The Spanish bailout has triggered a big ongoing debate on the issue of seniority for public creditors. Certain commentators and market actors claim that it is because the European Stability Mechanism (ESM) sees itself as a preferred creditor that the announcement of a Spanish bailout has led to rising spreads. They say that seniority means that once the ESM comes in, it reduces the effective claims of the private bondholders in the event of a restructuring.
This piece exposes the flaws in this thinking both in the general case and more particularly in the case of Spain. We conclude that if the EU wants to rescue Spain, the trick is not to remove seniority from the ESM but 1) to remove all uncertainties around the future of the Eurozone 2) make conditionality more growth friendly 3) channel the bailout directly to needy banks without going through the sovereign.
A growing consensus of analysts and informed commentators have criticized both the EU’s handling of the growing sovereign crisis in the Euro area as well as its proposed plans for future reform supposedly designed to prevent a recurrence of this crisis. There is an urgent need to change course.
Our latest paper (download here) offers several new suggestions on how best to 1) institutionalize a successful and credible crisis management response in the EU in the short and long term 2) improve the existing European Financial Stability Facility 3) construct a permanent European Stabilization Mechanism.
“Throughout this crisis, EU governments put the interests of bank bondholders over those of taxpayers. This has eroded market discipline, imposed unnecessary and unfair burdens on EU taxpayers and shielded bondholders from the consequences of the risks they undertook. The Commissions’ proposals today will help draw a line under this costly policy mistake.”
“The crisis exposed the lack of a fair, predictable and market stabilizing burden sharing regime for both sovereign and bank bondholders. This proposal plugs a part of that gap.”
“A bondholder bail-in regime, properly implemented, can be good for financial stability, taxpayers and even for bondholders themselves if it protects against value destroying bank runs and bankruptcy.”
“Proposals to bail in or haircut bank bondholders can help 1) improve market discipline 2) bring about fairer burden sharing 3) protect taxpayers 4) stabilize the EU financial system.”
Each day seems to bring a new idea that proponents claim will get us out of the crisis. No matter which of these policy paths politicians eventually choose they are likely to find it blocked by neither Greece nor Ireland being able to repay all of their outstanding debts. The way out can only be cleared by a decisive restructuring of these debts – the sooner the better.
The EU is at a crossroads. One way is the high road towards a fiscal union and the low road takes us back to each state fending for itself, the paradigm that prevailed before Greece was ‘rescued’. Euro-federalists have suggested everything from minimalist E-bonds to a complete fiscal union. Sceptics have called for kicking troubled countries out of the Euro zone.
Political expediency and economic logic rules out such a break up and political stalemate and public opinion stand in the way of a fully fledged fiscal union. The only feasible option lies in the middle. Since the announcement of the Greek aid package, the EU seems to be moving along this mid-path towards a 'shadow fiscal union'.
“The treaty change discussion might end up opening Pandora’s box.” “This was definitely not urgent and probably not even necessary to set up what will be a mechanism only for liquidity support not fiscal transfers.”