EFSF Borrowing Rate

Calculated Risk is one of the best economics and finance blogs out there. It’s a fantastic free resource for analysis of the US macroeconomy, financial markets, housing markets and other issues. Ireland has hit CR’s radar in the past week or so and in a number of posts he has written that the likely borrowing rate from the EFSF will be 8%.

I believe the source for this figure is an article by Wolfgang Munchau (who in turn perhaps based it on a Barclay’s Capital research note that was subsequently corrected). I discussed this issue here: I believe the correct rate will be lower than 6%. This is still very high but it is worth clarifying that the 8% figure just seems to be based on flawed calculations.

CR must get a million emails and comments a day, so I thought I’d use the blogosphere to hopefully clarify this issue.

25 replies on “EFSF Borrowing Rate”

@Karl Whelan

Glad to know that you are a Calculated Risk fan. I’d also recommend Mike Shedlock’s ‘Global Economic Trend Analysis’, though I reckon most readers here are already familiar with it.

Shedlock is a kind of Morgan Kelly at cosmic level and, like the Irish Prophet, his forecasting skills border on the uncanny. His commenters are also more informed and articulate than those at CR, in my view.

http://globaleconomicanalysis.blogspot.com/

One of the comments under the CR posting on Irish bond rates:

“What difference does it make when we’ve set up a system that allows some of the most pathological people on the planet to run us over and make billions in the process, and pay us off with food stamps when things go awry?”

Says it all really.

I thought the bigger question from their summary wasn’t the rate but the timing.

Ireland has until next June to make progress. If Ireland does need a bailout next year, it will probably come from the European Financial Stability Facility (EFSF) – and at rates of around 8%.

It looks like its CR’s reading of the situation is with enough money already borrowed to pay wages till June 2011, the paddies can procrastinate for another 6 months.

It seems to me that the EFSF will have to set rates below 6%. The fact that current market rates are c. 8% is irrelevant.

With EC signing off on bailout of Anglo (and the other banks) because they do not want to see systemic risk (or contagion) developing, they should at the very least underwrite approx €50billion of Irish debt by offering to buy €50b of Irish debt at an average EU bond rate (this could be ring-fenced) at a rate close to 5.5%. Furthermore, this form of non-standard monetary policy would have the effect of stabilising the Irish sovereign bond market and bring about lower spreads (moving bond yields to c. 6%).

Based on John McHale’s previous post, with nominal rates at 6% the national debt can be sustainable.

Perhaps one way out of this pickle would be to nationalise profitable oil and gas projects such as the Corrib field? (Obviously not something that FF would do but that MK’s putative right-wingers would?)

Winston Smith

“With EC signing off on bailout of Anglo (and the other banks) because they do not want to see systemic risk (or contagion) developing, they should at the very least underwrite approx €50billion of Irish debt by offering to buy €50b of Irish debt at an average EU bond rate (this could be ring-fenced) at a rate close to 5.5%. Furthermore, this form of non-standard monetary policy would have the effect of stabilising the Irish sovereign bond market and bring about lower spreads (moving bond yields to c. 6%).”

I didn’t ask the EC (whatever that is) to “sign off” on “bailout of Anglo”.

If the EC (whatever that is) want to “sign off” on the bailout of Anglo they can go ahead and print €50,000,000,000.

Why you think the EC (whatever that is) should lend Ireland money to bailout Anglo Irish is beyond me.

You have spent insufficient time reading the dictionary of Newspeak.

Are you not familiar with “The Theory and Practice of Oligarchical Collectivism”?

Why should Ireland accept slave/colonial status?

Why not dump Anglo/INBS and now Allied Irish Banks?

@winston& Joseph

Is it not the case that buying Government Bonds is verboten under Lisbon and that the Greece bailout was engineered under the tsunami clause (122 I think)

There was a time when the term political economy was used instead of the “science” of economics. Ireland’s predicament at the moment is heavily loaded on the political side of the equation. As a reasonably intelligent person with money invested in Irish gov’t bonds or Irish gov’t backed bonds one would have to be aware that the present right of centre coalition gov’t could be replaced with a nationalistic, parochial or god forbid socialist gov’t within a few months. Never forget that when politics comes in the door science flys out the window. Trust is a delicate creature, do the Irish trust their gov’t?, do foreigners trust the Irish gov’t?

Constantin Gurdgiev recently posited where the yield should be based on an IMF paper- he was right.

@ceteris paribus.
Nothing is verboten in the heat of battle. Right now Ireland is in a fight for survival. But so is the European banking system. Personally I think the interest rate proposed by Winston is too high but at the end of the day, the interest rate has to be low enough to allow both patients to survive.

@JR: “. . .interest rate has to be low enough to allow both patients to survive.”

Yes indeed. But what sort of aggregare economic growth do this require? Not what nominal value of – but what should the nature and type of that growth be? Very pregnant silence from all sides on this one. I do not know the answer to this one. Down on the farm?

