13/05/2010

Flash : The European Financial Stabilisation Mechanism

(A poorly conceived time bomb on a short fuse!)

 

As details of the historic decisions reached by ECOFIN over the weekend emerge, the fears expressed in my initial analysis are unfortunately rearing their ugly head.

 

In the conclusions of ECOFIN it is stated that the main element of the European Stabilisation Mechanism, i.e. the €440 billion to be provided by the EMU Members, is to be structured by creating a Special Purpose Vehicle that will issue securities guaranteed “on a pro rata basis by participating Member States in a coordinated manner”. In other terms that means that the guarantee is “several” and not “joint”.

 

The market implications of this construction are extremely disturbing:

 

-          A several guarantee implies that the rating (expected to measure the risk of receiving full interest and principal on a timely basis) will be set at the level of the weakest link (Greece) or close thereto in view of the very low level of the latter’s commitment. Additionally, other EMU Members are on some Rating Agencies watch list with negative implications: should these downgrades come to pass, the rating of the SPV’s securities would also suffer commensurately. Under the most favourable conditions a single “A” rating is the best that can be expected.

-          The funding costs of the SPV will be sub-optimal depriving the beneficiaries of one of the main attractions of the mechanism, that is to say funding costs close the German rates.

-          Sub-optimal ratings and funding costs have also detrimental long term implications for the market appraisal of EU securities (including possibly fairly rapidly those issued by the EIB). It will lead psychologically to a weakened image of EMU, the sustainability of the Euro and, ultimately, of the EU itself. The market will fail to understand the difference between EU securities benefitting from a budgetary guarantee (implying an AAA joint and several guarantee of all 27 Member States) and Eurozone SPV securities benefitting from a several guarantee of EMU Members, in particular because the Eurozone is supposed to comprise the most creditworthy EU Member States.

-          The Rating Agencies are bound to become once against the target of – this time – unjustified criticism and together with “speculators” be the sacrificial scapegoats on which the politicians will blame the next attack by market operators. Once investors have taken the real measure of what is being proposed, a large part of the work of ECOFIN will prove to be not only useless but even counterproductive as it will underline, once again, the lack of understanding of markets by those who manage our affairs.

 

It is not too late, but is of the highest urgency to correct this structural flaw of the European Financial Stabilisation Mechanism. This is bound to prove politically difficult but is nevertheless indispensable. My preference, as stated earlier, is that the guarantees are provided by the EU 27 rather than the EMU 16, configuration that should make it easier for Germany to agree though it implies also the participation of the United Kingdom. At the end of the day, there will be little solace for Germany to have “limited its exposure” to its pro-rata share of the guarantee, if in the process the whole EMU construction is swept away. That is why it is in the interests of all 27 EU Members to rally around and show real solidarity that is needed to convince the markets and reassure public opinion.

 

Brussels 13 May 2010

23:39 Écrit par Paul N. Goldschmidt 13 Ave. Victoria 1000 Bruxelles dans Général | Lien permanent | Commentaires (0) |  Facebook |

Les commentaires sont fermés.