ESM Details

Details of the proposed structure of the new European Stabilisation Mechanism can be found in various parts of the World Wide Web thingy, e.g. here and here.

Two things jump out to me. First, the agreed margin on a 7.5 year fixed rate loan from the EFM would be 260 basis points, about 60 points lower than the current rates on offer from the EFSF. Perhaps someone will insert a clause making the margin dependent on a country’s corporate tax rate but somehow I doubt it.

Second, despite a lot of previous focus on the idea that only bonds issued after 2013 would be eligible for restructuring, the proposal does not contain such a commitment. As expected, there is a commitment that government bonds with a maturity greater than one year issued after the introduction of the ESM will have to have collective action clauses facilitating restructuring. But rather than adopt a position that existing bonds cannot be haircut, the proposal seems to essentially take the opposite strategy. A country that fails a “sustainability analysis”

will be required to to engage in active negotiations in good faith with its creditors to secure their direct involvement in restoring debt sustainability. The granting of the financial assistance will be contingent on the Member State having a credible plan and demonstrating sufficient commitment to ensure adequate and proportionate private sector involvement.

I’m all in favour of this, having argued at various times (e.g. here and here) that a proposal to only haircut bonds issued after the introduction of ESM was unworkable. However, this does help to explain the market jitters of the past few days. The Irish two-year bond yield was up another 40 points or so today and stands at 10.25% as I write, having reached as high as 10.7% earlier today.

24 thoughts on “ESM Details”

  1. Being & Time, Being & Time

    This is the Tango. And more than obvious now that neither Angie nor Nicky had read it prior to their ill-timed and ill-judged bilateral Dance of the BondFires at Deauville.

    In our case, 10.25% is our present Being & Time: the point of no return, and well beyond time to take Heidegger’s Hammer to banking system debt. This is our strongest negotiating tool, but its power diminishes exponentially as time moves on – by 2013 it will be totally powerless and full blown conflationist vichy_debt/sovereign default will ensue … only supreme fools, or fully certified absolute eejits, would wait for that one.

    Will we ever wake up?

  2. The EU has really been impressive in its complete and rank incompetence throughout this last year of the crisis. Is it any wonder the markets are running for the hills. Constantlly doing half measures and half-turnarounds, and then constantly allowing local politics to shape every decision. Look at the US and UK responses to the crisis – shore up the banks, print some cash, let their central banks go into overdrive. Yes those countries have long terms issues to deal with, but at least they had a coherent strategy how to get out of this mess. The EU, not so much. Not at all in fact.

  3. @Karl

    It is striking that while the Term Sheet is explicit that the CACs are post June 2013, there is no such explicit deferment noted for the PSI. I wonder where that would leave the lack of preferred status for the EFSF. Debtors have traditionally been quite selective when it comes to restructuring, but it would make a bit of a mockery of the trumpeted lack of seniority.

    Your position in regard to resolution/bail-ins is perfectly reasonable. I would just make one point in regard to the chorus of international opinion pushing for such approaches: I think a large part of the motivation is concern about lack of market discipline (creditor moral hazard) under bailouts. A lot of these positions — Eichengreen, Roubini, and others — can be traced back to the aftermath of the Mexican, Asian and other crises.

    But lack of market discipline seems a remote concern for us given where we are at the moment. There is a right time and a wrong time to worry about moral hazard — a point made by Larry Summers during the Asian crisis, but I didn’t properly appreciate until our own brush with severe market discipline. That is why I am led to approaches that I think give us a better chance of regaining market access, which tend to be more on the dependable bailout end of the spectrum, with the quid pro quo being some combination of strict conditionality and credibly signing up for more “regulatory” forms of discipline.

  4. @John McHale

    So called ‘moral hazard’ (sic) lost all relevance around here in late September 2008 – each time I see it in print I cringe ….. I was never a great fan of the term anyway …

  5. @ Bond. Eoin Bond

    Spot on.

    Well Portugal may have gave them something more to think about now !

  6. @ John

    The CACs element, if passed, means that market discipline is coming one way or another but moral hazard is not my primary concern with what I have perceived up to now as the policy of only post-2013 bonds being eligible for haircut.

    My concern about protecting existing bondholders is that the numbers don’t add up and this could hurt sovereigns attempting to get market funding after the line in the sand has been drawn. Whatever chance Ireland has of getting out of a sovereign default, it is strengthened, not weakened, by the fact that existing bondholders can be bailed in.

