Dow Jones Newswires ran a story early this morning which is provoking shockwaves somewhere.
The German finance ministry is examining rescue measures for euro-zone countries which are struggling financially, Der Spiegel weekly magazine said in an advance release of a report to be published in its next edition.
Four options are under consideration. The first option is helping such countries which face insolvency via a bilateral bond, with a creditworthy country taking up the loan and providing it to a needy country. A second option would be a joint bond issued by creditworthy countries. Also under consideration is a rescue package led by the European Union, either on its own or with the involvement of the International Monetary Fund, the magazine reports without disclosing sources. The finance ministry wasn ‘t immediately available to comment on the report. German Finance Minister Peer Steinbrueck said Wednesday that a breakup of the euro zone was an “absurd” suggestion and governments would stand ready to act if any country struggled with severe financial problems. Chancellor Angela Merkel said Thursday that Germany would give its contribution to the IMF if it were asked for help. The euro has declined sharply against the dollar this week as investors are worried about euro-zone banks active in Eastern Europe. Austria, which has several large banks active in the region, is seen as particularly vulnerable. European Commissioner for Economic and Monetary Affairs Joaquin Almunia said Wednesday that the commission shares Austria ‘s concerns, but added that the bloc has limited instruments at its disposal.
The German Finance Ministry on Friday denied a report in weekly magazine Der Spiegel that it is weighing plans for a coordinated rescue of financially distressed euro-zone countries. “The Spiegel report doesn’t correspond with the facts. The Federal Finance Ministry isn’t working on any such concepts,” said finance ministry spokeswoman Jeanette Schwamberger in Berlin, according to Dow Jones Newswires. The spokeswoman said Germany has “no doubt about the unity of the monetary union,” but that rising bond yield spreads within the euro zone warrant “joint action by the European Commission, European Central Bank” and euro-zone finance ministers “to discuss measures with the affected member states to reverse this development.”
However if you look carefully at the last sentence in the Reuters report on the same story, you will see that nothing is really being denied, since there are “theoretical considerations” in the works, we just aren’t at the formal report stage yet.
German FinMin dismisses report on euro bond issues
Germany’s Finance Ministry on Friday dismissed a report by Der Spiegel magazine that it was looking at possible rescue measures for other euro zone states with severe financial difficulties.
“The above mentioned article by Der Spiegel magazine does not represent the facts,” the ministry said in a statement. “The German finance ministry is not working on such concepts.” The ministry added that wider bond spreads within the euro zone were an issue for the European Commission, European Central Bank and Eurogroup. The EU’s budget rules remained important, as well as structural reforms to improve competitiveness, it said.
“Everything beyond this are theoretical considerations,” it added.
And if you notice the headline, you will see we are already up and over the radar folks :).
I don’t see how the Eurobond concept can work. You aren’t buying a seat at the table when you buy these bonds. The weaker EU nations have no need to change their ways as they have been bailed out.
The market signals corrective action when the interest rate spread between EU countries goes up. The Eurobond neuters that effective action. The next time these countries hit the wall they have everyone half-way pregnant. Nobody has to change a thing. The Eurobond gave everyone a “do-over”.
I can see Euro money going into these bonds as they have a dog in that hunt, but what about the rest of the world? Can the European investor prosper if they invest all their monies at home while everyone is investing in the next greatest thing? Demographics et al point to Europe being a low growth area.
I think George loves this Euro-bond concept because it will be guaranteed short speculator money maker once the world economy turns around.
Once inflation hits and the squabbling starts around the table, and investors are told this is now a hedge fund with a restrictive redemption policy… people will not be happy.
There is money in discontent…
Trichet today rejected the idea that the Eurozone has a weak link, referring to Ireland in particular.
“I don’t see how the Eurobond concept can work. You aren’t buying a seat at the table when you buy these bonds. The weaker EU nations have no need to change their ways as they have been bailed out.”
Sorry, I don’t quite follow. How do US Treasuries work. How does Washington keep Alabama in line?
In addition I am proposing a very tight pact, and a mechanism for keeping their spending on a leash. Of course there could always be better ideas.
Basically, what is involved is an end to this silly idea of “nation” as we are currently practising it. We have to rectify a gap in the original eurozone architecture. You are right, of course, we can either go forwards or backwards, but if we go backwards, I have not the slightest doubt the whole edifice will split apart under the stress.
