EFSF/ESM bond buying in primary market not much better
June 28, 2012 2 Comments
I’ve already explained why EFSF/ESM secondary market bond purchases wouldn’t really help. One of the ideas floating around the EU summit is that the EFSF/ESM can buy bonds in the primary markets. While this would be more effective in terms of reducing borrowing costs and buying time, it is unlikely to buy enough time to draw a line under the eurozone crisis for three reasons.
First, the arsenal available in the EFSF/ESM for bond purchases is only EUR400bn once you earmark EUR100bn for the Spanish bank bailout. Spain and Italy have around EUR200bn left in financing needs this year. Assuming that short-term debt in 2012 and 2013 will be issued with new short-term debt that matures in 2013-14, their financing needs will be around EUR590bn in 2013 and EUR580bn in 2014. Given that the EFSF/ESM can only buy up to 50% of debt issuance in the primary markets, the EU bailout funds will be exhausted by early 2014. Admittedly the Spanish and Italian tbills may be rolled over in the markets without EFSF/ESM support; even Greece is still issuing tbills, afterall. Not including tbill rollovers, therefore, we can assume that the EFSF/ESM can help suppress bond yields by buying in the primary market through 2014. Is this enough time for Spain and Italy to implement structural reforms, have them bite and return to sustainable growth? I’m certainly skeptical.
Second, there is a problem with subordination; the EFSF is de facto senior and the ESM is both de facto and de jure senior. If these bailout funds are used to purchase debt in the primary markets, then in the event of a debt restructuring private investors would be forced to accept a larger haircut. This could serve to drive up bond yields. It is possible the core countries will back down on ESM seniority if a deal championed by the Finnish government is agreed, which envisions government bonds being covered by collateral (assets, equity or earmarked tax revenues). The Finnish idea also envisions the EFSF serving as a backstop for the covered sovereign bonds, most likely through a first loss guarantee. This proposal could help eliminate one concern over subordination (EFSF/ESM de facto seniority), only to replace it with another as covered bonds and first loss EFSF bonds create new tiers in the bond markets.
Third, there will be conditionality imposed in exchange for EFSF/ESM primary market bond purchases, and I question Mario Monti’s mandate for accepting a program involving conditionality. When there is an Italian election next April, we can be sure that anti-bailout forces (Berlusconi’s PdL, the Lega Nord, Beppe Grillo) will have gained popularity and will have an influential voice, either in government or in opposition. The new Italian government could back out of the conditionality, which would send Italian borrowing costs soaring.
This proposal could once again buy some time, but it does not address any of the underlying fundamental causes of the crisis and cannot buy enough time for Spain and Italy to restructure their economies and regain competitiveness.
For more analysis on the idea of EFSF/ESM primary market bond purchases, see RGE’s analysis here.
For analysis on the other ideas on the table at the June 28-29th EU summit and how effective they are likely to be, see “Eurozone Summit Preview: Don’t Expect Any Bold Moves“