ESM will not have preferred creditor status

News organisations are reporting the European Stability Mechanism will not have IMF-style preferred creditor status for countries already in a bailout after all, which is a significant change from the draft treaty setting out the planned design of the fund.   Some reports here: FT; Irish Times; Reuters.

It has been apparent from the timing of spikes in bond yields, as well as from investor/rating-agency reactions, that features of the ESM’s design are considered impediments to Ireland regaining its creditworthiness.   The annoucement is therefore welcome news, though the limited initial falls in bond yields suggest it is not a panacea (see here).  Greater clarity about future debt-sustainability tests and also the form of future private sector involvement are important additional steps.   Greece-related developments are likely to be the main market movers for the time being.

72 replies on “ESM will not have preferred creditor status”

@ John

Those bond yields have actually risen today.

Michael Noonan is positively purring at this development almost hinting that it was a result of his negotiation skills.

In fact, this is bad news for Ireland. It seemed for a moment that we were pulling the trick of making new creditors ahead of the queue in front of existing creditors. A great move which any corporation or individual would like to have at its disposal. However, the EU realising the danger that there might never be a return to the market has stepped in to clarify the rules. This reduces the scope for interest rate reductions on the EU funding. Unless one believed that the Troika support might actually some day be withdrawn, to my mind this is a bad development.

It is likely Ireland would have to satisfy the debt sustainability criteria before being allowed to access ESM.

You might get your bond holdings haircut as part of the requirements for that.

Where there is a real advantage would appear to be post-ESM-entry. Say if in 2014 there was a default. If you were a holder of Irish sov bonds then, you would not find your bonds defaulted on disproportionately more because the outstanding ESM debt was senior.

A small piece of good news from Ireland’s perspective for sure, but lack of preferred creditor status is hardly going to go down well with reluctant German, Finnish etc. taxpayers being forced to lend to us.

AFAICT the story broke too late to have much effect on yields but it can’t hurt.

It’s bad news. The EU is a bondholder that can really really squeeze us to pay.
Absolute disaster makes default much much messier. Now we don’t just welsh on the likes of Goldmann we welsh on Germany.
This has transformed the money owed by one bank to another into the money owed by one nation to another.
Wake up guys – we can’t draw any money down under these terms. It brings the old pari passu trick to a whole new level

Will it make any difference in the case of Greece? It seems that the latest austerity package being imposed on them is very close to the tipping point.
Looking at public sector wages for nurses and teachers, I am amazed at the low levels as compared to Ireland. A teacher with 15 years service is getting 1200 a month and a nurse with 25 years service is quoted as receiving 1200 pm at the moment with this set to be reduced to 900pm.
If these numbers are correct then they are justified in resisting any further austerity.

@Brian Woods II

How on earth can this be bad news for Ireland? There is absolutely no reason this reduces the scope for an interest cut. And the change to the ESM means that investors will no longer worry about some EU official at a stroke of a pen declaring Ireland is unsustainable while official ESM holdings of Irish bonds go untouched but private sector holdings get a haircut. even with Troika support guaranteed the fact that private bondholders would be junior to that support was always going to deter them from investing

I think its pretty significant and was probably lost in headline fatigue today.

It’s another example of “Europe” showing a lot of flexibility in how they deal with the changing dynamic of the different bailouts. We’ll get a rate reduction and some type of longer term facility for the banks ecb lending too.


I’m surprised by your take on this. There have been few signs that the interest rate on the bailout loans has been affected by the risk to official creditors — compare Greece and Ireland. The rationale for the premium over the borrowing costs to the guaranteed EFSF/EFSM seems to be more to do with ensuring a “dissuasive” effect on future reliance on official borrowing. On the other hand, having the debt structure stuffed with preferred official creditors must dissude potential market investors from putting their money in given any doubts about debt sustainability and the PSI threat under ESM.

@ All


“Laurent Bilke, an analyst at Nomura, said in a note that it would be “very positive” if Greek debt could be rolled over into bonds with better ratings – ideally those issued by the European financial stability facility, a mechanism set up by eurozone leaders to help finance bail-outs, and which has already agreed to borrow on behalf of Portugal and Ireland.

Wolfgang Schäuble, Germany’s finance minister, maintained on Monday that the private sector should take part in aid to Greece. “There’s no need for additional incentives,” he said. “Everybody has a self-interest in the stable development of Greece.”

@ All

The above is from the FT.

Of equal importance is the change to the EFSF.

