The Eurozone Summit


Mostly “Talk”, little “Substance”



In an environment already steeped in political, economic and environmental problems such as the turmoil in the Arab countries, the resurgence of inflation or the Japanese earthquake, the communiqué issued at the end of this second meeting EMU Heads of State and Governments will do little to reassure markets concerning the capacity of the Eurozone to deal effectively with the persisting Euro area sovereign debt crisis.  


Indeed, much of the posturing by the parties involved in the negotiations reveals a lack of coherence and continuity between the unanimous decisions made during the first timely and successful meeting of Eurozone Heads, early October 2008 (in the immediate aftermath of the Lehman collapse), and the attitude adopted more recently by some of the more stable EMU Members.


Back in 2008, the urgency of avoiding a systemic collapse of the global financial system enticed the then 16 EMU Members to commit not to let any of their respective banks “fail” and to insure all “deposits” up to €100.000. These very sensible measures achieved their purpose by avoiding a “run on the banks”, allowing each Government to reassure its citizens in the face of grave doubts concerning the solvency of many banking institutions and avoiding the domino effect that a failure might trigger.


At that time, German depositors were at least as likely to ask for their money back as Dutch, Irish, Italian, or other depositors. Indeed, in the months that followed the German Government had to rescue several of its major banking institutions with their “taxpayers” money as did the Belgian, Dutch and French, Irish and Spanish authorities, not to mention the UK and the US, among major non EMU countries.


In this process, a vast amount of indebtedness was merely transferred from the banking system to their respective Governments, all of which did not have the same capacity to assume this additional burden.


When two years later the Greek Sovereign debt crisis erupted, followed shortly by the Irish one, the more stable EMU Members were called in for support alongside the IMF. Not only did they insist on appropriate conditionality, but also imposed on borrowers making good on the earlier 2008 pledge to guarantee the solvency of their respective banking systems, considerably aggravating thereby the burden put on an already highly compromised situation.


By this sleight of hand – which initially went largely unnoticed and was supposedly justified by the continuing fragility of the banking sector as a whole – the stronger EMU Members were in fact transferring to the taxpayers of the weaker ones, the cost of saving their own banks who had (and still have) excessive exposures - of their own making - to banks in the peripheral weaker Member States. This outcome was never the intention of the initial “blanket” guarantee which was aimed solely at reassuring markets on the brink of collapse.


It is particularly clear in the Irish case where a very significant part of the EU/IMF “rescue package” (€35 billion) is dedicated contractually to recapitalise the bankrupt banking sector. It would seem only appropriate (and fair) that the cost of restructuring be shared between the Irish Government responsible for “recapitalising” the banks and the creditors (other than insured depositors but including foreign banks) who must simultaneously accept a significant reduction in the value of their claims. To the extent that these measures put German, French, Dutch or other banks in difficulty, it should be – in line with the spirit of the initial 2008 pledge – up to their respective Governments to “bail them out” rather than the Irish taxpayer.


Recognizing this state of affairs is a precondition to any reasonable and necessary agreement on burden sharing in dealing effectively with the sovereign debt crisis. There is an enormous political risk in refusing to face this reality which could put the future of the Union itself in jeopardy, wrecking havoc in all 17 EMU countries.


Failing to reach a reasonable compromise, citizens of Greece, Ireland, and Portugal are likely to rebel against the very idea of the Euro and throw this still infant and healthy baby away with the bathwater. Even in less directly affected EMU Members, the populist sirens, advocating an exit from the Euro, such as French presidential candidate Marine Le Pen of the National Front, are increasing their audience daily. She capitalises adroitly on the worries about inflation, unemployment or immigration brainwashing citizens who, in search of a scapegoat, are more and more willing to believe that all their woes are caused by the European Union and the Euro.


There can be no doubt that, on purely rational grounds, a collapse of the Euro should be avoided at all costs, as often repeated by Chancellor Merkel and President Sarkosy. It is however wishful thinking that rationality and politics go hand in hand (as Colonel Gaddafi demonstrates daily). That is also the reason why the long Communiqué of yesterday’s Summit appears to be little more than a litany of pious intentions and is likely to have disastrous unintended consequences if, as was the case with the Stability and Growth Pact, it proves to be toothless and largely unenforceable.  


