The European sovereign bond markets are a bit calmer today, after ECB central bank governor Jean-Claude Trichet said the ECB might continue with its bond purchasing programme, and Portugal managed to auction €500mn in T-bills. But this may only be a temporary respite.
What strikes me about this latest crisis is how incredibly slow the EU and Eurogroup is to react to bond market crises. They come out with an emergency loan package for Ireland, but the package still has to be approved at an EU Summit in a few weeks and by a Eurogroup meeting of Eurozone finance ministers. It then comes out with plans for a new bail-out mechanism called the European Stability Mechanism (ESM), to replace the existing European Financial Stability Facility (EFSF) in 2013. The ESM will differ from the EFSF in that private creditors would be forced to take haircuts if a country is declared insolvent. Great…but who’s thinking as far ahead as 2013?
At the moment, the EFSF’s bail-out loans are pari passu with private creditors, so private creditors are treated the same in any eventual restructuring. That means private creditors could get a free ride on the EFSF’s largesse, much to chancellor Merkel’s disgust. So if investors think Portugal, Spain, Italy, Belgium or anyone else is going to default, best get them to do it now, before the ESM is introduced and investors might face a restructuring.
But when would a restructuring happen under the ESM? Investors would apparently be ‘encouraged’ to extend debt maturities after an ESM loan was released, but would only face an automatic restructuring if a country was officially pronounced insolvent. And that, it appears, would happen after a unanimous vote by the Eurogroup. Sort of a geo-economic version of the Eurovision Song Contest, if you will. Ireland…null points!
So how is this mess likely to play out? Reuters’ Luke Baker sketches five possible solutions:
1) A massive programme of European sovereign debt purchasing by the ECB, perhaps to the tune of €1-2 trillion. Baker suggests from his interviews that this is the most likely solution. That will likely lead to inflation in the Eurozone, and a weakening euro.
2) The Eurogroup makes the European Financial Stability Facility bigger. It still has €650bn in it, enough perhaps to cope with Spain defaulting, though not if Spain, Italy and others default within a short amount of time. EU policy-makers are apparently considering doubling it in size.
3) The Eurozone issues Eurozone bonds, thus pooling the credit strength of the Eurozone and hiding weaker members under the umbrella of the Union. The EFSF is, in fact, preparing to issue its first bonds in January, to finance the Ireland rescue package. This could be the first step towards a wider programme of Eurozone bond issuance.
4) Beg China for help. One EU policy-maker tells Baker: ‘Think about who’s got the money to handle this. The only country is China. We need China to step up and buy EU debt.” Hu – let the dogs out!
5) Eurozone moves to fiscal union. Trichet himself said recently: “We have got a monetary federation. We need quasi-budget federation as well. Yes, we could achieve that if there is strong monitoring and supervision of what there is. Because what exists doesn’t converge with the actual situation we are facing. It is a situation where we need quasi-federation of the budget.”
Some analysts think this is where the crisis is moving the Eurozone project. When bond markets attack, the Eurozone has to move to a higher level of complexity to defend itself. But just imagine a situation where Eurozone budget checkers are sent, like Hans Blix, to Italy or Greece to check how honest their accounting is. Hiding any secret debt in underground bunkers, Silvio?