The changes have little or nothing to do with Ireland but everything to do with Greece. The clear political intention is to limit its use to Greece. The political and opinion-forming leadership in Portugal has grasped this. And in Ireland?

Schaeuble is doing his best to create the necessary political smokescreen.

@ All

I should add that one of the motivations for Schaeuble’s caution is probably (i) the political need not to overshadow the European Council which is now doomed to succeed and (ii) to avoid an immediate debate on the further creation of an animal beginning to look very like a limited system of eurobonds, a solution which, if it had been accepted earlier by Germany, would have avoided lot of grief.


“Where there is a real advantage would appear to be post-ESM-entry. Say if in 2014 there was a default. If you were a holder of Irish sov bonds then, you would not find your bonds defaulted on disproportionately more because the outstanding ESM debt was senior.”

So the result would be a shifting of the current risk from existing State bondholders onto the ESM (socialization of debt). How will the ESM manage to get or retain a good rating if the risk is being shifted to that organization? Unless as you point out existing State bondhoders are haircut prior to entry of sovereign to ESM.

In any case it is the quantum of debt and the State’s ability to service it that would be the key issue for prospective bondholders. If one has to have too much regard for the order of the queue in a potential collapse the the sensible decision is to avoid the risk in the first place.

It does appear to be an advance.

This business of returning to the bond markets is complete and utter folly. We cannot rely on this source of funding ever ever again.
A sovereign is an entity with conscripted shareholders who face unlimited liability and where the board of directors is unaccountable, unskilled and unfirable.
A sovereign does not have the competence nor the legal protection to raise debt.
It would be much much better to ban the sovereign debt market than to allow it continue. Essentially every country should live within its means.
What is so difficult to grasp in this concept?

I would have liked a ‘debtor-in-possession’ system for both public and private creditors helping to finance a state after a call on the ESM. This would have given some protection to official creditors, while allowing a smooth return to the bond market.

But I do not regard this as very important. In my opinion, as long as Ireland and Portugal deliver on their commitments to the troika, they will get the financing they need, if necessary beyong the assumed date for a return to the bond market, and without any form of PSI.


The Brits are getting prepared…are we?

“Treasury plans for Greece to go bust
Treasury ministers have admitted that the Government is drawing up contingency plans for a Greek bankruptcy after being warned by a former foreign secretary that the euro “cannot last”….from Telegraph

@ Ceteris paribus
You must be joking. We can’t prepare for jack….
The way you prepare is to cut your deficit to zero by cutting public salaries, raising taxes and cutting social welfare.
Our crew – haven’t a clue.
Once the preferred creditor status is lost you will have ze Germans making sure that they get paid – and we all know what that will be like
Austerity macht frei (this one won’t make it past the moderator!)

re Greek wages:

..A teacher with 15 years service is getting 1200 a month and a nurse with 25 years service is quoted as receiving 1200 pm at the moment with this set to be reduced to 900pm.
If these numbers are correct then they are justified in resisting any further austerity…

I presume these are net figures. They are low, but I bet not as low as Slovakia, Latvia or Estonia. Currently Irish public sector is approx 30% ahead of the Irish private sector, never mind Greek comparatives. Teachers and nurses have a long way to fall both for comparative in Ireland and indeed externally.

Still good to know that those higher up the scale in the upper eschelons of the PS are completely insulated from such mundane competitive comparisons. It leaves them free to get on with the job of running the country.


Don’t economists always flag PPP – purchasing power parity – when doing wage comparisons?

Assuming fiscal austerity remains on track, Ireland’s real problem is our accumulated debt, and tail risk associated with the banks. This ESM announcement fails to address our problem…though as such, being the first non fudged forward looking announcement from Europe…it is welcome.

Ooops… Wait a second…the fudge is the ESM entry criteria….


“Essentially every country should live within its means.
What is so difficult to grasp in this concept?”

The difficulty would be economic cycles.

The difficulty some economists with limited market experience have is in realising that if investors stop thinking a recession is part of a cycle but is more of a tidal reverse, then they stop being willing to fund the deficits. At that point you either declare the market wrong (see opinions of union economists and labour party linked economists), stall for time and wait for gdp to bottom and bounce – or you undertake a deflation of your public sector costs.

Giving up your currency and central bank is a really effective way of increasing the possibility of this happening.

If there were no public sector deficits there would be a shortage of supply of debt during a private sector deleveraging. Savers buy debt.

@ John/Ceteris

I admit to being a bit out of my depth here.

