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Euroworried, Eurohappy, Euroflummoxed

posted by Anna Gelpern

Europe has fixed its debt and bank problems --  again.  Last week's EU summit produced a term sheet charting the path to a permanent, treaty-based crisis resolution regime, the European Stability Mechanism (term sheet embedded here starting p. 21).  You may recall it all started with revelations about Greece's government debt crisis in late 2009, and proceeded to reverberate around the Euro-periphery, with banking and government debt troubles bubbling up in Ireland, Portugal, Spain ... Italy ... Belgium ...   About a year ago, after much dithering, a one-off program for Greece, and a couple of false starts, Europe came up with an arrangement to finance countries in trouble, effective 2010-2013.  Soon thereafter, the European Financial Stabilization Mechanism and the European Financial Stability Facility deployed in Ireland, in conjunction with the IMF.   This is a fine overview.  Last week's deal establishes a standing successor to this model.   The term sheet is a fascinating study in EU governance (note the respective roles of the member states, the Commission, and the European Central Bank) and potentially an important step on the path to a fiscal union.  I will limit my comments to the legal and legal-sounding tidbits.

First, the ESM is presumptively cofinancing with the IMF.  This is good for both Europe and the IMF.  Europe gets the benefit of IMF crisis technique and the familiarity and predictability of its process.  The IMF gets qualified affirmation of relevance and political legitimacy.  This is a big change from the 1990s, when Asia's attempt at a regional monetary fund was seen as a threat.  Today collaboration is the word, perhaps a necessity.  Even so, local politics will preserve the element of surprise at every cofinanced disbursement.

Second, Private Sector Involvement gets pride of place.  Private Sector Involvement, or PSI, is '90s speak for sovereign debt restructuring -- suspension, rollover, or debt reduction by private creditors in conjunction with official support for a distressed sovereign.  (This is the bible steeped in that period's history, citing all the relevant pronouncements; see here for a short authoritive account.)  The EU term sheet pretty much promises PSI with every ESM financing, but is open on the methods:  when debt is sustainable, a rollover might do, when it is not, debt reduction is in order.  Stay tuned for more interminable liquidity-solvency debates.

Third, in conjunction with PSI, Europe is doubling down on those magical collective action clauses.  At this point, any invocation of CACs must mean a move to harmonize domestic debt documentation and a signal that Eurozone debt can really really be restructured.  No, really.  After 2013.  This is a touch feckless, but basically fine.  I am all for reading and rationalizing contracts.

Fourth and perhaps most interesting, is the short paragraph on page 32 conferring "preferred creditor status" on the ESM, but conceding the IMF would remain senior to all.  In this context, preferred creditor status has stood for the customary exemption of the IMF and major multilateral development banks, such as the World Bank, from sovereign debt restructuring.  The dominant rationale is along the lines of Debtor-In-Possession financing in bankruptcy:  they are financing the distressed sovereign's rehabilitation when no one else would.  However, existing institutions have been very careful not to claim legal rights -- priority has been emphatically informal.  In contrast, the EU appears to be proposing priority by treaty, and ropes in the IMF's status for good measure.  Will existing creditors graciously concede formal ex-post subordination?  I am sure the officials will square the circle somehow, but am equally sure that some lawyers are very busy studying pari passu and negative pledge clauses just now.

Finally, the goofy award of the document goes to the repeated statement that ESM financing will be subject to "strict" policy conditionality.  To be sure, it is a political necessity -- but are people really this thick?  If conditionality unmodified is not credible, surely "strict" must be hopeless.  ("Don't even THINK about parking here!")

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