Barclays recently argued that Italian policy reforms alone would not suffice to bring Italy out of the crisis; the country is also likely to need an external financial ‘shield’ to protect against destabilizing market dynamics. We now ask how large this ‘shield’ may need to be, and whether it is plausible that the required funding can be mobilized.

Italy’s potential demand for financial support cannot be taken in isolation, since other European sovereigns have already received substantial support from Europe and the IMF. Requirements to support Spain also need to be considered.

Barclays do not think that Italy or Spain need to be taken out of financial markets, as Ireland, Portugal and Greece were. Neither country has lost access to markets; financial support should be designed to protect market access, not compensate for its loss. And the larger the potential source of contingent finance, the smaller the likelihood that this financial ‘war chest’ will need to be used.

While there is no scientifically precise way to estimate the contingent funding required to protect market access, we think 18-24 months of public financing requirements is a reasonable benchmark. This amounts to a range of EUR 500 billion to EUR 800 billion for Italy and Spain together.

It is possible to come up with joint contributions from the EFSF, the IMF and the ECB (via the SMP program) that add up to this amount. But the funding is not in place for now, and things may need to get (even) worse before it is catalyzed. The constraint that the ECB operate only in the secondary market does not eliminate, but does weaken the force of its contribution to the program.

The odds of success in managing the euro area crisis depend to a large degree on developing a more coherent vision of the post-crisis landscape. Both markets and policymakers need greater clarity on the institutional endgame of the European financial drama, without which markets are unlikely to settle.