However, instinctively, if you are up to your neck in debt it has to be a good thing that you have access to a creditor who can rank higher than your existing creditors. I guess that is why IMF loans are so “cheap”.

I don’t really know how EU loan interest is set but I understand that the loans are backed by market funding and so the credit status of the loans must have some impact on the interest rate.

It is the EU who desperately wants Ireland to return to the market. For our part, yes that would be a return to economic sovereignty. For choice I would prefer our official lenders had preferential status which should show through as cheaper funding costs. What’s the big deal about returning to the markets?


The proponents of the Euro were keen to stress that it would allow easy exposure of overpricing and encourage competitive forces.

PPP is something you employ a lot when analysing different currency regions.

You cannot have two economies sharing one currency where one country has double the costs and salaries of the other – unless there is something uniquely advantageous about the expensive one.

Greece might have to have costs and prices domestically lower than the EZ average because of its economy’s fundamentals. How can Ireland sustain high cost economy unless low corporation tax is such a fantastic wheeze that it justifies that.

@ Grumpy
But shouldn’t “savers” just invest in private sector ventures and be exposed to the risks inherent in that?
That would work fine

@ Desmond Brennan

“Ooops… Wait a second…the fudge is the ESM entry criteria….”

As I understand it you have to pass the exam to get in…debt sustainability.

I see Juncker saying that Greek debt is sustainable. The whole world knows it is not. So how can anyone (including markets) have faith in the announcements of EU officials given this sort of drivel.


IMF loans are “cheap” because primarily they have a genuine interest in returning an applicant country back into a normal functioning market economy (you can disagree about whether their methods are always correct). They’re not interested in making a buck off it, and they don’t care all that much about moral hazard. Whatever works, works, and cheap funding makes sense for that approach. Half of the EU probably wants that of Ireland too, but the other half seems hell bent on proving a point to the periphery via expensive loans with strict conditions. As John McH noted above, the rate on the EU loans was originally “high” to discourage any sovereign from taking them, but given that there’s 3 countries now using the EAMS facilities, it seems insane to load expensive loans onto over indebted economies. I’ll go as far as saying its damn near suicidal, and its risking the entire Euro project. The EU needs to cop on and provide the funding to the applicant countries at the cheapest rate possible, even if that involves some element of subsidisation. They’ve finally understoof that ESM seniority scared all private investors away, and have belatedly changed their minds in the nick of time. Perhaps its a sign that some strong and rational voices are starting to come to the fore in this whole sorry mess.

At the end of the day, regaining our economic sovereignty is the key policy that this government needs to focus on. That will only happen when we can fund ourselves, or, just as good, don’t need any funding at all. Deficit reduction and convincing the markets to fund a decreasing and sustainable deficit will let us make our decisions that will be in our own self interest. That should be the wish of everyone on here.

This is definitely welcome however I don’t share John’s optimism that this is going to be a game changer for Ireland.

It does change the recovery if default happens however I think our problem is that the markets thinks default is extremely likely and the recovery rate isn’t going to change that.

You are right to try to bring these ideas from schäuble to the attention of this blog. They might be quite important in my opinion. You do not seem to succeed because the information is extremely fuzzy at this stage. To me, it very much looks like Brady bonds. I would regard that by far as the best form of PSI for Greece.

It means that it’s actually possible in principle for Ireland to avoid defaulting.

@ Eureka

having some form of long term risk free (or close to risk free given the current situation) return is an important way of pricing all other risks, as well as a place to store wealth. Long term government bonds are primarily used for one or ther other of these purposes. Government do also borrow for investment purposes (a road, an airport etc), and while the private sector is and should be heavily involved in these, it cannot always be that way (a hospital, a school).


When the private sector is deleveraging there are insufficient investment opportunities for the private sector saver. Join that together with the requirement for social safety nets and social cohesion and you need the public sector to become a net borrower during recessions.

Right wing economics is just as wrong as left wing economics.

Those of you here who are tired of what has become economics ‘orthodoxy’ that is both the root cause of the crisis & the non-solutions should watch the presentations of University of Missouri Kansas City economists at a recent conference in Dublin. A must see.

The videos are here:

In particular, those by Stephanie Kelton, Prof Randall Wray (2 items) & Prof Bill Black. The times (out of the day’s sessions) are indicated so you skip direct to them.

They are highly relevant to both Ireland’s and the wider Eurozone problems.

It’s high time ideas like these recieved the widest possible public debate.

