The president of the ECB, Mario Draghi has declared the Euro-zone for”irreversible” with great effect in the media. Thus it would not be profitable for investors to speculate in a breakdown of the Euro. The ECB would make the”convertibility premium” that segregates the financial markets – go away. Draghis other remark about a new program concept that would”address the reservations about seniority” got considerable less attention.
This referred to the preferred creditor status of the ECB. A lot of private creditors had not – in order to avoid a messy state bankruptcy – taken kindly at all to taking a higher ”haircut” because the ECB didn’t play along. That made it clear that there are different groups of creditors and that the risk of a high “haircut” is greater the more debt the ECB buys.
The article is highly recommended, and if possible should be studied in the original rather than my rather inept translation.
The ECB loan to Spain will probably be senior to all subsequent Spanish sovereign bonds, so in the event of a Spanish default the new Spanish sovereign bond will take all losses – before the ECB takes any. This will mean that any purchases of Spanish sovereign bonds by the ECB will be of the old type of sovereign bonds that have equal seniority to the ECB loan. This in turn will increase the seniority of the ECB debt as the old sovereign bonds reach maturity and the new are issued to refinance the Spanish public debt.
This would go a long way to explain the events – and non-events of the past fortnight:
1) Spain has as of yet not formally applied for an ECB buy of Spanish Sovereign debt. On the contrary Spain seem to have tried to sell more sovereign bond before the loan goes into effect poisoning all subsequent issues of sovereign bond with higher risk: “Buy now – still wine of last year’s vintage!”
This will make sense of the rise in interest rates the last week or so: I wouldn’t put it past Jens Weidmann to sell Spanish sovereign debt simultaneously to depress bond prices in order to curb the Spanish attempt to water down the preferred position of the ECB.
Apparently the market reacted to the ECB’s wishes and Rajoy has no option but to cut public spending with a further 102 bio. EUR. Again the Neue Zürcher Zeitung:
2) US Secretary of the Treasury Geithner didn’t seem to get more for his lightning visit to Europe last Monday than polite Italian words – the German Finance Minister Schäuble isn’t polite (and annoyed his vacation was interrupted!). Schäuble was very relaxed (according to his emphatic and repeated assurances) in rejecting the need for a ECB buy of Spanish sovereign bonds to give the Spaniards a more affordable interest rate and some reform leeway. Of course he was relaxed: The application of the tourniquet was going according to plan.
The preferred status of the (on average) 12½ year 100 bio. EUR loan to Spain at 3% interest will have a senior status any subsequent loans the risk premium on new Spanish sovereign bond will make the loan prohibitively expensive – unless Spain both cut public spending, tax evaders and pensioners and take losses in the banks. Spain has walked to in between a rock and a hard place – and there is no easy way out.
The meeting with Draghi presumably met with similar lack of understanding as the need for a further ECB buy of Spanish debt isn’t there: Spain has promised to behave (they are out of playful options). Spain will not need refinancing beyond the already promised measures – it is simply not possible – the “markets” might just as well get used to it. Besides it will not go through the German parliament – Merkel will see to that.
It is surprising that Geithner and both presidential candidates understand so very little. The Euro will NOT break up. Spain will behave responsibly – they have no other option: Spain can’t leave the Euro-zone as they can’t refinance their debt and running a deficit they can’t just default, as they need constant new loans. Germany get both low interest rates and a debased currency – why should they be worried?
The Americans might be dissatisfied with the strong dollar that leaves little room for their exports to solve their sad job situation and bankrupt financial sector – Europe knows the problem – thank you very much. On the other hand the USA has a vast costumer for their grain – should be enough to pay for their rotten banks – so don’t expect any handouts: Mind your own business – it needs tender loving care.