And if Frankfurt and London fall then New York and Tokyo won’t be far behind given the level of interlocking, remember, Moby Dick did drag Captain Ahab down to the icy deep with him. Also, the strongest factor which makes all this so doable right now, no one really knows at this point who is “strong” and who is “weak” here. Who would have guessed only 12 months ago that Ireland might be the first to be eaten by the wolves, or Austria the second (see my latest post) or the UK the third.
Alabama is a state in the Union, where the constitution delineates which roles and responsibilities have been delegated to Washington. It is a very tight relationship. There is not much wiggle room.
The Eurobond is a backed by a loose cadre of countries. If the Eurobond fails, does Germany and France actually back the loan or do we create a UNBond to replace the Eurobond?
It is reasonable to expect Germany and France to extract political/economic considerations from those states vying for their backing. If a Eurobond is stateless, who backs it? What are you buying when you put your money in?
I see the Eurobond smoothing and “fudging” the risk profile of European bonds. It’s a new initiative that should have been laid out in better times. Everyone knows there was no political will to support such an instrument in better times. I can understand the merit in the Eurobond for those wanting to borrow money. What is the merit of the Eurobond for those wanting to lend money? If the answer is simply you can lend to Portugal, Italy, Greece and Spain and have Britain, Germany or France back these bonds; why not lend to Britain, Germany or France and have them lend to the others? In these trying times, I think investors are looking for an explicit guarantee, not an implicit guarantee.
Now if you want to simply create a mechanism where the printing presses are opened up by all European central banks to buy each others Eurobonds, have at her.
Hi again,
“The Eurobond is a backed by a loose cadre of countries. If the Eurobond fails, does Germany and France actually back the loan or do we create a UNBond to replace the Eurobond?”
Oh, ok. If that’s your worry, no problem the answer is yes, although the thing is, which few seem to be contemplating, it may be German that has problems one day, and Portugal who has to help. Anyway, no doubt about it, any EU bond would be backed by all member states, whether in or out of the eurozone.
And it is backed by the Maastricht treaty, which may have rather more wiggle room than you are happy with, but who knows, it might even get tightened up a bit in the light of this.
“It’s a new initiative that should have been laid out in better times.”
Well obviously. But it wasn’t, and now the hard times have come and we need them, and they can be used to “coerce”, since any state which needed them, but failed to comply which go straight into default if they were refused. That’s a lot of leverage power, I think.
And since everyone has their backs to the wall here, I doubt there is going to be much room for tolerance.
“Now if you want to simply create a mechanism where the printing presses are opened up by all European central banks to buy each others Eurobonds, have at her.”
Well, this is what you can’t do in Europe I think, because that role now belongs to the ECB. The local central banks are simply book-keeping centres, except outside the eurozone, of course.
What they could do, as in TARP, is run out a load of EU bonds, and then park the takings on the ECB balance sheet, to let them do some quantitative easing, but that is going to be the content of my next post.
The bonds I am talking about here is to give fiscal clout to the EU Commission, since we need a common fiscal capacity (beyond the current structural funds one) to go with the monetary infrastructure. We have a structural deficit, and we need to start to address that issue. This is what the bonds are about.
As for the credit rating, S&Ps take the view that it should be the highest there is, my guess is that it will become the benchmark (since German bonds are already slipping), given that the EU has very little current debt, and vast fundraising power. The point is, this is not that different from those much hated mortgage backed securities, in the sense that such bonds are backed by a stream of income in the form of the money the states park with the EU to pay into the structural funds programme, thus if any state failed to meet payment on a bond the Commission could pay directly out of these funds while it sorted out what to do with the problematic member.
Here’s what S&Ps had to say last November:
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Standard & Poor’s today said it had assigned its ‘AAA’ senior unsecured debt rating to the European Community’s (AAA/Stable/A-1+) upcoming inaugural EUR2 billion bond maturing in 2011.
The ratings on the European Community (EC) reflect strong member state support, including that of several of the world’s most advanced economies, constituting a major bloc in the world economy.
The commitment of EC member states to closer European integration continues to be strong, as reflected both by the formation of EMU and by the ongoing enlargement of the Community.
EC budget policies are prudent. By law, estimated budget revenues must equal estimated expenditures. Budget resources are derived almost entirely from revenues paid by member states independently of national parliaments.