The latest ideas appearing out of Berlin look interesting, but first a comment about the fact that everybody from Juncker to Colm McCarthy in his weekend Sindo column is making the claim that with PSI some combination of the EU banks/Greek banks/ECB “will go bust”. Generally these statements are made with no quantitative analysis at all. So let’s look at the figures, with respect to the 7-year extension plan (now abandoned) which implies a 15% NPV writedown (figures from economist magazine and a couple of recent bank research reports)

EU banks: Estimates are that less than 1% of capital would be lost. Banks have been reducing their exposure for some time. Banks with the biggest exposures are either Greek, or public (i.e. ECB and a couple of German banks). Private banks are no longer exposed much. So overall not a big problem.

Greek banks: Estimates are in the range of a €6bn loss, which is within the amount allocated in the current bailout plan for recapitalization. (I believe that higher loss estimates floating around e.g. of €18-20bn are for the scenario where Greece does a hard default with a 40-50% haircut, not the 7-year extension plan). So overall not a big problem.

ECB: Estimates of a €6bn loss (due to drop in value of GGBs which were purchased in the secondary market). This loss is spread across the ESCB, which has a capitalization of €80bn. Not a big problem.

CDS market: Estimates of payments needed are in the €4-5bn range. Not a big problem.

You might even think that the 7-year extension plan was not just some figure picked at random, but was picked to ensure that the losses incurred could be handled across the system…

Notwithstanding the lack of evidence that all these banks would go bust the key argument against PSI seems be that of contagion, and in particular that there will be a deposit flight from Greek banks and that the ECB won’t continue to provide liquidity. So it seems that the latest plan being floated (if I read it correctly) is that the EFSF will fund ‘eurobonds’ which will be given to the Greek government who will give them to the Greek banks who will give them to the ECB and which will retire the current junk GGB collateral. This seems like a debt exchange with a significant discount (whether the new bonds replace the GGBs at the ECB’s purchase price, or current level, or something in the middle isn’t clear). In effect the losses made on the secondary market transactions by the private sector become realized savings for the Greek government.

So for Ireland I think the cunning plan should be to depress the current market value of Irish bonds, get the ECB to ‘secretly’ buy these, and then retire them later with these ‘eurobonds’. To depress the current market value I would suggest letting Noonan, Varadkar, Mathews, Burton, Gilmore etc. off the leash and make confusing and contradictory statements, which would lower confidence and the bond price. An added bonus would be the entertainment provided. After the purchases have been made on the secondary market they could all be called back in and told to get on message again.

Crazy scheme or a sensible way forward?

Following on from my last comment some commentary by SocGen can be found here

Takes the view that the latest scheme could potentially be monetizing the debt, though I don’t see it like that. However as the author says up front, everything is as clear as mud right now.

@Bond. Eoin Bond

“it seems insane to load expensive loans onto over indebted economies. I’ll go as far as saying its damn near suicidal, and its risking the entire Euro project.”

I can only second that. I think this is where Jack Straw was coming from in the UK parliament yesterday and there seems to be a lot of chatter in the UK about preparing for a ‘definite’ Greek default – it’s a done deal according to some so best to plan accordingly. Mind you, I also got the impression Jack was pretty happy to see that happen. A funny (peculiar) man. Anti-Euro (anti anything European!) seems to crop up a lot and in many unusual places in the UK.

@Brian G

“To depress the current market value I would suggest letting Noonan, Varadkar, Mathews, Burton, Gilmore etc. off the leash and make confusing and contradictory statements,”

This isn’t happening already?

I’m not quite sure what the keyboard symbol for ‘tongue-in-cheek’ is.

@ Incognito et al

I agree with your view that the Schaeuble views are important and the overall situation far from clear. The comparison with Brady Bonds is also apt, insofar as my hazy understanding of how they worked takes me, in that banks and other investors taking a loss did not have to do so immeditaely, the entire exercise being based on a US Treasury (EFSF!) guarantee.

Bryan G has also provided some interesting analysis of how the approach might work.

I would also come back to the point with regard to the changes in the EFSF and especially this comment by Regling.

“By raising the over-guarantee, we will make the EFSF more efficient,” he continued. “We can eliminate the cap reserve and therefore also overborrowing, which was necessary as a credit enhancement to protect bondholders and to obtain triple-A ratings.”

I am no expert in this area, but will this not automatically reduce the cost of borrowing to Ireland?

As for the rest, the general situation – involving not just the EZ but also the UK and the US in particular – is now totally political with some very odd participants, notably the big three rating agencies.

