ESM

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. 

The EFSF is supported by the 17 Euro area Member States who have guaranteed to repay any of its liabilities up to a maximum of Euro 726 billion with each country offering a percentage of this. Germany’s share of the guarantee is Euro 211 billion and France’s is Euro 158 billion. Because a decision was taken that the EFSF would seek an AAA rating its capacity is limited by the amount of guarantees it has from AAA rated member states which is only Euro 440 billion.

This is enough to support Greece, Ireland and Portugal which are all small but not Spain and Italy which are also now facing unsustainably high borrowing costs. There is ZERO political will amongst member states to increase the size of their support for the EFSF so the challenge is to find a way of increasing its effective firepower without increasing MS support. The only way of doing this is to increase the RISK that the EFSF takes. One way of thinking about this is that now that MS have promised Euro 440 billion which they had intended to be used as ‘debt’ which is relatively safe and turn this into ‘equity’ which is far more risky. The size done not change, but the risk goes up.