The BBC has obtained a leaked copy of the EU draft communique on the so-called permanent bailout mechanism. Attentive readers may recall that current programs extend only to 2013, leaving a big question mark as to what would happen next, given the high odds that the countries perceived to be at risk would not be out of the woods by then.
The result, which is not out of line with previous ideas that have been voiced, may nevertheless rattle the relevant bond issues further. Key points:
New bailout funds would be senior to existing government debt (this is a standard feature of IMF rescues and bankruptcy financings)
Restructuring is a requirement in the “unexpected” instance the government in question is determined to be insolvent
Future government bonds (from 2013) will need to include terms that make restructuring less difficult
Note that these changes would require an change in the EU treaty, which in turn means a referendum in Ireland. In addition, the treaty wording change is broad, and would allow for the creation of senior e-bonds. In other words, it would represent a major step towards fiscal union.
Key details from the BBC:
The decision may significantly raise the future cost of borrowing for over-indebted eurozone governments….
In future, Brussels may require a crisis-stricken eurozone government to force losses on its existing private lenders – including investors in government bonds – before it would provide a bail-out package.
And if a government got into trouble later down the line, it would be required to default on its other debts, while continuing to make payments on its rescue loans…
From June 2013, government bonds will also have to include “collective action clauses”, which would make it much easier for an insolvent government to get the consent of its lenders to any future debt write-offs…
The rhetoric in the communique comes in stark contrast to the actual bail-out of the Irish Republic in November.
In that rescue, Brussels is accused of having insisted that Dublin honour in full its guarantee of the Irish banks. Many Irish are angry that this has landed taxpayers with the bill for repaying loans made to its insolvent banks….
The planned Lisbon Treaty amendment is short and open-ended, leaving European leaders flexibility to structure the new arrangement however they choose.
It states only that: “The Member States whose currency is the euro may establish a stability mechanism to safeguard the stability of the euro area as a whole. The granting of financial assistance under the mechanism will be made subject to strict conditionality.”
The EU is inching towards recognition of its underlying problem, that its banking sector is too large relative to the size of the underlying economies, and therefore bank creditors will need to take losses. The mechanism will evidently be through restructuring of member country debt, but if the banks start to look too wobbly, the ECB is likely to let them pledge assets in return for cheap loans, in a repeat of the Fed alphabet facility playbook. The question would then become how big a balance sheet Germany will allow the ECB to carry.
And of course, if the Irish refuse to approve the treaty change, what then does the eurozone do?