I got some flak the other day for this post on the EFSF’s fundraising efforts for Ireland because some people figured there was no problem. At this point, though, there does seem to be an issue. See here and here.
This is hardly confidence-inspiring news. EFSF is supposed to save the Eurozone and offer Ireland cheap and long-term funding. What if the markets decide not to play ball and decline to offer the facility sufficient funding at low rates or long maturities?
The eurozone rescue fund has scaled back a planned bond issue designed to finance the bail-out of Ireland amid uncertainty over the level of demand.
The offering will provide a key test of investor sentiment after the announcement last week of new plans to tackle the eurozone debt crisis.
The bond from the European Financial Stability Facility will only target €3bn, instead of €5bn, and will be in 10-year bonds rather than a 15-year maturity because of worries over demand. A 10-year bond is more likely to attract interest from Asian central banks than a longer maturity …
Already delayed from last week, EFSF officials decided to price this week because market conditions could deteriorate if they held off any longer.
The bond is expected to price at yields of about 3.30 per cent, and about 130 basis points over Germany, the European market benchmark. This is a big mark-up since the middle of September when existing 10-year EFSF bonds were trading around 2.60 per cent and only 70bp over Germany.
Update: Eoin points us to an Oct 13 statement indicating they intended a €3 billion issue. Thanks Eoin. It appears the FT over-egged this one. They’re probably right about the delay, the reduced maturity and the higher yield
There are a lot of reasons why attention has turned to the idea of leveraging EFSF via one of a number of possible methods. If this can be done, it takes a big step towards solving both the solvency and liquidity issues plaguing Euro area sovereigns and banks – on the liquidity front, a €2 trillion or €3 trillion fund is big enough to buy up Spanish and Italian bonds for a number of years, while €440 billion is big enough to absorb a lot of the potential losses.
The financial press are abuzz with various mechanisms that could be used to leverage up the EFSF. However, I was surprised today to twice read that Gros and Meyer’s proposal to have EFSF (or some vehicle funded by EFSF) register as a credit institution and borrow from ECB is likely to be illegal.
The Wall Street Journal reports
Klaus Regling, chief executive of the European Financial Stability Facility, told a podium discussion that “there are serious concerns” that such a scheme wouldn’t be allowed under the EU Treaty, which forbids the ECB from financing governments directly.
And at the FT’s Money Supply blog, Ralph Atkins writes
But Jens Weidmann, Germany’s Bundesbank president and ECB governing council member, has already made clear his opposition. Giving the EFSF access to ECB funding, Mr Weidmann argues, would be “monetary financing” – central bank funding of governments – which is banned under European Union treaties …
More crucially, an ECB legal opinion issued in March made clear that the European Stability Mechanism – a permanent fund expected to replace the temporary EFSF from 2013 – would not be allowed access to its liquidity because of the ban on monetary financing. “The ECB recalls that the monetary financing prohibition…is one of the basic pillars of the legal architecture of economic and monetary union,” its lawyers wrote then. I am not a lawyer, but to me that would also rule out giving the EFSF access.
The ECB legal opinion states
Article 123 TFEU would not allow the ESM to become a counterparty of the Eurosystem under Article 18 of the Statute of the ESCB. On this latter element, the ECB recalls that the monetary financing prohibition in Article 123 TFEU is one of the basic pillars of the legal architecture of EMU
Of course, we in Ireland have been here before. Back in 2009, a number of very serious people assured us that nationalising any banks would be inadvisable because the ECB was prohibited under the monetary financing clause from lending to nationalised banks. (That Anglo were at the time borrowing in a big way from the ECB didn’t seem to get in the way of what seemed like a great argument).
1. Overdraft facilities or any other type of credit facility with the European Central Bank or with the central banks of the Member States (hereinafter referred to as ‘national central banks’) in favour of Union institutions, bodies, offices or agencies, central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of Member States shall be prohibited, as shall the purchase directly from them by the European Central Bank or national central banks of debt instruments.
