The world waits to see whether the euro zone will send its bailout fund, the European Financial Stability Facility, into uncharted waters: Buying the government bonds of Spain.
That’s risky business. Might euro-zone officials be trying to sidestep some of that risk?An obscure reference in a statistical document broaches the notion of a complex method by which the county whose bonds the EFSF is buying–let’s call it Spain–guarantees that the bailout fund won’t lose money on its transactions.
Now, a guarantee from the country you’re meant to be rescuing isn’t the strongest assurance in the world. But it may give the bailout fund an edge over private bondholders if Spain is unable to repay all its debts.
Let’s back up.
European leaders are frantically trying to find a way to keep Spain financed. The country must sell tens of billions of bonds this year, and high bond yields suggest there’s not much demand.
One option–awaited by many at today’s European Central Bank meeting–would be for the ECB to start scooping up bonds.
But the ECB has repeatedly signaled that it would like the EFSF to go along and buy some bonds, too. That would spread the risk beyond the central bank and onto the euro-zone governments themselves. Many euro-zone officials want the governments to bear as little risk as possible.
Finland has demanded collateral from aid recipients, and some have suggested that a country whose banks are rescued by a bailout fund in the future might have to indemnify the fund against losses.
We’d wondered how the EFSF would handle bond purchases. If it bought bonds, then sold them in the secondary market at a loss, who would swallow that loss?
If Spain’s bond debt were to be restructured, like Greece’s was, what would happen?
The Eurostat document in question, from April, concerns the wonky but important question of how governments should account for the various rescue transactions they are contemplating.
In the context of discussing how EFSF bond-market purchases would be recorded in the books is footnote 6: The EFSF could use a technique so-called “variable balance loan” for these interventions.
In this system, EFSF will have recourse on the issuing country, which statistically can be considered a form of guarantee to the EFSF, that would compensate the EFSF if the bond would fall under its purchase price by the EFSF.
Eurostat will not record this specific guarantee as debt, but consider it as a contingent liability. As we understand it, this “variable balance loan” would be a separate line-of-credit agreement between the EFSF and Spain.
The line of credit would start with a zero balance. If the EFSF’s newly acquired portfolio of Spanish bonds falls below its purchase price, then the balance would rise: Spain would owe the EFSF money to compensate it for losses.
It doesn’t appear that the balance would be changed daily–only when the EFSF disposes of bonds, or when they mature.
An EFSF spokesperson says the idea is that the “country in question would be liable for the difference between the purchase price of the bond and the value received by the EFSF upon its sale or redemption.”
Now, there’s no requirement that EFSF use this method, and the euro-zone countries have wide discretion to figure out how they want to deal with potential losses on bond buying.
The EFSF’s guidelines on bond purchases say only that the bailout fund will agree on a method for handling losses (or profits) with the country whose bonds are being bought. If the variable-balance loan is used, though, the ramifications are noteworthy.
As a bondholder, the EFSF would have the same status in a default as any private bondholder and, absent a maneuver like the one Greece performed to exempt the ECB’s bondholdings from the Greek restructuring, it would be hard to treat the EFSF’s bonds differently than privately held bonds.
But with a separate agreement on the side that entitles it to an extra payoff, the EFSF would presumably have greater claims on Spain in a default than a private bondholder with no such side deal.
wsj.com
That’s risky business. Might euro-zone officials be trying to sidestep some of that risk?An obscure reference in a statistical document broaches the notion of a complex method by which the county whose bonds the EFSF is buying–let’s call it Spain–guarantees that the bailout fund won’t lose money on its transactions.
Now, a guarantee from the country you’re meant to be rescuing isn’t the strongest assurance in the world. But it may give the bailout fund an edge over private bondholders if Spain is unable to repay all its debts.
Let’s back up.
European leaders are frantically trying to find a way to keep Spain financed. The country must sell tens of billions of bonds this year, and high bond yields suggest there’s not much demand.
One option–awaited by many at today’s European Central Bank meeting–would be for the ECB to start scooping up bonds.
But the ECB has repeatedly signaled that it would like the EFSF to go along and buy some bonds, too. That would spread the risk beyond the central bank and onto the euro-zone governments themselves. Many euro-zone officials want the governments to bear as little risk as possible.
Finland has demanded collateral from aid recipients, and some have suggested that a country whose banks are rescued by a bailout fund in the future might have to indemnify the fund against losses.
We’d wondered how the EFSF would handle bond purchases. If it bought bonds, then sold them in the secondary market at a loss, who would swallow that loss?
If Spain’s bond debt were to be restructured, like Greece’s was, what would happen?
The Eurostat document in question, from April, concerns the wonky but important question of how governments should account for the various rescue transactions they are contemplating.
In the context of discussing how EFSF bond-market purchases would be recorded in the books is footnote 6: The EFSF could use a technique so-called “variable balance loan” for these interventions.
In this system, EFSF will have recourse on the issuing country, which statistically can be considered a form of guarantee to the EFSF, that would compensate the EFSF if the bond would fall under its purchase price by the EFSF.
Eurostat will not record this specific guarantee as debt, but consider it as a contingent liability. As we understand it, this “variable balance loan” would be a separate line-of-credit agreement between the EFSF and Spain.
The line of credit would start with a zero balance. If the EFSF’s newly acquired portfolio of Spanish bonds falls below its purchase price, then the balance would rise: Spain would owe the EFSF money to compensate it for losses.
It doesn’t appear that the balance would be changed daily–only when the EFSF disposes of bonds, or when they mature.
An EFSF spokesperson says the idea is that the “country in question would be liable for the difference between the purchase price of the bond and the value received by the EFSF upon its sale or redemption.”
Now, there’s no requirement that EFSF use this method, and the euro-zone countries have wide discretion to figure out how they want to deal with potential losses on bond buying.
The EFSF’s guidelines on bond purchases say only that the bailout fund will agree on a method for handling losses (or profits) with the country whose bonds are being bought. If the variable-balance loan is used, though, the ramifications are noteworthy.
As a bondholder, the EFSF would have the same status in a default as any private bondholder and, absent a maneuver like the one Greece performed to exempt the ECB’s bondholdings from the Greek restructuring, it would be hard to treat the EFSF’s bonds differently than privately held bonds.
But with a separate agreement on the side that entitles it to an extra payoff, the EFSF would presumably have greater claims on Spain in a default than a private bondholder with no such side deal.
wsj.com
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