  7. My understanding, at variance with many in the market, was that this CAC angle was very much the intention all along.The CACs are simply intended to facilitate (relatively) orderly restructuring should push come to shove, rather than give the green light for restructuring those specific bonds….the latter reading seems perverse. Inserting CACs into new bonds doesn’t affect seniority.

  8. @Karl Whelan

    … humbly suggest make distinctions between various ‘bondholders’ – the term ‘bondholder’ without a qualifier, is highly dangerous …… it may signal acceptance of vichy_bank/sovereign conflationism …. or the Irish penchant for universal obligations …..[neither of which we can afford]

    Patricia the Irish Sovereign_in_Exile is particularly picky, strenuously and vehemently picky in fact, for very understandable reasons, on this particular point.

  9. @Karl

    I could buy that if I thought a near-term restructuing (with continued transitional funding) was on the cards. As I noted on another thread, I think there is a big danger that we are entering a “no-man’s land”, where restructuring is postponed, but hangs over us like a fog. We could end up in a quasi permanent state of dependency, or possibly with an eventual default that could have been avoided, and with all the reputational damage that goes with it. (Behind this, I admit, is the belief that there still is reasonable chance that a default can be avoided and market access restored with the right kind of assistance — though I am becoming increasingly pessimistic about the latter.)

    Quick point on the CACs: If memory serves me right, Eichengreen and Mody have found that they don’t have a large effect on spreads; so we might be able to survive that in terms of market access. I think the broader balance between bail-ins and bailouts in official policy matters more.

  10. @ John

    Perhaps we’re communicating at cross purposes as it’s not always the ideal way to get point across. Forget near-term restructuring for a moment. Most of the existing Irish sovereign debt is long-term in nature and will still be around in 2013.

    If this debt is given a special blessing as being immune to restructuring, then all of the risk of restructuring will fall on debt to be issued in the future and then perhaps nobody buys this debt, which would then guarantee a restructuring.

    On academic studies of CACs, I doubt if Eichengreen and Mody were studying economies already on the brink of default.

  11. @ DOD

    Not sure about all that sovereign in exile business but I’m pretty clearly talking about sovereign bondholders — more than most, I have railed against the conflation of holders of bank and sovereign debt.

  12. @Karl Whelan

    I know that you are – I can read the implicit (and you have been consistent on conflationist fallacy from day-1 +1) – but others reading your posts may not. Simply reminding of the importance of the qualifiers/signifiers ‘sovereign’ and ‘bank’ …. for new, and external readers.

    Patricia the Irish Sovereign_in_Exile takes note of these qualifiers/distinctions. When bank bond debt is sorted, if ever, she will come home – and looking forward to meeting you for afternoon tea, and mutual discussion re affairs of the ‘sovereign bond’ market.

  13. @Karl W

    “Perhaps we’re communicating at cross purposes as it’s not always the ideal way to get point across. Forget near-term restructuring for a moment. Most of the existing Irish sovereign debt is long-term in nature and will still be around in 2013.

    If this debt is given a special blessing as being immune to restructuring, then all of the risk of restructuring will fall on debt to be issued in the future and then perhaps nobody buys this debt, which would then guarantee a restructuring.”

    Don’t get why it would be. Wouldn’t it be required to be restructured as a condition of ESM assistance?

    The original proposal of ESM was likely to cause funding problems if the CACs made the debt easier to resructure. The counter to this was maybe local law would leave the existing open to restructuring via domestic law without EZ interference – hence conditionality.
    ESM can also impose conditions on loans to sovereigns, including the right to require a debt restructuring.

  14. I agree we have been commenting at cross purposes, and probably agree more than it seems. A couple of points of agreement and then the possible disagreement:

    First, putting aside fair burden sharing and moral hazard, I think we are both focusing here on how to secure future market access.

    Second, if private sector involvement (bail-in) is to be a key feature of the new regime, it is best that existing bondholders are brought into the net. (There might be some advantage between now and 2013 for exempting them, but financing over the next couple of years is not the main issue given the EU-IMF programme.)