This is immediately followed by
2. Paragraph 1 shall not apply to publicly owned credit institutions which, in the context of the supply of reserves by central banks, shall be given the same treatment by national central banks and the European Central Bank as private credit institutions.
So while the ECB may recall the monetary financing prohibition, you could argue that they don’t recall it very well. One could quibble that EFSF is not currently not a “publicly owned credit institution” but it’s hardly high octane financial engineering to create a vehicle funded by EFSF that counts as such.
Well thanks Silvio! If it weren’t for the comical actions of Signor Berlusconi, I doubt if we would have obtained yesterday’s long-hoped-for interest rate cut on our EU loans. Certainly, the cut isn’t in any way related to the negotiating skills of the government – who were last seen essentially waving a white flag on this issue.
On the substance of the deal, like Namawinelake, I’m frustrated at the lack of useful detail about the new interest rate and potential changes in loan maturities.
An annual saving of €800 million is being widely cited but I have my doubts if the correct amount has actually been calculated. My guess is that the final savings could be a bit larger, perhaps as much as €1.2 billion annually.
The first open question relates to which funds the cut is being applied to and the second relates to the size of the cut in the interest rate itself. The statement merely says
The EFSF lending rates and maturities we agreed upon for Greece will be applied also for Portugal and Ireland.
However, Ireland is only borrowing €17.7 billion from EFSF and no reasonable multiple of this number delivers annual savings of about €800 million. It seems most likely that the reasonable assumption is being made that the interest rate will also be cut on Ireland’s €22.5 billion of loans from the EFSM, though as this is an EU vehicle, last night’s meeting could not announce such a cut.
If we applied a cut of “about two percent” to the “about €40 billion” of EFSF and EFSM loans, then my fuzzy math calculations come up with “about €800 million”. So that’s the likely source of the figure.
However, it seems likely to me that the terms of Ireland’s €4.8 billion in promised bilateral loans from the UK, Denmark and Sweden will be renegotiated, so a more accurate fuzzy math would apply “about two percent” to exactly €45 billion to arrive at “about €900 million”.
Then there’s the question of the size of the interest rate cut. The Irish media have clung firmly to the notion that the average interest rate on our loans was about 5.8 percent, despite plenty of evidence that the cost of the EU component was going to be higher than had been projected last November.
As I reported here a few weeks ago, by my calculations (spreadsheet here), the average interest rate on Ireland’s EU loan was going to be 6.21 percent. The Eurozone statement promises an interest rate
equivalent to those of the Balance of Payments facility (currently approx. 3.5%), close to, without going below, the EFSF funding cost.
That could imply a cut of 2.7 percent, which if applied to the full €45 billion would give “about €1.2 billion”. That may be right or wrong since we don’t have much information yet. But I suspect that once things are worked out, the savings will be greater than the €800 million being quoted.
Update: Sean O’Rourke just put my calculations to Michael Noon on the RTE News at One. The Minister conceded that it was likely that the interest rate cuts would be extended to the bilateral loans and that this would get the savings up to €900 million.
When a higher figure of €1.2 billion was put to him, the Minister noted that this might have included the likely reduction in future IMF rates (something I’ve written about before but wasn’t including here.) The difference here comes from my comparison of the “about 3.5 percent” with my calculated current average EU rate of 6.2%.
With the average margin over cost of funds currently running at about 300 basis points, it still seems to me that a reduction of this margin to get the interest rate “close to” the funding cost sounds like a reduction closer to three percent than two percent. But I could be wrong.
Here‘s a link to the Eurogroup statement from last night. This is promising
To this end, Ministers stand ready to adopt further measures that will improve the euro area’s systemic capacity to resist contagion risk, including enhancing the flexibility and the scope of the EFSF, lengthening the maturities of the loans and lowering the interest rates, including through a collateral arrangement where appropriate. Proposals to this effect will be presented to Ministers shortly.
