushed bond yields up to worrying levels. European policymakers wondered if a rescue programme would be needed, and, if so, if it could be big enough to make a difference.

‘A programme was discussed back then. In fact, I remember it was the topic of the moment at the Cannes Group of 20 in November 2011,’ said Grilli, the Italian deputy finance minister at the time, who would become finance minister in July 2012.

In Cannes, the leaders ended up encouraging Italy to work more closely with the IMF, rather than recommend that the country take the extra step of requesting aid. The end-of-summit communiqué said: ‘We support the measures presented by Italy in the Euro Summit and the agreed detailed assessment and monitoring by the European Commission. In this context, we welcome Italy’s decision to invite the IMF to carry out a public verification of its policy implementation on a quarterly basis’^[4].

The ESM’s Nicola Giammarioli, who was at the IMF at the time, now heads the ESM strategy team, and has been mission chief to Greece and Ireland. He said that precisely because Italy was so big, with sufficient resources, it was able to find a solution from within. And because Italy – like most euro area countries – maintained good relations with financial markets throughout the crisis, it did not face the same loss of access to borrowing that other euro area member states encountered when spreads began to widen.

The exaggerated fears for Italy would not be borne out, but, as long as the euro area leaders tried to keep the joint rescue capacity small, there was equal pressure from financial markets to question if it would be enough to protect the euro area from a meltdown. The cascade of crises in the US had persuaded markets to be wary of small-scale relief efforts.

Shock and awe characterised the US plan, said IMF Managing Director Lagarde. The then-US Treasury secretary, Henry ‘Hank’ Paulson, had famously told colleagues in 2008 he was looking for a ‘bazooka’ to blast at the market and turn sentiment around^[5]. That became the $700 billion Troubled Asset Relief Program – a number chosen in a bid to exceed the market’s expectations.

But that approach was foreign to Europe, Lagarde said. ‘That was very much the hallmark of the US. The go big or go home approach to life. Tim Geithner and others on the US side were always advocating bigger than big if you can. Whereas, in Europe, we’re a little bit more cautious and concerned because we knew that member states were being drawn into something that was not necessarily in their respective purview, because it was new and different.’

Regling made the point that, if you assumed the ESM would get a full fresh start and included all past commitments, the euro area already had €800 billion available: about €50 billion remained in the EFSF programmes for Ireland and Portugal, about €100 billion in EFSF funds were already earmarked for Greece, and the euro area also had its incoming €500 billion permanent firewall plus the IMF’s €150 billion.

But just days before the end-March 2012 capacity review, the total firepower that leaders planned to deploy was still an open question.

If the euro area did nothing, total firewall capacity would be capped at €500 billion, with the EFSF’s existing €192 billion in commitments subtracted from the ceiling to make only about €300 billion available for use. Under the middle-ground option, the ESM could start afresh, but the EFSF would be capped at what had already been committed. For maximum effect, the euro area could decide that, for the year until the EFSF stopped accepting new programmes, the firewall would have access to its full €440 billion capacity on top of the €500 billion coming in with the ESM.

‘The ECB welcomes the commitment of Europe’s leaders to regularly review the lending capacity of the ESM and urges them to quickly agree on a significant increase of the resources of the ESM by combining the lending capacity of the ESM and the EFSF,’ said Peter Praet, a member of the ECB’s Executive Board, in a March 2012 article published by a European financial markets conference^[6].

Just one week before the 30 March meeting in Copenhagen, a draft circulated widely in the press suggested the maximalist issue would win the day. The EFSF’s roughly €240 billion in unused capacity could be tapped ‘in exceptional circumstances following a unanimous decision of euro area Heads of State or Government notably in case the ESM capacity would prove insufficient’^[7]. But that language did not occur in the final draft, meaning the potential maximum ceiling of combining the two funds to make €940 billion was never enshrined in policy.

Instead, finance ministers went for the middle option. They agreed on a combined ceiling for the EFSF and ESM of €700 billion: the full permanent firewall plus the roughly €200 billion that had already been committed from the temporary backstop. Their statement also echoed the €800 billion number that Regling had been using in the markets, by adding on the €53 billion paid out of the Greek Loan Facility and the €49 billion paid out of the EU- wide European Financial Stabilisation Mechanism. ‘All together the euro area is mobilising an overall firewall of approximately EUR 800 billion, more than USD 1 trillion,’ the Eurogroup said in a statement^[8].

The firepower debate was finally over^[9].