Category: Bailout

The Black Hole Grows

It has been apparent for some time that proposed design of the post-2013 ESM — notably preferred official creditor status and arrangements for creditor bail-ins — is undermining peripheral country creditworthiness. The so-called bailout mechanisms have the rather grotesque feature that they can suck a country in once it begins to show enough vulnerability.  

At the moment, markets do not want to lend to Portugal in large part because markets expect Portugal will enter the bailout mechanisms, increasing the risk they will be caught up as junior creditors in later accelerated bail-ins.  This could end up happening well before 2013; hence the surge in our 2-year yields. These fears are likely to be self-fulfilling, despite the resistance of the Portuguese government (no doubt informed by watching what happened to Ireland).  As we are learning more by the day, once in, it is damn hard to get out.   Peripheral yields have shot up every time the ESM became that bit more certain (latest news on the agreement here).   With the evidence so clear, it is hard to understand how European leaders persist with a solution that could end up destroying the Eurozone.   The interest rate issue appears a sideshow by comparison.

The FT has a couple of good articles that nicely capture that damage being done to our and others’ creditworthiness (see here and here).  A flavour:

Investors warned they could boycott peripheral eurozone bond markets as reform of the region’s bail-out fund sparked fears of a sovereign default in Europe.

Irish three-year bond yields leapt close to a full percentage point at one point on Tuesday, while the cost of borrowing for Portugal and Greece also shot up on worries that one of these countries would have to restructure their bonds.

European finance ministers finally drew up plans to make investors share the burden of potential sovereign defaults beyond the summer of 2013 in a deal hammered out on Monday night. Concerns centre on the preferred creditor status given to European Stability Mechanism, the permanent eurozone rescue fund, which takes up the reins from the temporary fund, in the middle of 2013.

Investors warn that this will mean they will be the last in the queue for the recovery of money in the event of a default. One fund manager said: “We will definitely not buy peripheral bonds now, not with the uncertainty this has created.”

Tamara Burnell, head of sovereign and financials analysis, M&G Investments, said: “This agreement will not do anything further to encourage investors to buy peripheral bonds.

Inversion: Two-Year Bond Rate Moves Above Ten-Year

As I write, the two-year Irish bond yield has risen from 9.3% to above 10% and is now higher than the ten-year bond yield. I suspect this may be a reaction to yesterday’s meeting of Euro area finance ministers and the prospect that Ireland will not get a reduction in its interest rate. But I’d be interested in hearing if people can point to other reasons.

Daniel Thomas: Irish Bail-Out Terms Endanger EU’s Future

Here‘s an article by my UCD colleague Daniel Thomas that makes an important argument. If the Irish authorities are to get anywhere in relation to getting a better deal on issues such as the interest rates on official loans or dealing with our banking problems, they cannot rely on arguments based on narrow self interest.

Dan points to the dangers to the EU political reform process stemming from Ireland getting a bad deal. I think one can also argue that a deeper role for the EU in solving Ireland’s banking crisis can also be justified on the grounds that it can help to maintain financial stability throughout the Eurozone.

Kenny Returns from Brussels

Enda Kenny has returned from Brussels without any agreement yet to reduce Ireland’s interest rate (Irish Times story here and FT story here). Not surprisingly, Mr. Kenny wasn’t too keen to give up Ireland’s 12.5% corporate tax rate in return for a mere one percent reduction in the interest rate on the EU loans.

To my mind, there is a lot of shadow boxing going on here. The EFSF is an EU institution and it cannot set the terms of its lending on a bilateral basis with individual countries. I’d be surprised if thee tradeoff between these two elements ended up being as explicit as suggested in this weekend’s news stories.

I think the business about interest rates and corporation tax rates has a feel of fiddling while Rome burns. More interesting were Kenny’s comments about the ECB:

“I made the point that for me to conclude a deal here I need to be much clearer in respect of elements related to the ECB,” he said.

“I spoke to president Jean-Claude Trichet and the Minister for Finance will be meeting with him on Monday. He has agreed that I should meet with him before the [next EU summit on March] 24th/25th to discuss a number of issues relating to the ECB and its positions.

“Before the council meets again in two weeks time we hope to be in a much clear position insofar as Ireland’s position is concerned and continue on our progress arising from the mandate that I’ve got about an improvement in the terms of the package for Ireland,” the Taoiseach said.

He continued: “In the next couple of weeks I expect to be in a much clearer position in respect of the state of what we have inherited is in respect of Ireland’s position.

“We’ll have had discussions with the ECB in respect of a number of matters. We’ll have a much clearer picture of what’s emerging from the stress tests and as the principle has now been accepted and implemented of a reduction in the interest rate I . . . would regard that actually as the beginning of a process.”

I reckon they could fill Croke Park if they sold tickets for those discussions with the ECB.

Failure to Catalyse

While the change of government has brought a welcome fresh start, long-term bond yields – and the implied probability of an Irish default they signal – continue to rise.   The 10-year yield is now above levels that forced Ireland to seek the EU-IMF assistance programme in November.  It is of course early days.    But there is no getting away from the message the bond market is sending.  

The hope behind the programme is that it would catalyse private funding.    With this in mind, it is interesting to look at the literature on the catalytic effect of official funding, much of it originating from the IMF itself (see here for an example).   The basic idea is that official funding can be a complement to private funding.   

Continue reading “Failure to Catalyse”