I know what the historic options have been. But these are not going to be available in a few years – energy prices will be much higher, even with the economic downturn.

I formed the opinion some years ago, before Ireland went into this current downturn that it would result is a permanent economic regression. Our standard of living (not the cost unfortunately) would be in mid 1990s. OK for most I suppose, but surely in the wrong direction if you want to be able to pay down debt without defaulting on some or even all of it.

Brian P

Bill at CR does get a lot of emails, but you’d be amazed at how good he is at replying to them. Send him an email, and there’s a good chance he’d get back to you.

Damning with fair praise, eh? Like your style!

If they do not correct, then perhaps damn with less than praise? But I was always one for confrontation!

The interesting thing is just how interest rates will go eventually? As economists all know but seldom say, credit is created instantly by anyone who still manages to hold the confidence of the users of that credit. Therefore, as all issuers eventually default when fiat is concerned, timing is Very important. They want a little “crisis” to devalue the euro, but do not want to cause further damage to the money machine. Ultimately the burden of the cost of all of this is distributed and those who can afford the most usually end up paying more per capita. The exact amount is for finessing by pols. In Europe.

In the meantime, I expect more news management from Ollie et al. Euro down but confidence maintained? They probably will overshoot but what indicia do we anticipate they wioll use?

Karl,

You may have seen this clip on Bloomberg http://www.bloomberg.com/video/64352822/

Two leading US analysts discuss the prospect of Ireland’s financial problems and what options are open to us as a nation when we run out of cash – 60 days according to these guys.

One of the analysts goes on to claim that the EFSF is a “sham”in that it is not funded. According to the analyst, there is no EU rescue fund.

Is this guy correct?

What sort of volumes are being traded on the 10 year today ? With the speculators looking for blood it is like something out of mythology.

@Karl

Thanks for a great blog. Re your calculation of the EFSF cost to a borrower, you quote 4(8) from the Framework Agreement and interpret it as requiring the borrower to pay interest on 120% of the facility. Here’s an alternative interpretation.

I read 2(3) as the member countries provide a 120% guarantee and 4(8) as the loan having the Margin (the spread over EFSF funding costs) PVed and, along with the 50bps Service Charge, paid upfront by being deducted from the disbursement. PVing 300bps (the Greek margin) over 3yrs results in a 17.5% deduction (with a discount factor of 1.57% 3yr s/a swap rate).

4(8) also says ‘together with such other amounts as EFSF decides to retain as an additional cash buffer’ but is unspecific on an amount. If that were 5% (?) then the total cash disbursement would be reduced by (0.5+17.5+5)=23%, the retained monies being the facility ‘Cash Reserve’ which earns interest for the guarantors, 4(9).

If the ‘coupon’ is EFSF funding rate+Margin = 1.57+300bps = 4.57% (so headline rate of less than 5%), but payable on 100 when 77 is received (and presumably paid back), the effective cost is then 5.94% (rising by 0.4% for a cash buffer increase to 10% eg Cash Reserve of 28%).

So, still less than Mr Munchau’s 8% and only a bit more than your suggested 5.68%. Note thought that 3year swaps are creeping toward the 2% level above which a headline rate of 5% would be exceeded, assuming 3% Margin.

This looks to me like a bond issue with a 4.57% coupon and 0.5% underwriting fee where an amount equal to the interest is escrowed over the life of the bond and then released at maturity to meet redemption, the bond having been serviced independently to the ecrow account. I would be interested to hear any other interpretations

Sorry if this in the wrong thread, it seemed more current than the other.

@Karl

Before I move on, another point raised in many comments I have seen is how close the EFSF could borrow to 3year swaps. It will only issue when a country makes a request and is probably in imminent trouble and so markets will likely be at best nervous.

Its guarantee comprises 7% Ireland, Portugal, Greece combined, 11.9% by Spain and 17.9% by Italy. If markets were nervous about either Spain or Italy at the point of issue then their contribution to the gurantee would be in question hence the perception of the (if not the actual) AAA rating. If the problem causing market volatility and contagion leading to a country drawing on the EFSF originated in either Spain or Italy it is quite possible that an EFSF bond issue would be too difficult for the market to price and so the facility would fail.

Commissioner Rehn has been out in NY presenting to investors obviously expecting international investors to particiapte in any bond issue. At the point of crisis when the EFSF needs to tap the market is a EUR issue really likely to appeal to nonEuropean investors? The EFSF can issue in other currencies, who then bears that FX risk? It would have to be the borrower nation, further adding to borrowing costs.

I can easily see another 10-25bps for issuing a multibillion, multitranche, multicurrency bond wth a questionable rating out of a CDO type structure in a volatile market and 10-25bps (?) for an FX swap. So I think another 0.25% can be conservatively added. 3yr swaps are now at 1.82 putting the cost nearer 6.5%.

@Karl,

Apologies…a correction is required to my above analysis. 300bps PVed over 3yrs is obviously not a 17% discount but nearer 9%, reducing the effective rate by 0.35%. That still leaves my estimate at north of 6%.

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