    Third, the main disagreement seems to be on whether a regime featuring PSI is in Ireland’s interests. If I thought default is unavoidable, I would be inclined to agree that it is. But, and I think the recent movement in spreads bears this out, a regime with PSI at its core makes default, if not inevitable, much more likely. Moreover, other countries are much more likely to be dragged in, and I think it puts the euro project at much greater risk. I hope but doubt that European policy makers know what they are doing. At the very least they should provide their explanation for what is happening to market risk premia, and how they believe their solution can stop the crisis from spreading.

    [A paper by William Cline on “creditor relations” for a major NBER emerging markets crisis conference back in 2000 captures the downside of “default-friendly regimes”. A quote:

    “This [default pain as quasi collateral] theory means that any international arrangements that convey the impression that default is painless will tend to depress capital flows to emerging market economies. Essentially, a default-friendly international regime deprives international lenders of their quasi-collateral: heightened economic difficulty for the defaulter. The defaulting country may enjoy a one-time windfall gain of not having to repay its outstanding debt, but it will face a dearth of willing lenders in the future. Perhaps more important, there will be a negative externality of the defaulting country’s actions for other emerging market borrowers. If it is blessed by an international regime seen as facilitating the default, the country’s actions will increase the perceived risk of lending to all emerging market borrowers.”

    Full paper available at:

  15. It is hard to reconcile an explicit policy of forcing existing sovereign debt holders to take haircuts with an implicit policy that existing unguaranteed bank bondholders should not take haircuts.

    Is that implicit policy and the “side agreement” to the EFSF loan going to disappear in a puff of smoke soon enough?

  16. The conflation of bank debt with sovereign debt is a problem. If it can’t be reversed, can it at least be made into a lesser problem?

    The biggest problem seems to be that cash is being paid out on ELG – The problem with that is that it concludes the transaction and no (further) losses can be imposed on the bondholder.

    Suppose it would be possible to work with the ECB and the European commission to make this a lesser problem. One possibility could be to amend the ELG to include some clauses regarding the nature of the payment. For instance, a bank where equity has been wiped out could be given the option to pay cash or with 10 year Irish government bonds paying the ECB base-rate as interest.

    Currently the ELG covered bonds are getting a deal that is too good. The discussion about whether or not the ELG can be reversed has been discussed a lot. An amendment to the ELG has not, are there any creative ideas out there on what an acceptable amendment could be?

  17. Should Ireland and Greece resist ESM unless there is an assurance that Ireland and Greece are to be transferred into it?

  18. It is hard to reconcile an explicit policy of forcing existing sovereign debt holders to take haircuts with an implicit policy that existing unguaranteed bank bondholders should not take haircuts.

    Hard but not impossible. Simply veto any ‘sovereign’ default until all unguaranteed bank bondholders have been paid in full, then allow the ‘sovereign’ to default. Of course that can’t be done with a state which is sovereign in a meaningful sense, but Greece, Ireland and Portugal are semi-sovereign at best.

  19. If Portugal takes a bailout presumably the ECB will take over on the refinancing of all relevant bank bonds , as it has done so successfully in the Irish case.

  20. I’m sure I’m missing something obvious here, but I don’t understand the reaction to Portugal. The government has just failed to get an austerity package through and we are going to have new elections. Everyone assumes that we will now get a European/IMF package. But surely that will require even greater austerity than the outgoing government was proposing? And why should we assume the new Parliament will be willing to accept even tougher measures.
    In Ireland, the new government has at least been able to say that the deal was already done when it got there. That won’t be true for whoever ends up running Portugal.
    No doubt this will be stitched up somehow, but I really don’t see how.

  21. … waiting for Spain … Moody downgrade 30 Caja banks this morning …

    The Tangos are Greece and Portugal; Ireland and Spain

    Ireland and Spain is the Tango to force bank-resolution at KORE EU LEVEL

  22. Contributors often refer to domestic Irish bank’s exposure to countrparts in Germany and France but the Central Bank said yesterday that the total exposure to the two countries accounts for 6% of €194bn at end Dec 2010.

    Only 15% of the exposure is to banks and 71% is to residents of the UK and US.

    The UK accounts for 59% including teh units of Irish banks in the North.

  23. @ Michael Hennigan

    I think you’ll find that what people are referring to is the exposure of German and French banks to Ireland banks (the money owed by Irish banks to them) rather than the other way around.

  24. Can anyone clarify if the absence of a guarantee that only debt issued after 2013 will be restructured has been discussed elsewhere? Or even better can anyone give me a definitive answer on this?
    So far the only place I have seen the absence of this from the agreement being discussed is here.

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