Photo: Håkan Dahlström
EU leaders are considering scrapping clause in the permanent European stability fund mechanism set to go into effect in 2013 that would force the private sector to take haircuts on sovereign bonds in the event of a bailout, according to Reuters.This would not, however, effect the current deal for private sector involvement in the Greek bailout.
It’s the latest instalment in a deepening divide pitting France, Italy, Spain, and the majority of the eurozone against Germany, Finland, and the Netherlands.
The European Stability Mechanism, the permanent successor to the European Financial Stability Facility, is meant to serve as a permanent rescue fund that would take action to prevent borrowing costs from escalating and contagion from happening. It’s supposed to go into effect by mid-2013, though EU leaders have said they might try to push that date forward to as soon as mid-2012.
Currently, the mechanism stipulates that debt restructuring–and with it, haircuts on private sector holdings of sovereign bonds–could be pursued as a preventative measure rather than only in cases of severe insolvency. This would make sovereign bonds riskier assets to hold.
Outgoing Italian European Central Bank member Lorenzo Bini-Smaghi trashed this policy in a speech last year, arguing that sovereign debt is not like corporate debt because it shouldn’t be risky by nature:
To sum up, private sector involvement, if pursued imprudently, i.e. automatically rather than as the last resort:
- does not help save taxpayers’ money; indeed, it may cost them more money;
- favours short-term speculation over long-term investment, which is certainly undesirable;
- discourages and even delays any new investments in a country implementing an adjustment programme.
The idea works for countries like Germany, Finland, and the Netherlands, all of which have triple-A credit ratings and substantial investment in the euro periphery. But it hurts countries like Spain and Italy, with borrowing costs spiraling out of control because of fear, not insolvency.
Investors buy sovereign bonds to have stable, nearly risk-free investments. Any risk in that investment doesn’t serve them, because they don’t buy sovereign bonds to make risky investments. In order to allow struggling eurozone countries to stay in or return to the market for financing after the crisis is over, EU leaders will have to assure investors that they won’t lose out from lending them cash.
EU leaders are right to consider dropping these clauses from the ESM, and continued opposition from Germany, Finland, and the Netherlands would only further demonstrate their unwillingness to take necessary steps to bolster market confidence in the eurozone.