I said previously that any eurozone bail-out should ideally happen after 2013. Events have overtaken me. It would be best, now, if vulnerable euro member states could hang on for a couple more years. And all because of domestic German politics.
Angela Merkel’s coalition partners, the Free Democrats, resisted the idea of paying in so much capital to the eurozone rescue fund so quickly. As a result, the eurozone rescue fund will be capitalised later, and more slowly.
It would be better for sizable eurozone bail-outs to occur after July 2013. This is the implication of a strange state of affairs in Brussels: namely that policymakers have agreed how to fund the future ESM to its full value, but not its predecessor, the EFSF.
Only about €250bn of the existing €440bn European Financial Stability Facility is available to bail out beleaguered eurozone sovereigns. This is because the fund wants to lend with an AAA rating, but several contributing eurozone sovereigns are rated lower. Increasing the rating is achieved, in effect, by overcollateralising each loan. Now it has been agreed to increase the lending capacity of the EFSF, but no word yet as to how. Apparently, further overcollateralisation has been ruled out: according to Citi’s Jurgen Michels, the lending capacity of the eurozone’s transitional measures (currently the EFSF and EFSM) shall never exceed €500bn.
The ban on further overcollateralising the rescue fund might seem odd, since that is partly the solution agreed for the European Stability Mechanism.
Despite record yields, no bonds bought by the ECB settled last week – that’s two in a row for the eurozone central bank. The stock of ECB-bought bonds therefore remains at €77.5bn. Next week might be different, however, as demand for Portugal’s unexpectedly successful bond auction last week might have been driven by ECB purchases.
In future, buying government bonds at auction is a role that might pass to the eurozone’s rescue fund, the EFSF. A deal struck between eurozone heads of state over the weekend agrees that the fund can intervene in primary market (i.e. government debt auctions) in exceptional circumstances. This would not entirely replace the ECB’s role, as they have bought debt in the secondary (i.e. resale) bond market, too. Of €77.5bn ECB bond purchases, we do not know the split between primary and secondary debt – though anecdotally, secondary market purchases seem to have been bigger.
If it is approved, the nascent agreement reached in the small hours of Saturday morning will address many of the symptoms of the eurozone’s disease. Note, though, that the fundamental issue of bond haircuts was not addressed. Euro leaders’ hard work leaves them on target for what was a very tight March 24/25 deadline. Measures include:
- Increase the effective lending capacity of the EFSF from ~ €250bn to €440bn. The Fund already had €440bn at its disposal in theory, but needed to hold back a proportion in order to issue AAA-rated debt. Discussions are ongoing on how to achieve this.
- Give the EFSF the right, “as an exception”, to intervene in primary debt markets – though with such strict conditionality that some analysts say this will make little effective difference. The right, which will extend to EFSF successor, the ESM, is not a full substitute for the ECB’s bond-buying programme, since the ECB buys bonds in both the primary market (government auctions) and secondary market (resale of already-issued bonds).
- Lower the rates charged by the EFSF on bail-out loans to take into account debt sustainability of recipient countries. Rates should remain above facility’s funding costs and in line with IMF pricing principles.
- Specifically, for Greece: reduce the interest rate on rescue loans from 5.25 to 4.25 per cent and increase the average maturity of Greek bail-out loans from 4 to 7.5 years.
- €500bn funding confirmed for the ESM, EFSF successor.
- Further explore the idea of a financial transaction tax.
Europe’s permanent rescue fund will have half a trillion euro available to lend. This might seem a bit low, given current discussions about extending the size and mandate of the current (temporary) €500bn rescue system. But officials point out that the current system, comprising the EFSM* (€60bn) and the EFSF** (€440bn), can only lend about €255bn in order to maintain a triple-A rating on its debt; the permanent ESM***, by contrast, will be able to lend the full amount.
Agreement on the sum involved has not reassured markets, however: much is yet to be agreed, and upcoming Finnish elections could threaten unanimity on signing off the changes by March 24-25. That timeline was already tight. Several additional finance minister summits have been mooted or agreed before the end of March to help achieve the aim. Indeed, given that economic co-ordination and budgetary rules are also on the agenda, agreeing the fund’s size was the bare minimum. How the ESM will be funded remains unclear. One hopes agreements went further in private.
Back to zero for the ECB, as latest data reveal the central bank didn’t buy any government bonds settling last week under the Securities Markets Programme.
Yields on government bonds – which ECB purchases act to depress – remain near record highs in several southern European countries, and in Belgium. In Portugal, in particular, yields remain above the important psychological level of 7 per cent.
Klaus Regling, EFSF chief, is apparently wondering whether he could have demanded better terms for Tuesday’s 2016 bond, given spectacular demand. Indeed, he probably could have secured a higher price (lower yield) – a valuable lesson for the remaining €21bn-odd debt to be issued this year. But would Ireland benefit if he did, or would the EFSF just stand to make a bigger margin?
The 2016 €5bn bond issued by the eurozone yesterday is intended to finance a loan for Ireland. Lex points out that of the €5bn raised at 2.89 per cent, only €3.3bn will be lent to Ireland – at about 6.05 per cent. (The final cost to Ireland and the exact loan amount won’t be known tillthe EFSF has reinvested the cash reserve and buffer.)
Strong demand for today’s eurozone bond issue, priced at a yield equivalent to 2.89 per cent. Hardly surprising. For exactly the same risk profile as German bonds, you get half a percentage point extra payment per annum for your money. (48 basis points, to be precise.)
The news is being greeted as a vote of confidence in the eurozone. Likewise, Japan’s pledge to buy at least 20 per cent of the bonds was treated as an offer of support. Klaus Regling, EFSF chief, said: “The huge investor interest confirms confidence in the strategy adopted to restore financial stability in the euro area.” But does it? Really?
Surely hard-headed profit-seeking is a more plausible explanation? After all, a vote of confidence would be investors buying Portuguese, Greek or Irish bonds; whereas here they are buying bonds backed in full by Germany. The legal framework of the EFSF makes clear that member states are each independently liable for debt issued, up to their maximum commitment. The only exceptions are countries currently “stepping out” (Greece; Ireland) and those that have not yet signed up in full (recent euro-joiner Estonia). See the table below.
European officials are considering measures to overhaul the eurozone’s €440bn rescue fund, including using it to buy bonds of distressed governments, say people involved in the deliberations. The changes would make it easier to aid debt-burdened economies without resorting to fully fledged bail-outs.
Buying bonds of distressed countries to lower their borrowing costs is currently only being employed by the European Central Bank, a policy that has proved controversial.