But I’m not holding my breath waiting for an impressive intervention.
The topic of the interest rate on Ireland’s EU loans has attracted a lot of attention. Unfortunately, however, hard information on the loans and comparisons with the loans being offered to Portugal is not always easy to come by. The purpose of this post is to provide the information that is publicly available on this issue and to present new calculations of the likely interest rates on Ireland’s loans.
The most common media reference point for the cost of Ireland’s loans is this information note released by the NTMA in November. That document projected the cost of Ireland’s loans from the European Financial Stability Mechanism (EFSM) at 5.7 percent and the cost of Ireland’s loans from the European Financial Stability Facility (EFSF) at 6.05 percent.
With €22.5 billion being provided to Ireland by the EFSM, €17.7 billion by the EFSF and €4.8 billion coming from bilateral loans, the NTMA note assumed the interest rate on the bilateral loans would be the same as the EFSF rate. Thus, the estimated average cost of the EU loans was 5.875 percent. (I am leaving aside in this note the question of the cost of funding from the IMF, which is determined according to standard, if somewhat complex, IMF procedures.)
In a briefing note for the Oireachtas Committee on European Affairs, I noted that market interest rates had risen since the November briefing and the pricing of the first EFSM bond had not gone as well as anticipated. Based on those considerations, I suggested that the cost of EFSM funding was likely to be 6.09 percent while the cost of EFSF loans would be 6.44 percent.
The period since that briefing note was written has seen a number of EFSF and EFSM bonds issued to Ireland and Portugal, so now seems like a good time to attempt to get a more accurate picture.
Here’s a link to a spreadsheet that describes each of the bonds issued by EFSF and EFSM as well as the conditions on which they were disbursed to Ireland and Portugal. I have made estimates of what the interest rates will be on funds that are not yet drawn down by assessing their likely average maturity (to match the planned 7.5 year average maturity for Ireland and Portugal), calculating current market interest rates for those maturities (based on the mid-swaps benchmark used by the EFSF and EFSM) and then adding in the estimated margins.
A quick summary:
1. The average interest rate on EFSM loans for Ireland is projected to be 6.13 percent.
2. For Portugal, the EFSM loans project to have an average interest rate of 5.34 percent. The lower rate than for Ireland is because the EFSM’s profit margin on Portuguese loans is 77 basis points lower than for Ireland.
3. The average cost of EFSF loans for Ireland is projected to be 6.29 percent. This is lower than I had estimated in January because I had used the assumption underlying the NTMA’s November document that the margin over funding cost that would determine the effective borrowing cost for Ireland would be 317 basis points. Based on the one EFSF bond issue for Ireland so far, I now estimate that this average margin will be 305 basis points.
4. The average cost of EFSF loans for Portugal is projected to be 5.76 percent.
5. Based on the assumption that Ireland’s bilateral loans (not yet drawn down) will carry the same average interest rate as the EFSF, the average interest rate on Ireland’s EU loans will be 6.21 percent, 33.5 basis points higher than estimated last November. The average interest rate on Portugal’s EU loans is projected to be 5.55 percent, 66 basis points lower than the projected rate for Ireland.
6. The current terms on Greece’s EU-IMF loans have been widely reported to be 4.2 percent for a 7.5 year average maturity after Greece was granted a 100 basis point reduction at the March 11 meeting of the Heads of Government of the Euro Area member states.
For those interested, here’s a rough description of how the calculations were done.
The saga over Ireland’s request for a reduction in the interest rate on its EU loans continues, with the French continuing to link this issue with Ireland’s corporate tax, a role they swap every so often with the Germans (media stories from today here and here). As Christine Lagarde’s recent comments show, having made such a big deal of the issue, the French are now motivated to achieve the crucial goal that “Everybody will have to save face.”