Bryan G:

In the Sunday Independent I was trying to argue that ‘debt relief’ for Greece would bust the Greek banks but it should be clear that ‘debt relief’ means an NPV cut of 40 or 50%, not the PSI now mooted which will cut NPV by far less and possibly by very little. So I do not think that the PSI, when it emerges, will bust the Greek banks. It will not make much difference to Greek solvency either.

A little paragraph that jumped out from the Irish Times report:

“The change to the ESM’s rules relates only to countries which are already in EU-IMF rescue plans – Ireland, Greece and Portugal – so the ESM’s preferred creditor status will remain intact otherwise.”

If anyone could help clarify:

In the long run, bond buyers can buy into the ESM and/or sovereign debt (and/or other kinds). Given a choice, why would anyone buy sovereign debt for preference, if the ESM is always first in the queue? Is it because the return will be higher? Or because some soveriegns are still a safer bet?

@ Ceteris paribus

The problem with the Greek public sector appears to be numbers not pay levels.

I recall for example a report last year that there were thousands more teachers than classrooms for them.

The current PM’s father Andreas, a former economics professor, had worked with his father in the 1960s and saw at first hand how his father as prime minister had been thwarted by the forces of the Right led by the young gullible king, followed by a military dictatorship.

Andreas was determined on winning power in 1981 to help his supporters by introducing a welfare state and providing an opportunity to move into the middle class through public sector jobs.

In Ireland, a few years previously, another economics professor had tried a more limited form of the same experiment and the Irish public pay bill jumped by 34% in 1979.

Greece like Ireland, also had the legacy of a bitter civil war.

@ Eoin
..but sovereign bonds are low risk not because they are solid investments but because all the machinery of a democratic state can be used to extract the repayments from its citizens. I’m not trying to be a socialist about this but it’s not the solidness of the investment but the size of the heavies that make sovereign bonds low risk.

Is it necessary for savers to have a low(no) risk option? Shouldn’t savers be happy just to get their money back (maybe plus inflation)? Why should people be rewarded just for lacking the imagination to spend their money? Every time somebody saves money it has an opportunity cost for the real economy so is there really an economic need to have rates of return above inflation for any savings (I’m out of my depth on the inflation piece but do you know what I mean?). So having this highly destructive sovereign debt market just to guarantee returns to savers is just not worth it.

Re the second point of how to build schools/hospitals. Private companies tender to build the schools/hospitals. They raise the debt and the state signs a contract with them to pay x over a certain term. So the state is bound into a contract (which gives it legal protection) and the private limited company can raise debt (where it too has legal protection). Everybody is ok.

I’m not sure about the evening out cycles argument. It’s not working that well now for sure. Sovereign debt markets prolong cycles. You hit a downturn. Ideally you would borrow to stimulate the economy but….the cost of your borrowing goes up because you have hit a downturn. And then the cost of your repayments will extend the downturn. In fact by acting as a distracting “safe haven” during down turns sovereign debt markets distort natural corrections – the savings should actually be invested in stocks and equities in a downturn (thus returning companies to profits) rather than sovereign debt.

The crux of this is this: Bond traders and bankers are under pressure to generate a return for the people who save money with them. But life is tough and economies contract as well as grow (but try telling that to a client). So they developed the sovereign debt market as a way of guaranteeing those returns. And they pumped money into it. And the real strength of that sovereign debt market is that you can use the ECB, the EU, democratic governments and ultimatley the tax collecting apparatus of any state to get it back. The sovereign debt market doesn’t guarantee returns through wise investment – it guarantees returns through brute force.

@Colm McCarthy

Fair enough. In general, however, many commentators and EU figures such as Juncker overstate the potential impact of a GGB restructuring on EU banks and the ECB. Here is a quote from Nomura (assuming 40% haircut)

European banks in total hold just EUR 39bn of the EUR 330bn of Greek government
debt outstanding compared with total equity capital of EUR 1.8trn. Thus an illustrative
40% haircut on Greek government debt would result in losses of just EUR 16bn, or 0.9%
of European banks’ capital base. Even for the more exposed German and French banks,
the impact in aggregate would be a hit of just 1-2% of capital (though of course some
individual banks will have higher exposures than others).

In France the bank with the largest exposure to GGBs is BNP, with about €5bn, so with a 40% haircut I think this amounts to only 2-2.5% of capital. Next highest is SocGen with exposure of €3bn, so I don’t see that French banks are in much trouble.

