Saturday, August 06, 2011

EFSF and the ESM fail without Spain and Italy as Guarantors

If the ECB were to start purchases of Italian and Spanish bonds, so far I have been unable to determine where the costs would fall. The difficulties of such a programme, however, were well spelt out in this briefing from Deutsche Börse Group of 11th July, linked here.

The replacement for the EFSF,  is the ESM which Treaty was signed on 11th July 2011, but unable to come into effect until Article 136 of the EU treaties is ratified by all EU member states:

"3. The Member States whose currency is the euro may establish a stability mechanism to be activated if indispensible 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."

The ESM, nevertheless, most probably provides the most recent and accurate assessment as to how the obligations are presently being shared among the guarantors, as set out at the end of the new (as yet unratified) Treaty agreement:

ESM Member                          Number of shares
Kingdom of Belgium                       243 397
Federal Republic of Germany     1 900 248
Republic of Estonia                          13 020
Ireland                                             111 454
Hellenic Republic                            197 169
Kingdom of Spain                            833 259
French Republic                           1 427 013
Italian Republic                             1 253 959
Republic of Cyprus                            13 734
Grand Duchy of Luxembourg             17 528
Malta                                                    5 117
Kingdom of the Netherlands             400 190
Republic of Austria                            194 838
Portuguese Republic                         175 644
Republic of Slovenia                            29 932
Slovak Republic                                   57 680
Republic of Finland                            125 818
 Total                                                7 000 000

Spain and Italy together therefore represent a larger share than even Germany, equal to almost 30% of the total. Given the uncertainty of future IMF contributions to new loans, which up to this date had been one third of monies advanced AND given also the fact that earlier contributions of non-euro area EU member states from the EFSM were also a significant mitigating factor, the new ESM facility can immediately be seen as completely unsustainable were it to be applied on its own to the third and fourth largest, previously contributing, countries of Spain and Italy!

Indeed can Spain and Italy (along with Cyprus, Belgium and Slovenia) really even now be expected to still make their payments to the Greek Bailout 2.0?

Note in particular, Paragraph 7 (on Page 6) of the EFSF framework agreement, which provides an opt out from any further installment payments, which must now be under consideration in Italy, as hinted at by a questioner during the ECB press conference last week!

If a euro-area Member State encounters financial difficulties such that it makes a demand for a stability support loan from EFSF, it may by written notice together with supporting information satisfactory to the other Guarantors request the other Guarantors (with a copy to the Commission, the Eurogroup Working Group Chairman) to accept that the Guarantor in question does not participate in issuing a Guarantee in respect of any further debt issuance by EFSF. The decision of the euro-area Member States in relation to such a request is to be made at the latest when they decide upon making any further Loan Facility Agreements or further Loans.

All these aspects, either taken together, or even separately must drive one to the conclusion that the euro currency cannot be sustained (never mind the recent silence from the IMF). There is precious little time remaining this weekend to adopt a more sensible common front with which to face the markets on Monday morning.

Olli Rehn, again left to flounder alone today, on behalf of the EU, urgently needs a change of policy and some powerful support from the two culpable Heads of State, Angela Merkel and President Sarkozy. 

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Anonymous Denis Cooper said...

If the ECB embarked on large scale purchases of Italian and Spanish bonds, then surely it could simply create whatever new money was needed?

According to Article 123 TFEU the ECB could do that, provided it only purchased previously issued bonds in the secondary market rather than buying them direct from the governments.

"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."

It would then, however:

a) Arguably be in breach of Article 124 TFEU, by rigging the market so that the governments could continue to sell new bonds to investors who would not otherwise have bought them:

"Any measure, not based on prudential considerations, establishing privileged access by 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 to financial institutions, shall be prohibited.".

Of course there is the precedent that the Bank of England arguably breached Article 124 during the period of "quantitative easing", as the UK's "opt-out" protocol does not provide an exemption from that Article.

b) Risk failing in its primary objective of maintaining price stability, Articles 119 TFEU and Article 127 TFEU:

"1. The primary objective of the European System of Central Banks (hereinafter referred to as "the ESCB") shall be to maintain price stability."

as well as departing from "the principle of an open market economy with free competition, favouring an efficient allocation of resources" laid down in the treaties.

c) Risk bankrupting itself if the value of its accumulated portfolio of bonds - assets on its balance sheet - drops too far below the value of the new money it created to buy them - a liability on its balance sheet.

It's understandable that at least some members of the ECB Governing Council are very reluctant to be dragged any further down that road, and would prefer the EFSF to borrow existing money and lend it on to the governments of distressed eurozone states.

5:19 PM  
Anonymous Denis Cooper said...

On the ESM treaty, I hope that MPs will read it and think hard about it before they approve the amendment to Article 136 TFEU embodied in the European Council Decision 2011/199/EU of March 25th.

Basically that amendment would give the leaders of the eurozone states licence to do more or less whatever they agreed among themselves - which in the case of the leaders of the smaller states would usually mean agreeing to whatever the leaders of the larger states demanded - while allowing those leaders to more or less escape from the control of their national parliaments.

Perhaps the Irish people should be concerned that their government has already decided that neither the amendment to Article 136 TFEU, nor the ESM treaty which it is being erected on that new legal base, will be put to a referendum - Written Answers to Questions 65 and 74 here:

5:45 PM  

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