It is worth noting, however, that the French signed this document “Conclusions of the Heads of State of Government in the Euro Area” on March 11. It stated:
Pricing of the EFSF should be lowered to better take into account debt sustainability of the recipient countries, while remaining above the funding costs of the facility, with an adequate mark up for risk, and in line with the IMF pricing principles.
Note the absence of any mention of corporation tax or renegotiation of deals.
Despite the constant repetition of the line that Ireland is somehow looking to change the status quo, it seems to me that there is a strong case for the opposite position. Having agreed to change the pricing of EFSF loans on March 11, the EU’s principle political leaders have reneged on this agreement for the moment, most likely because the political kudos that come with appearing tough on Ireland outweigh those associated with honouring agreements made at Heads of State level.
Those who believe that Ireland’s situation will end well because European institutions have our best interests at heart may wish to consider how things have played out over the past few weeks.
In his latest speech, Lorenzo Bini-Smaghi provides some insights into how European financial stability can be improved. Some key passages:
One objection to a more integrated banking system in Europe is the role of national budgets in crisis resolution. As long as budgets remain national – so goes the argument – crisis resolution has to remain national, and so does supervision. The crisis has shown that bank resolution and restructuring are more complicated for cross-border institutions, given that any fiscal costs have to be distributed across several host sovereigns. As Charles Goodhart has said, “…cross-border banks are international in life, but national in death”. 
As I see it, enhanced financial integration in the euro area does not necessarily imply a need for greater fiscal union – if that is understood as a pooling of tax revenues, harmonisation of tax rates or issuance of a common bond. Instead, we must develop the capacity at the area-wide level to address specific financial tensions that threaten to spill over to the area as a whole, minimising disruptions to market integration and supporting the transmission of monetary policy.
The recent crisis – and, in particular, developments in Ireland – have demonstrated that, despite the imperfect integration of the European financial system, very strong cross-border contagion takes place within the financial sector. The instruments available at present to block this contagion are not efficient and have side-effects. In practice, much of the burden to contain contagion has fallen on central banks. This is neither desirable nor appropriate.
In my view, the European authorities need to develop a capacity to conduct a ‘surgical strike’ on problematic financial institutions or market segments in the event of a financial crisis. Through such actions, the area-wide externalities created by specific problems can be contained. In practice, this means ensuring that programmes such as the European Financial Stability Facility (EFSF) or the European Financial Stabilisation Mechanism (EFSM) – and their envisaged permanent successors – are given sufficient financial resources and the required flexibility by the Member States to act as necessary to support financial stability. To do so, these bodies may also need to be able to support the recapitalisation of an ailing banking system, if its weakness threatens the stability of the area as a whole. All this of course comes with strict conditionality in the context of an overall EU/IMF programme.
This has been the case in both the Greek and Irish programmes, in which funds are dedicated to the recapitalisation of the weak banks. A more systematic approach should be pursued, making it easier for countries to implement such a scheme.
The recent crisis has demonstrated that the European financial system was insufficiently robust. Further measures to deepen integration and bolster stability are required. Looking forward, we have to identify any remaining weaknesses and seek to address them.
Until now, it has generally been argued that the main responsibility for financial supervision has to remain at national level. The consequences of failures in supervision ultimately fall on the taxpayers of the country where the bank resides. To align incentives and ensure appropriate accountability, nationally defined tax bases imply nationally defined supervisory institutions.
However, the crisis has demonstrated that the implications of supervisory failures extend well beyond national boundaries. First, cross-border contagion has been magnified by externalities and spillovers arising from greater area-wide financial integration. Second, experience has shown that, within a more integrated market, greater specialisation may imply that financial systems in one country outgrow the capacity of national taxpayers to support them.
The implications of this experience are profound. As I have argued, they point to the need for a much greater euro area and EU perspective in the supervisory and regulatory framework. While progress has been made in this domain, much remains to be done.