On the ECB front the Economist quoted a BarCap figure of €18bn losses (assuming a 50% haircut) and said

If a Greek restructuring were to happen and trigger losses, the ECB has a capital cushion of just over €5 billion, which is due to rise to €7.5 billion by the end of 2012. That may look thin given the potential for the euro-zone crisis to spiral beyond Greece. But the ECB is owned by the 17 euro-area NCBs, and the combined capital of the Eurosystem was worth over €80 billion at the start of June.

@ Eureka

you should read Niall Ferguson’s “The Ascent of Money”. The ability to store wealth in low risk form was one of the key drivers of civilisations being able to grow and prosper. I think its slightly unfair to term savers as “unimaginative”, certainly in the case of pensioners or families anyway, and most government bond rates only just about track the rate of real inflation anyway, so not sure that they’re getting a free ride??

On the private sector building schools – PPP’s are great in theory, but i believe they’ve been very expensive for the State in practice.

I’m not exactly convinced that this change is designed to improve creditworthiness. It seems a bit too noble. Core states have generally acted out of self interest to date. So I’ve scratched my head to come up with an alternative motivation.

Is it possible that this change will effect the outcome of stress tests / ratings of core member banks and that this is the real reason for this action? i.e. this move is designed to benefit core member banks.


“Sovereign debt markets prolong cycles. You hit a downturn. Ideally you would borrow to stimulate the economy but….the cost of your borrowing goes up because you have hit a downturn”

No it doesn’t. Downturn = lower inflationary pressure = lower yields.

Bond investors don’t mind recessions for that reason.

Look at a graph of bond yields in Japan, US or UK to demonstrate that.

There is an argument that supply of sov bonds in a recession drives up yields – right wing philosophy says this happens. I did lots of analysis on this at one point and found in reality the effect is in most cases very small – vanishingly so compared to inflation expectations.

The only problem arises when, like Ireland, the prevailing view is that there is not just a recession. There was a tidal flow of money into the country for decades. There is now a tidal flow out – and the fact that it is the private sector costs that are deflating – not the public sector cost – is leaving the country high and dry.

If every country banned fiscal deficits, think about the effect of the fiscal drag and what would happen to all the savings the states built up – you couldn’t buy Treasury bonds with them.


It is a common misperception that the US government guaranteed Brady Bonds. The role of the US Treasury was to issue the zero-coupon securities that were purchased by the debtor governments as collateral. Since I imagine there will be many variants of “Brady bond-like” schemes proposed before all is said and done, the following description of how they work is useful (note that in this description “Government” means the debtor government (e.g. Mexico))

The following are typical elements of the restructure leading to issue of a Brady Bond. The creditors together with the Government and the debtors, agreed to write down the face amounts of the debts, to some fraction of their original value; say, 50%. Second, it was agreed that these debts, whatever their original terms or current status, would be repaid over a fixed longer term, say 15 or 20 years, at some agreed manageable interest rate and principal repayment schedule. Third, the bonds became Government instruments; that is, while payments might be made on them by the original debtors, the instrument called the “Brady Bond” traded as a Government issued security. The original creditors then received these Brady Bonds, as full payment of and in proportion to their original claims, and were free to trade them on ordinary bond markets.

The payments of the Brady Bond were secured by three concurrent devices. First, the creditors made payments against the renegotiated amounts due as agreed in the restructure. Second, the Government guaranteed those payments. But, third, the subtle part: as assurance of those payments, the Government also purchased a security which was deposited in escrow, assuring payment. Typically that security was a zero-coupon bond issued by the US treasury, for the specific purpose, and purchased by the local Government. Thus, rather than the local Government itself paying on the bonds (thus making them a current obligation from their budget) the Government bought an asset, the zero coupon bond, and pledged that as assurance of payment of the tradable Brady Bonds. Thus, if at term of the zero coupon bond, there was no default, the local Government received its asset, the full value of the zero coupon bond at its term.

@ Gavin Kostick

This is a question which has also been intriguing me and to which I have been trying to find an an answer. If the report is correct, it will take some fancy legal drafting to implement this provision as (i) an amendment to Article 136 of the Treaty on the Functioning of the European Union has to be put in place before Germany can ratify the treaty establsihing the ESM and (ii) said treaty is an enabling treaty for use in a last resort situation only which, by definition, can hardly be defined beforehand.

@ Ahura

don’t see how this will impact on stress tests (which i think are more or less finished anyway) in any way at all. I think its a realisation, finally, by the EU that their crisis response has been a bit too heavy on avoiding moral hazard and a bit light on workable solutions.

