Endless Parade of Ineffective European Agreements Continues

Greece has effectively defaulted again, for what I believe is now the fourth time in the past 3 years. Here are highlights from the full Eurogroup statement on Greece (h/t Delusional Economics).

The Eurogroup noted that the outlook for the sustainability of Greek government debt has worsened compared to March 2012 when the second programme was concluded, mainly on account of a deteriorated macro-economic situation and delays in programme implementation

...

Against this background and after having been reassured of the authorities' resolve to carry the fiscal and structural reform momentum forward and with a positive outcome of the possible debt buy-back operation, the euro area Member States would be prepared to consider the following initiatives:

• A lowering by 100 bps of the interest rate charged to Greece on the loans provided in the context of the Greek Loan Facility. Member States under a full financial assistance programme are not required to participate in the lowering of the GLF interest rates for the period in which they receive themselves financial assistance.

• A lowering by 10 bps of the guarantee fee costs paid by Greece on the EFSF loans.

• An extension of the maturities of the bilateral and EFSF loans by 15 years and a deferral of interest payments of Greece on EFSF loans by 10 years. These measures will not affect the creditworthiness of EFSF, which is fully backed by the guarantees from Member States.

• A commitment by Member States to pass on to Greece's segregated account, an amount equivalent to the income on the SMP portfolio accruing to their national central bank as from budget year 2013. Member States under a full financial assistance programme are not required to participate in this scheme for the period in which they receive themselves financial assistance.The Eurogroup stresses, however, that the above-mentioned benefits of initiatives by euro area Member States would accrue to Greece in a phased manner and conditional upon a strong implementation by the country of the agreed reform measures in the programme period as well as in the post-programme surveillance period.

While I fully expect the market and economic blogosphere to cheer this new agreement, I remain convinced that this deal will be as equally unsuccessful as the previous three (not including the many failed agreements for other countries). From my perspective it is not surprising that Greece’s economic situation has worsened during the past year. What is surprising is the Eurogroup’s ability to commend Greece’s efforts and push to strengthen those previous efforts that have resulted in an increasingly unsustainable economic and political environment.

This agreement, once again, does not actually reduce sovereign debt outstanding but, instead, reduces the interest rate and extends the maturity of previous loans. Although this eases the debt burden ever so slightly, the conditionality of further structural adjustment practically ensures the economy will continue to dramatically underperform. This declining growth will continue to offset attempts to reduce the budget deficit or debt-to-GDP ratio. Considering the lofty expectations for Greece’s economy and budget that accompany this agreement, I feel confident in predicting that a future agreement will read:

The Eurogroup noted that the outlook for the sustainability of Greek government debt has worsened compared to November 2012 when the fourth programme was enacted, mainly on account of a deteriorated macro-economic situation.

Europe is clearly determined to continue kicking the can down the road. Despite the continued optimism regarding each new agreement, the economic reality is that unemployment keeps rising and growth remains in decline, especially for peripheral Europe. The parade of ineffective agreements is far from over.  

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Unending Subordination of Private Creditors Continues

ESM Flaws Emerge Prior to Ratification

On Monday, in Unending Subordination of Private Creditors Continues, I noted that the terms of Spain’s bank bailout had yet to be determined. More specifically, it remains unclear if the funds will come from the EFSF or ESM:

If funds for Spain's banks come from the EFSF, the new loans would not explicitly be senior to other private claims but Spain would no longer be able to guarantee the previous loans to Greece, Ireland and Portugal. If the funds come from the ESM (which has yet to be ratified by Germany), the new loans would explicitly be senior to other private claims, however Spain could continue to guarantee loans from the EFSF and ESM.

Although these questions remain unanswered, Mike ‘Mish” Shedlock sheds light on the ESM and asks if there are Any Rabbits Left in the Hat?

Assuming the treaty passes, please turn your attention to Article 41.

ARTICLE 41 ... payment of paid-in shares of the amount initially subscribed by each ESM Member shall be made in five annual instalments of 20 % each of the total amount. The first instalment shall be paid by each ESM Member within fifteen days of the date of entry into force of this Treaty. The remaining four instalments shall each be payable on the first, second, third and fourth anniversary of the payment date of the first instalment.  

Mish’s reader, Brett, who pointed out the above article then offers a breakdown of each country’s contribution in the first year.

Capital Contribution Analysis

ESM Member	Capital subscription (EUR)	2012 Contribution (20%)
Kingdom of Belgium	€ 24,339,700,000.00	€ 4,867,940,000
Federal Republic of Germany	€ 190,024,800,000.00	€ 38,004,960,000
Republic of Estonia	€ 1,302,000,000.00	€ 260,400,000
Ireland	€ 11,145,400,000.00	€ 2,229,080,000
Hellenic Republic	€ 19,716,900,000.00	€ 3,943,380,000
Kingdom of Spain	€ 83,325,900,000.00	€ 16,665,180,000
French Republic	€ 142,701,300,000.00	€ 28,540,260,000
Italian Republic	€ 125,395,900,000.00	€ 25,079,180,000
Republic of Cyprus	€ 1,373,400,000.00	€ 274,680,000
Grand Duchy of Luxembourg	€ 1,752,800,000.00	€ 350,560,000
Malta	€ 511,700,000.00	€ 102,340,000
Kingdom of the Netherlands	€ 40,019,000,000.00	€ 8,003,800,000
Republic of Austria	€ 19,483,800,000.00	€ 3,896,760,000
Portuguese Republic	€ 17,564,400,000.00	€ 3,512,880,000
Republic of Slovenia	€ 2,993,200,000.00	€ 598,640,000
Slovak Republic	€ 5,768,000,000.00	€ 1,153,600,000
Republic of Finland	€ 12,581,800,000.00	€ 2,516,360,000
Total	€ 700,000,000,000.00	€ 140,000,000,000
Less Spain		-16,665,180,000
Total Less Spain		€ 123,334,820,000
Less Greece		-3,943,380,000
Total Less Spain + Greece		€ 119,391,440,000
Less Portugal		-3,512,880,000
Total Less Spain + Greece + Portugal		€ 115,878,560,000

Brett argues that Spain, Greece and Portugal will not be able to contribute given their current public debt troubles. This may be true, but it seems to ignore a specific advantage of the ESM over the EFSF (as noted above), which is that countries can continue to provide guarantees while receiving loans from the fund.

Assuming that Spain contributes their portion, the contributions of Greece and Portugal remain dubious. Would the EU provide new bailouts so that those countries could meet their commitments? Also, what about Ireland and Cyprus? Having been shut out of debt markets, will those countries increase their public debt further in order to provide capital to the ESM?

Even if all €140 billion is obtained, the current Spanish bank bailout of €100 billion will deplete most of the current funds. Given that Irish banks remain insolvent and Spanish banks will require far greater sums, where will the next round of funding come from? Yields on Spanish and Italian debt are already unsustainable and rising fast, even before these large capital contributions are made. What happens if Spain or Italy requires a bailout for their public debt later in the year?

When the ESM was proposed, the notion of a €700 billion bailout fund sounded impressive. It’s now clear that the structure of subordinating private debt places upward pressure on yields and the sum is utterly inadequate for the task at hand. Whether or not the ESM gets ratified in the near future, the crisis will continue.