I appeared today before the Oireachtas Committee on European Affairs to discuss the interest rates on the EU-IMF loans. I provided the committee with a briefing paper (available here) and a short presentation (available here). I will edit this post later to include the transcript of my opening statement and the questions and answer session when these materials are posted on the Oireachtas website.
There’s a lot of material in the briefing note and I’m not going to repeat it here. One point I would briefly point to, however, is that the note discusses how recent movements in market interest rates and the pricing of EFSM’s initial bond issue on January 5th (EU Commission press release here) meant that, by my estimates, the cost of funding from the EFSF and EFSM would be 40 basis points higher than had been estimated in the December note released by the NTMA.
These materials were prepared prior to today’s €5 billion bond auction the EFSF. Press stories have been very positive about how this bond auction went (e.g. here and here). However, the material I prepared discussed the pricing of the EFSM bond yield relative to swap rates. The January 5th bond was priced at mid-swaps +12 basis points while this bond mid-swaps +6 basis points, so the interest rate on today’s bond would not change my judgment on this issue by much.
Update: As promised here‘s the transcript of my appearance
Even as we are distracted by political upheavals at home, the debate on how best to reorient the euro zone’s bailout mechanisms continues. The proposal gaining most traction, with at least a degree of German support, is to allow countries in difficulty to use EFSF funds to buyback their own debt on the secondary market. The initial focus is on Greece, but any new mechanism should be available in time to Ireland. (Wolfgang Munchau provides a critical analysis here.)
The attraction of buybacks is that they allow a country to reduce the face value of outstanding debt without a formal default. A disadvantage is that they can be gamed by bondholders: it makes sense for bondholders to hold out for a higher price if a buyback is really expected to improve creditworthiness. One partial solution that I mentioned previously is for countries to buy back the debt accumulated by the ECB through its Securities Markets Programme (see here).
Writing on Friday before the latest developments, Arthur Beesley reminds us of the stakes:
[T]he debate merits serious attention across the political spectrum in Dublin. Political activity for the next . . . weeks will centre on the election, but neither the Government nor the Opposition can afford to lie low on this front.
The debate on Greek debt takes place amid an intensive negotiation of key reforms to the European Financial Stability Facility (EFSF) rescue fund, including lower interest rates. Any inattention here would hamper Ireland’s argument for a rate cut, which is already difficult. But the Irish dimension does not end there, far from it.
. . .
[S]etting the election date brings clarity as to when a new government is likely to take office. From the perspective of European talks, the timing is tricky enough. Polling day is March 11th. EU leaders are working to make final decisions on EFSF reforms and a new permanent bailout fund at a summit only 13 days later.
There will be time – just about – to install a new taoiseach. By then, however, the really tough talking may well be done.
The FT is reporting that the Christine Lagarde is the latest high-level official to offer tentative support for bond purchases by the EFSF as a central element in the reform of liquidity support measures.
Christine Lagarde, French finance minister, said France was ready to discuss allowing the eurozone’s €440bn ($588bn) bail-out fund to start buying bonds of struggling European economies amid signs of consensus that it would become the primary new tool for tackling Europe’s ongoing debt crisis.
How significant a development would this be? The first thing to note is that ECB bond purchases have failed to bring market yields to affordable levels. While probably helping to a degree, the ECB’s secondary-market purchases have lacked commitment and provide no real certainty to investors on how high yields could rise. Secondary market purchases by the EFSF are unlikely to be much more effective unless operated at a very different scale.
In principle, however, official primary-market bond purchases could provide guaranteed funding at some maximum interest rate. This maximum rate could be set high enough to create strong incentives to rely on market funding. I would presume that the total amount of funding would be capped and the programme would have a time limit. But because they involve purchases of ordinary bonds, concern about the seniority of official creditors should be lessened. Overall, the existence of such an official buyer of last resort should give market investors reasonable confidence that governments would be able to roll over their borrowing as bonds mature over a significant time period. The proposal has the potential to provide support to a country facing difficult market conditions without crowding out longer-term private investors from the market; such crowding out appears to be a major shortcoming of current support measures.