Indeed, how can one believe that by end of April 2011, France will submit a comprehensive set of “concrete commitments in the areas listed, (some of which are highly contentious) due to be implemented during the next twelve months? Either the President will present a bona fide plan, offering his – not so loyal - opposition a perfect target for criticism; as an example, the socialist’s pledge to restore the retirement age to 60 years flies in the face of the carefully worded Communiqué, but will hardly be sacrificed on the altar of the European “convergence”. Alternatively, the President’s proposals will have no real substance killing the credibility of the process from the outset.


The Commission will then, once again, will find itself in an untenable position and, rather being strengthened as suggested by President van Rompuy, is likely to be further weakened. Indeed, if it expresses an objective but critical assessment of the proposals (that EMU Members have pledged to endorse or otherwise justify their refusal), it will be used as a very effective electoral weapon to undermine further the image of the EU pointing to an “unacceptable” interference in the internal affairs of the country; if, on the other hand, the Commission refrains from criticisms, it will lose all credibility, destroying all effectiveness of the process.


Turning now briefly to the second point of the Summit’s agenda concerning the European Stability Mechanism (ESM), the Communiqué reiterates the unsatisfactory conclusions of the earlier ECOFIN, in particular by only confirming the amounts pledged to the existing EFSF and EFSM (€500billion), already decided last June, and which are notoriously insufficient to cope with any extension of the debt crisis to a major EMU economy (See my note ECOFIN FLASH of 15/02/2011).


Additional details have nevertheless surfaced in three key areas:


-          the capital structure of the ESM is to be composed of “paid-in and callable capital as well as guarantees”;

-          the possibility for the ESM (and the EFSF) “to intervene, as an exception, in the debt primary market in the context of a programme with strict conditionality”;

-          the granting of “preferred creditor status to ESM loans”.


Each one of these points raises significant questions that the market will wish to see clarified rapidly if – as should be the case – one wishes to establish a firm underpinning for the ESM and avoid the type of ambiguity that arose late last year when the true borrowing capacity of the EFSF was disclosed. (In order to keep these remarks as concise as possible, I have relegated to a technical annexe the more detailed discussion concerning these questions.)




There remains a very short window before the forthcoming Summit on March 24/25 which is meant to finalise the “Pact for the Euro” and details of the “European Stability Mechanism”.


Should, once again, the market be disappointed with the outcome, renewed instability in the Sovereign debt market is to be expected.


Bold and clear answers underpinned by a strong show of EU/EMU solidarity are all the more needed that the additional external global uncertainties will tend to exacerbate any wavering in the support needed to maintain EMU credibility.


Brussels, 13th March 2011 


Paul N. Goldschmidt

Director, European Commission (ret); Member of the Thomas More Institute.



Tel: +32 (02) 6475310                                 +33 (04) 94732015                         Mob: +32 (0497) 549259

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Technical Notes



1.            The capital structure of the ESM is to be composed of “paid-in and callable capital as well as guarantees”.


The obvious purpose for strengthening the capital structure of the ESM (relative to the EFSF) is to ensure that the full “borrowing capacity of the mechanism”, i.e. €500 billion, will benefit from an undisputable “AAA” rating.


Under the current EFSF arrangements, the effective amount susceptible to benefit from the existing AAA rating is limited to around €250 billion representing the commitments of AAA rated countries including their contractual 20% enhancement.


By introducing an additional element of “own funds” in the form of paid-in and callable capital, the amounts taken into consideration for the “AAA” cushion should include: all the “paid in capital”, plus the “callable capital” of AAA rated participants, plus the guarantee commitments of AAA rated members, the sum of which should not be less than € 500billion.


This raises the following questions:


Is it anticipated, under this new structure, that the 20 % enhancement of the Members guarantee commitments be maintained?


Will the EFSF mechanism of “stepping out guarantor” be maintained within the ESM? If so, how is the €500billion to be effectively available? If not what happens?