Under the Macro-Financial Assistance (MFA) program, nonmember states are eligible for lending to help them introduce political, economic, and institutional reforms to bring them in line with EU standards. Under the Balance of Payments (BoP) program, only member states who haven’t adopted the euro and who are experiencing external payment difficulties are eligible for assistance. The EC had EUR755 million of outstanding loans under the MFA program as of May 2008, mainly funded through borrowing under its EUR4 billion EMTN program.
The BoP facility has been reactivated in November 2008, with the provision of a EUR6.5 billion facility to the Republic of Hungary (BBB/Negative/A-3). As a result, and in order to be prepared should there be the need to provide similar support to other sovereigns, the EC member states are preparing to extend the overall ceiling on the BoP facility from EUR12 billion to EUR25 billion, which requires the funding available under the EMTN program to be increased (from EUR4 billion to EUR20 billion).
And here’s the Fitch view:
The ratings of the European Community (EC) are based on the strong support it receives from the 27 member states of the European Union (EU), which have a high credit quality overall. They also reflect the strict internal rules implemented on its lending activities. Support from the 27 member states is strong: according to the founding treaty, the EC budget must always be balanced and its 27 member states are legally obliged, jointly and severally, ultimately to provide the funds required to service the EC’s debt, guaranteeing its liabilities with the credit standing of the strongest member states.
The EC is engaged in sovereign lending under three programmes: loans for EU member countries experiencing balance ofâ€payments difficulties, financial assistance for nonâ€EU member countries, and guarantees to loans granted by the European Investment Bank (EIB) outside the EU. The balanceâ€ofâ€payment financing programme, which had not been used since 1993, will be reâ€activated in 2008, as the EC has approved a financial aid package of EUR6.5bn to Hungary; it will be disbursed in a maximum of four tranches, with the initial payment of EUR2bn scheduled for December 2008. In 2008, the EC intends to raise the maximum outstanding amount of loans to be granted under this facility from EUR12bn to EUR25bn.
The EC’s financings are funded by borrowings from banks or from the debt market. The lending and borrowing activities of the EC adhere to strict prudential rules. Funding is exactly matched to loans in terms of maturity, interest payments and currency.
The EC enjoys a de facto preferred creditor status: reimbursement of interest and principal to the EC takes priority over funds owed to other creditors, except multilateral development banks. The EC’s creditworthiness is also protected by various layers of support. On default by a borrower, EU budget funds from its treasury prevent delays in servicing debt, ensuring prompt payments to the EC’s creditors. If a nonâ€member debtor state has not paid within three months, a guarantee fund, funded from the EU budget, can be used. This fund is also used to cover defaults on loans made by EURATOM, the European Atomic Energy Community. The fund’s assets totalled EUR1,027m at endâ€2007, or 8.3% of loans and guarantees to non EU members covered by the fund, which is slightly below the 9% target. If there are no monies left in the guarantee fund, the EC will call on EU budget funds. Further, member states could be called on.
Key Rating Drivers · The Outlook on the rating is Stable. The ratings are driven by support of the EU’s member states. Downgrades of the EU’s ‘AAA’â€rated member states could have a negative impact on the credit quality of the EC. A material change in the support mechanism could also prompt a rating review.
Profile
The EC is one of the three supranational bodies known collectively as the European Communities, along with EURATOM and the European Coal and Steel Community (which ceased its core activities in 2002). The EC possesses an independent legal personality from the member states and the most comprehensive legal capacity given to legal persons in a member state.
Every economy is backstopped by it’s banking system. In order for Europe to maintain a “reasonable” velocity of money, it’s banking system had to reach leverage levels of 60:1. The Canadian banking system operated on leverage levels of 20:1. The US system operated on levels of 40:1.
The European banking system needs the high leverage in order to survive. Look at it like an engine. You can get your horsepower from torque or revs. I think the “torque” in the economy relates to the aptitude of the population to create wealth using the commodities at hand. “Revs” is textbook economics.
The Eurobond scenario forces all European economies to find a “satisfactory” level. If they choose to optimize their activity and others don’t, there is now a potential claim (through taxes and transfer payments) to pay for problems encountered by those who operate at slower speeds or different values.
Under the Eurobond scenario, those economies who operate “black markets” will prosper. With the black market, they have two smaller engines, one of which needs to be shared.
Why would an institutional investor consider investing in such a scenario? Where is the upside? Unless there is a political reason to invest in this type of instrument, there will be many better opportunities to invest elsewhere.
Is there a seat at the table for those who invest in the New European Experiment?
It’s nice that S&P says this is the way to go. We should trust them. Have they ever been wrong on any big calls?