The Irish parliament yesterday published the text of the European Stability Mechanism. The document includes terms that will effectively subordinate private sector bondholders, including a clause that establishes that loans from the ESM to struggling sovereign issuers will have preferred creditor status. Loans from the IMF already enjoy this treatment; those from the ESM will be next in line in order of seniority.
The analysts noted grimly that “our worries over this text are confirmed”, adding that “it represents more of the same failed policies”. They said that the subordination of existing bondholders “will be a good enough reason in itself for multi-notch downgrades and widespread selling of secondary debt. We really have to wonder whether the officials that drew up this structure understand how markets work, and the longer-term dangers they are creating for the funding of sovereign debt and the structures of the euro.”
The European government debt market remains highly domestically focused, with banks obliged to invest in sovereign paper for liquidity purposes. [According to one debt syndicate banker active in the government bond market], international demand for European government bonds might diminish, but he also believes investors will take some comfort from the establishment of the €500 billion permanent bailout facility.
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