Of course, the devil is in the detail, and there is little concrete yet about how such bond purchases would actually operate. It is also unclear whether these new facilities would be available to countries already in support programmes. But it is an interesting development.
The NTMA have released a note explaining the interest rate associated with the bailout package. The average interest rate is 5.82% and the average maturity of the borrowings is 7.5 years.
The 5.82% is presented as being comprised of an average rate of 5.7% from the IMF and EFSM and 6.05% from the EFSF.
The statement leaves a few questions unanswered about the IMF and EU rates.
Regarding the IMF rate, the IMF’s statement on Sunday night said
At the current SDR interest rate, the average lending interest rate at the peak level of access under the arrangement (2,320 percent of quota) would be 3.12 percent during the first three years, and just under 4 percent after three years.
How do we get from a weighted average of 3.12% and 4% to the government’s figure of 5.7%? The answer appears to be related to the fact that the IMF lends in SDRs at a floating rate. From the NTMA statement:
The SDR comprises a basket of four currencies, Euro, Sterling, the US Dollar and Japanese Yen. The IMF’s SDR lending rate is based on the three month floating interest rates for the currencies in the basket. In the presentation of the financial support programme the interest cost on the IMF’s floating rate SDR lending is expressed as the equivalent rate when the funds are fully swapped into fixed rate Euro of 7.5 years duration.
Since both IMF and NTMA statements must be true, this suggests that the cost of swapping a floating rate SDR loan into a fixed rate Euro loan is somewhere between 170 and 258 basis points. That seems very high to me.
Regards the EFSM rate, the NTMA tell us that it “will be at a rate similar to the IMF funds, i.e. 5.7 per cent per annum.” But presumably the EFSM is lending in euros and so there was no need to undertake a very expensive swap exercise, so this deal factors in a profit margin for the EFSF that does not apply to the IMF loan.
Finally, the mystery that is the EFSF rate is revealed. 6.05%. Less than the 6.7% that was doing the rounds last week but more than the 5.7% that I had guessed a few weeks ago and still a pretty hefty rate.
I have to confess to having no idea how this 6.05% was arrived at. The EFSF FAQ states
fixed-rate loans are based upon the rates corresponding to swap rates for the relevant maturities. In addition there is a charge of 300 basis points for maturities up to three years and an extra 100 basis points per year for loans longer than three years. A one time service fee of 50 basis points is charged to cover operational costs.
So let’s plug in the numbers consistent with a seven year maturity. The seven year swap rate is 2.85%. Add 400 basis points for the profit margin and you’re at 6.85%. And this ignores the 50 basis point service fee which, if annualised over the term, would bring the rate up to 6.92%. Finally, this also ignores the following aspect of EFSF lending. From the framework agreement:
The Service Fee and the net present value of the anticipated Margin, together with such other amounts as EFSF decides to retain as an additional cash buffer, will be deducted from the cash amount remitted to Borrower in respect of each Loan (such that on the disbursement date (the “Disbursement Date”) the Borrower receives the net amount (the “Net Disbursement Amount”)) but shall not reduce the principal amount of such Loan that the Borrower is liable to repay and on which interest accrues under the relevant Loan.
This seems to mean that we are paying the service fee and margin up front. In addition, we are going to pay interest on a cash buffer, which is money kept by EFSF that we’ll never see.
So, two thoughts here. First, it seems likely that the government negotiated in the final days to get the “profit margin” aspect of the EFSF money down. Second, I wouldn’t be surprised if the true effective cost of this loan is understated by the 6.05% figure, for instance because it doesn’t include the up-front service fee or the role played by the cash buffer.
A full detailed explanation of the EFSF rate from either the Irish government or the EFSF would be very welcome.