@ Bond, Eoin Bond
I have no problem with “storing” wealth.
A reason that “storing wealth” is essential for economic development is that it gives people security. But the banking system is not “storing wealth” any more it is destroying wealth. It is taking wealth from people – public servants etc all over the EU. For what? To give savers a guaranteed return?
If I put €10 into a bank – should I really expect to get €12 back? Why? I have made no judgement call, I have taken no risk? All I should get back is my €10. Especially when my €2 is being extracted from my neighbour.

The PPP’s can be revised. Look at where we are now. No money for any capital projects – you can’t tell me that that’s any good.

@ Grumpy
I know you know a lot more about this than me but the lower yields reflects increased demand – right! All nice and dandy when the system works but once the yields begin to correlate inversely with economic growth you are fubbard (it seems?!) And that seems to be what is happening for the peripheral states. I don’t know enough about this but there are competing ways to invest too – Gold and those Credit Default Swaps. So that nice see-saw between money toing and froing between private and public sector doesn’t have to hold true any more.

Your point about banning fiscal deficits is probably right (I don;t know) but I think that the “savings” built up by a state should be exactly that – savings – not investments in somebody else’s debt. The state cannot act as a company – it lacks limits to liability and proper governance structures. Trading in debt should only be done by properly constructed legal entities. Unless the rules of the sovereign debt market are seriously overhauled states should never be allowed borrow again.


“a realisation, finally, by the EU that their crisis response has been a bit too heavy on avoiding moral hazard”

Surely they have trampled all over the idea of avoiding moral hazard for bank bond holders and would like to do the same for sovs. The Germans have tried to avoid moral hazard but have backed down.

@ Grumpy
I took your advice and did a little bit of googling over lunch (how sad is that)
The curves you directed tobelong to stable, productive economies with their own central bank etc.
More than inflation comes into it when you have default, political instability and a chance of a currency collapse coming into it.
The behaviour of the sovereign bond markets caused and is prolonging the recession in the periphery.
Countries should not borrow. We saw the effects of national debts in Africa in the 80’s and 90’s and we are seeing it in the rest of the world now.
This is not right-wing or left-wing – it’s just kno-wing when to call a halt to something very destructive

ISDA ruling on AIB failure to pay event…this was fully expected

“ISDA Determinations Committee: Allied Irish Banks, p.l.c. Failure to Pay Credit Event

LONDON, Tuesday, June 21, 2011 – The International Swaps and Derivatives Association, Inc. (ISDA) today announced that its EMEA Credit Derivatives Determinations Committee resolved that a Failure to Pay credit event occurred in respect of Allied Irish Banks, p.l.c. The Committee also voted to hold senior and subordinated auctions for Allied Irish Banks in respect of the Failure to Pay credit event.

This announcement follows the June 13 determination that a Restructuring credit event occurred in respect of Allied Irish Banks and that an auction may be held. The Restructuring Auction resolution had been made by the Committee on the understanding that if a Failure to Pay credit event occurred prior to the date of the auction for the Restructuring credit event, the auction may be held on the basis of the Failure to Pay credit event, rather than the Restructuring credit event. As such, the Committee also voted today that there will not be an auction held on the basis of the Restructuring credit event.”

“The behaviour of the sovereign bond markets caused and is prolonging the recession in the periphery”

surely more like:

The more-than-just-a-recession in the periphery caused and is prolonging the behaviour of the sovereign bond markets.


Article 136 is here:

Is it this bit you’re looking at?

‘3. The Member States whose currency is the euro may establish a stability mechanism to be activated if indispensable to safeguard the stability of the euro area as a whole. The granting of any required financial assistance under the mechanism will be made subject to strict conditionality.’.

Any chance on expanding on why this change effects the desirability of buying sovereign vs., ESM debts?

@ Grumpy
They needed somebody to lend to and lent irresponsibly to what they saw as “the sure thing” of Eurozone peripheral countries. They pushed the credit. We didnt’ need it.
All this begs the question though
Do the bond markets need countries to run fiscal deficits more than the countries themselves?
We don’t need bond markets for war any more – we certainly shouldn’t use them to finance public services. Do we really need them at all?

Why is preferred creditor status such a big deal? haven’t we been told there will never be a default?

