How to make it work!
In my recent papers I have drawn attention to the structural flaws of the plan to stabilise the Euro that has emerged from the recent EUROGROUPE/ECOFIN meetings.
In particular, I have questioned the compatibility of a “several” guarantee of EMU Members of up to €440 billion of obligations to be issued by a “Special Purpose Vehicle”, with the absolute necessity of securing a AAA rating for these securities.
I explained why, in my opinion, the proposed structure would lead the Rating Agencies to align their rating on the weakest link among the 16 EMU guarantors, creating a great deal of confusion in the market with regard to securities issued by other AAA rated community institutions, such as the European Union itself, the EIB, EURATOM or other entities.
At the conclusion of the Eurogroupe meeting on Monday 17th May, which was supposed to finalise the structure of the financing package, we were informed that these issues had been differed to further meeting of Finance Ministers to be held in Brussels on May 21st.
A meeting of the 27 EU Finance Ministers was indeed held under the presidency of Herman van Rompuy but apparently, it devoted its deliberations exclusively to the launching of the process that should lead, by the end of the year, to a tightening of EU Member’s budgetary rules together with procedures for surveillance and sanctions as well as initiating the long delayed “economic governance” of the Eurozone.
However welcome and necessary this initiative may be, it would be foolhardy for the Authorities to believe that markets are prepared to forgo, until the end of the year, answers to the specific questions surrounding the operation of the European Financial Stabilisation Mechanism. Failure to address urgently this problem will encourage market operators to test the resolve of EU policy makers once again.
It is with this in mind, and taking full account of the very sensitive political aspects involved, that I wish to make a concrete proposal which should be able to gain the support of both Germany and the United Kingdom as well as of all other EU Member States.
The two elements of the €500 billion would be largely left intact; in particular its largest €440 billion component would remain unchanged. With regard to the smaller €60 billon component which benefits from an EU budgetary guarantee, instead of being accessed by individual Member States, it would be made accessible only to the SPV, in the event of the failure of one of its guarantors.
The advantages of this structure are clear: under the present proposal, the failure of a country borrowing from the SPV leads automatically to a shortfall when the “several” guarantee of EMU Members is called upon because the defaulting borrower is itself one of the guarantors. By accessing the EU budgetary Facility to cover this deficiency, the SPV can ensure punctual service of the debt, avoiding default and acceleration of the repayment of both principal and interest on its obligations.
This is of course a great advantage for all the EMU guarantors and in particular for Germany who has the greatest share of the total risk. As far as the UK is concerned, it does not increase its commitment further than the implicit joint and several guarantee on the €60 billion budgetary line that it accepted at the May 2nd ECOFIN meeting.
The credit enhancement provided to the SPV’s obligations, by dedicating the new budgetary facility to covering any shortfall in debt servicing, should allow the Rating Agencies to improve their evaluation of the SPV’s credit risk and provide the coveted AAA rating. In order to secure the rating firmly, it might be necessary for the EU to commit to maintain at all times the unused amount of the Facility at, say, 125% of the SPV maturities falling due within the following 18 months. As, initially, it would only be interest rather than principal that would become due, the €60 billion budget line should be more than enough to cover several years of future payments.
Though somewhat more complex and less transparent than a direct budgetary guarantee of a single €500 billion would have provided, (which will probably mean that the level of interest paid by the SPV will be very marginally higher by a few basis points), the proposal avoids the need for amending the vote obtained last week in the German Parliament, or require the new British Government to assume any additional obligation. The only drawback is that the total package is reduced, in terms of availability to borrowers from, €500 to €440 billion but this latter amount, together with the €250 billion IMF commitment, would seem amply sufficient to reassure the markets.
It of the greatest importance that the market is informed as soon as possible as to the details surrounding the implementation of the European Stabilisation Mechanism if one wishes to avoid having to mobilise even more considerable amounts to restore stability in the foreign exchange markets.