Subject to further clarification, such a structure poses a series of “political questions”. In particular, are “non AAA rated” participants obliged to “pay in” an amount of capital equal to their callable capital and guarantee commitments? Would, as an alternative, non AAA rated Members be obliged to meet a “call” each time their commitments exceeded their “paid in capital”? What happens in case of a downgrade of an AAA rated Member?


Depending on the arrangements, some of the weaker Members might be put under severe strain at the time they can least afford it and consider the structure “discriminatory”. The most transparent solution is that the rating agencies disclose in advance their methodology in appraising the credit structure of the ESM.



2.            The possibility for the ESM (and the EFSF) “to intervene, as an exception, in the debt primary market in the context of a programme with strict conditionality”;


The wording of the Communiqué is puzzling: taken literally it seems to imply that the ESM could – exceptionally – subscribe to a new public issue (primary market) of a Member who is already benefitting from ESM assistance (subject to a programme with strict conditionality).


What is the purpose of such a curious intervention? It certainly does not replace by any stretch of the imagination the current “temporary” ECB purchase program of EU sovereign debt which consists in making open market purchases (secondary market) of securities of weaker issuers whose debt may be under abnormal pressure. By stabilising the market, the ECB aims at facilitating the continued access to the market by the issuer, thus performing a valuable service.


Another question raised by this proposal concerns the coherence with the proposed ESM “preferred creditor status” (discussed below). Indeed, if the ESM subscribes in the primary market to an issue distributed in parallel to other investors, it would seem unacceptable that the ESM would be in a privileged position in case of restructuring, having purchased the securities initially pari passu with other investors. The implication is that it should be made clear that such “purchases” by the ESM do not constitute “ESM loans” and therefore do not benefit from the privileged creditor status.


3.      The granting of “preferred creditor status to ESM loans”.


The questions raised by this proposal are mainly of a legal nature. The answers to be provided might have a significant impact on the marketability and cost of the sovereign debt of EMU Members, and particularly those facing the most severe indebtedness problems.


The first question concerns the “legal base” for such a disposition. Does the Treaty provide the authority to the EU to impose such a privilege and is it opposable to other creditors who might contest it? What is the basis for subordinating this privilege to the IMF’s claims? In this respect I refer to the recent excellent (7th Jan) paper by Citigroup (, which addresses this point clearly. I quote hereunder the relevant section:


The issue of ‘preferred creditor status’ is also not without ambiguity. First, it is

worth noting that ‘preferred creditor status’ is not a status conferred by law,

Treaty or international agreement, not even for the IMF, which has traditionally

enjoyed preferred creditor status, nor presumably for the ESM. To our

knowledge, the preferred creditor status of the IMF, which is based solely on

convention and historical precedent, has never been challenged in court.

Second, it is not clear why the original rationale that apparently prevented EU

policymakers from requesting preferred or senior creditor status for the EFSF

that having multiple preferred official creditors would make it less likely that

private creditors will lend to the sovereigns in the future — would no longer

apply. Certainly, in our view, a combination of shielding any debt issued prior to

2013 from debt restructuring (as the five finance ministers of Germany, France,

Italy, Spain and the UK appeared to do on 12 November 2010) and claiming

preferred creditor status for the ESM would make it very difficult for high-debt

euro area sovereigns to access private capital markets once the ESM is in

place. It is therefore just as well, from the point of view of future access by EA

sovereigns to the private markets, that there really is no practical mechanism

for keeping existing sovereign debt (that is, debt issued before the ESM

becomes effective) safe. The fact that most of this debt was issued under

domestic law ensures that it is bound to be at risk whenever the sovereign

encounters debt servicing problems.


In light of the foregoing, it seems appropriate that a thorough legal appraisal be undertaken before the European Council decided a measure that might prove unenforceable.



Brussels, 13th March 2011



Paul N. Goldschmidt

Director, European Commission (ret); Member of the Thomas More Institute.































Tel: +32 (02) 6475310                                 +33 (04) 94732015                         Mob: +32 (0497) 549259

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