@ Gavin Kostick

This not the text at issue. The proposed amendment to the TFEU is simply there to meet German requirement that the treaty on the ESM be fire-proofed against constitutional challenge. The text that I would like to see is that putting into legal language in the treaty establishing the ESM the limitation to countries availing of the EFSF of the change in respect of preferred creditor status.

In the same batch of papers submitted to the EU Parliament that included one by Karl Whelan (which is being discussed on another thread), are a group of 4 papers discussing Greek debt restructuring. They can be found here (click 30.6.2011).

The Darvas paper is very detailed and pretty much confirms the view above that the main problem would be with the Greek banks, with other EU banks, the ECB, non-financial Greek sector, CDS market etc. having problems that are manageable. Also describes why the current situation is quite different to the Lehmans default. Argues that more and better preparations should be made before the inevitable. One of the papers (Collignon) is a bit of an outlier and argues that Greece is in fact solvent and just has a liquidity problem.

@ Gavin Kostick

I see now that the answer to my question is probably to be found in an amendment to Article 35 of the EMS treaty (see linked text in original posting).

Preferred creditor status will remain for any actions by the ESM outside the three countries currently in receipt (or about to receive in the case of Greece) of EFSF funding.

No wonder the markets are underwhelmed!

@ Gavin Kostick

I should add that, after coming to what I imagine is a reasonably correct view, I am rather depressed by the misplaced euphoria in the Irish media reaction, all the more so if it is based on official briefing.

For a true assessment of the situation, one has to rely on the new Portuguese government cf.

In Ireland, meanwhile, more useless tilting at the windmill of the ECB continues.

ho ho ho 🙂

you guys…..

if you weren’t hell bent on anonymity I could put you on the air. It is radio but is could wear balaclavas in studio…

@Sarah Carey

The gotoguy/girlonGreece?

You could try Vicky Pryce in the UK (ex-wife of Chris Huhne MP). She was an economics guru at the DTI in the UK but I think she’s gone off to do her own thing these days. I’m not exactly sure where (maybe doing something with the LSE?). You no doubt have hunter-killer research assistants in the IT who can track her down. It’s possible Vicky might even be Greek’ish (was born there I think)?

I don’t know any Irish contacts on Greece sorry.

@ Bond. Eoin Bond,

“don’t see how this will impact on stress tests (which i think are more or less finished anyway) in any way at all.”

I raised this as a question. My thinking is that the latest stress tests will likely include stressing sovs. If the durations of the stress fall post ESM, then the loss given default would be very high.

@ Ahura

the stress tests will, as previously, include a stressing of sov’s in the trading book, but not sure about the banking book. But either way, i don’t think there will be any “ESM clause” which will have to guesstimate purely on the basis of potential ESM impact. I think they’ll take a more general headline figure that will be unadjusted for ESM status.

@ Bond
Ta for the hint
Got to episode 2 on the net. Very well written
Plus que ca change and all that

@ All

This Fionan Sheehan report in the Indo has to be the most interesting story that I have read in recent months, especially the following extract.

“Instead of a corporation tax hike, the French are now believed to be looking for a concession from the Irish government on the broad area of maintaining tight budgets.

Coalition sources indicated that options being explored include commitments from the Government not to go beyond budget allocations in areas of spending.

If money allocated for a specific area ran out before the end of the budgeted period, it would not be topped up.

The Government would also have to sign up to stringent budgetary restrictions.

The agreement would allow the French to say it had secured concessions from Ireland, while the Government could maintain it didn’t concede ground on corporation tax.”

The question of why the French were choosing to pursue the “Gallic spat” always had a rather obvious answer. The new Irish government had to be disabused of any idea that Ireland would be allowed to take any soft options at the expense of the rest of the EZ. Indeed, the issue has been debated at length on this blog.

But one wonders if the reasoning may not go deeper and the change in the French position, or rather the revelation of its true motivation, may not be linked to the change made in the ESM with regard to preferred creditor status for the three countries presently “in a programme”.

Two Voxeu articles, one by Paul de Grauw and another by Paolo Manasse, provide a reminder of the background.

Is the change in the preferred creditor status a recognition of the flaws inherent in the very concept of the ESM and a means of building into it a form of planned obsolescence? In other words, is the underlying idea now no more than that of deterrence, with a view to using the instrument solely for the case of Greece and getting Ireland (and possibly Portugal) out of the quarantine ward before it comes into force? The state of health of the Irish economy and ensuring that the new government keeps its nose to the grindstone are two obvious key elements. Another is the message from Michale Noonan to “get shopping!”. After all, it is only the government that is broke, not the Irish people.

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