The government has pushed the line in recent days that the flair up in the crisis is all about the banks. There is little doubt that the trigger was ECB concern about their large and rising exposure to the Irish banking system. But the idea that the banks are the problem and the state is fine – happily pre-funded as it is through the middle of next year – is nonsense. As it stands, the Irish state is not creditworthy. All else equal, it will become even less creditworthy as it burns through its valuable cash buffer. The vanishing credibility of the ELG guarantee along with the creditworthiness of the state is the major cause of the banks’ increasing reliance on the ECB. The intensified banking crisis is a (very significant) symptom of a deeper problem.
Of course, hopes are pinned that we can demonstrate political capacity to stabilise the debt to GDP ratio through a credible four-year plan and budget. This will be a massive challenge. Funding support on good terms – part of which could be used to “overcapitalise” the two main banks – would be a significant advantage in regaining market access; indeed, probably indispensible. The last thing we need is another incorrect diagnosis of the problem.
Even though it’s hard to separate fact from fiction in the fast-moving bailout story, reports that the Commission and ECB are pushing for Ireland to avail of the EFSF for broader European stability reasons could change the calculation in an important way. I still believe that Ireland’s best bet is to regain creditworthiness through a demonstration of political capacity with the budget and the four-year plan. The alternative of being forced to seek a bailout would involve at least as much austerity as our own adjustment and would do long-term reputational damage.
But acceding to a request to avail of the facility is potentially a different proposition. I don’t think our European partners could simply expect us to pursue a less nationally advantageous path in the interest of broader euro zone stability. The terms would have to be mutually advantageous relative to the next best options for both sides. One reasonable agreement that could meet this requirement is for our European partners to support our four-year plan with a credit line from the EFSF at a reasonable rate of interest (say the 5 percent rate provided to Greece). Access to the funds would be conditional on meeting the targets under the plan, which after all is being developed with input from the Commission and the ECB. The intention would still be to return to markets for funding rather than the use the facility, but the backstop of a dependable credit line on reasonable terms would give us a substantially greater chance of actually being able to access market funding both for the state and the banks.
Of course, it would be a mistake to exaggerate our bargaining power. The increasing reliance of our banks on the ECB means we are heavily dependent on their willingness to provide extraordinary support. But if the right deal is on offer, I worry that the government would be too inclined to resist for fear of a political backlash. All bailouts are not created equal. An invited bailout – on the right terms, and in line with our own chosen strategy – might well be worth accepting.
Constantin Gurdgiev and I offer different views on Ireland’s capacity to avoid default in today’s Irish Examiner. Articles here. The articles follow an introductory piece by the paper’s political reporter, Mary Regan.
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.
Today I re-read this piece that Wolfgang Munchau published in the FT on September 28th. Titled “The Truth Behind the EFSF” at Eurointelligence and “Could Any Country Risk a Eurozone Bail-Out?” at the FT, it concludes that countries that tap the facility will have to pay interest rates of about 8 percent. If this were true, then countries like Ireland could face very substantial financing costs even after seeking help from this fund, which would make successful stabilisation all the harder.
Looking into this issue, it seems to me that Munchau’s assertions about borrowing rates from the EFSF are not correct. By my calculations (see below) the EFSF borrowing rate would be a bit below 6 percent. Now this is still very high but given the large sums that would be involved if the facility swings into action (financing budget deficits and bond redemptions for three years) this difference is likely represent a significant amount of money.
Munchau calculates his 8 percent figure as a 4 percent cost of fundraising for the EFSF plus 350 basis points for administration charges and lending margins and an additional 50 basis points related to the fact that the EFSF will be holding back some of the funds raised as a “cash buffer.” While fundraising costs, administration charges and lending margins and the cash buffer do all come into calculating the correct borrowing rate, my read of it is that Munchau’s calculation isn’t accurate on any of these three figures.
I’ll admit, of course, that this stuff is pretty complicated, so let me start with providing the official sources and then people can tell me if I’ve got it wrong.
so writes a group of European academics and former policy officials in this FT op-ed.