Euro Area EC Stabilisation Fund - Operational?
This EFSF, €440bn + €310bn IMF contribution, is Euro Area's equivalent to TARP. Klaus Regling is the chief executive of the European Financial Stability Fund (EFSF), two years after he stepped down as the European Commission’s most senior economy official. He is German, reflecting the fact that Germany is supplying up to €148bn in debt guarantees, the largest slice of backing for the fund. The German national debt agency will help the fund arrange the guarantees in July.
Some time later this month the fund will become 'active' in theory when at least 90% of state guarantees are finalised. After borrowing, however quickly or long that takes, and once it is lending it can issue loans until June 13, 2013, only for three years. The 12 man tag team who will manage this will be in Luxembourg, probably in the glasshouse of the EIB.
It will borrow from markets to provide financial rescue funds to any indebted euro zone member government needing cheaper debt, except the loans won't be cheap, not at all, and not when reputational risk of accepting IMF austerity packages is included, if that is what they will be?
Governments provide guarantees to secure a Triple-A rating for EFSF and it will then with European Investment Bank (EIB) and Bundesrepublik Deutschland Finanzagentur (BDF) raise the funding to back the loans. If all €750bn is raised this year (v.unlikely) it would equal half again as much as all government borrowing in Europe in 2010 or equal to all government net borrowing after repaying maturing debt.
Who is going to write all the Medium Term Note paperwork along the lines of what private sector lenders normally require, with supporting financial account projections, a host of assurances, and then negotiate the borrowing rates? Law firms and investment banks of course, I imagine, for a generous % fee. The scale and complexity of this is I think beyond both EIB and BDF in terms of their experience, relationships and possibly too their predictive analytics systems.
It is unlikely that the borrowing will transpire on the basis of a few covering letters and government signed assurances, not when the Euro system's continuity is less than 100% certain, and although the total program period is short, only three years? It is another reason why governments want banks to borrow longer term, which is to reduce competition for their short to medium term needs such as to finance the EFSF. The EFSF will have a staff of 12, a fact I shall repeat several times just because I find it most incredible (worse than the 15 at UKFI ltd who manage £60bn of government bank investment in London or the 15 who manage €20bn of structured finance at legacy Fortis). Tell it to any banker who knows what's involved professionally to staff up MTN programmes, even when still using external advisors, and they will laugh until it hurts.
But EFSF will have help of EIB, IMF, ECB and BD Finanzagentur we hear. Are 12 core staff enough to contract and relationship manage all of that, even just coordinating, assuming they have a detailed roadmap of what to do, which I have good reasons to doubt? The US similar package, TARP, was staffed by 120, then 150, then another 200 staff on stability issues by 2010, and that was only in the US Treasury. More staff were employed on TARP in the Federal Reserve and in FDIC. TARP is qualitatively different from EFSF but only if one thinks that government finances are easier to understand than those of large financial groups and that making agreements over loans and their conditions with governments is easier than with banks or insurers or motorcar manufacturers.
It may not be the case that all of this amount is required. TARP took from Spring to Autumn of 2008 to get approved and that process helped to detail it more fully than the the few pages setting out EFSF for political approval within a few days rather than over 6 months. It may be that EFSF will not have to commit all its funding. No doubt the proponents of TARP thought the same until the Lehman Brothers was spectacularly allowed to fail.
TARP allocated $250bn for buying preference shares of distressed banks, for example, but only spent about $180bn on that. Some loans amortised and the money rolled over. Unexpected crisis funding came up, however, such as AIG and GMAC. EFSF cannot be sure what unexpected requirements it may be called upon to deal with. The ECB can help in providing liquidity support for EFSF if there are unexpected delays or other technical problems as it did recently by retiring nearly €500bn of liquidity on the one hand while extending €800bn on the other hand. Perhaps the IMF standby contribution will not be called upon?
For EFSF's borrowers (governments in financial distress)there is only so much preferred stock in banks that can be bought without shareholder protests and nationalisation and European Commission approval involving considerable political overheads and economic uncertainties. Similarly, if buying bank assets, toxic or not, that should also be capable of being financed as a repo swap at central banks. In the US example, about $400bn of TARP was allocated to buy banks' loanbook assets and another $50bn to cover against bank insolvencies.
Unlike EFSF, which appears to be a small office operation, TARP involved large staffing, teams from US Treasury, Federal Reserve and FDIC, and an audit unit, the Special Inspector General for the Troubled Asset Relief Program (SIGTARP). EC programmes will require a similar independent audit agency - who will do this; is one being established, or is this the IMF's job? There was also Congressional Oversight Committee on the job, but where is the European Parliament in this matter. This is all complicated by the Euro Area for which the EFSF is to exclusively apply being light on governance, it being only a big sub-section of the EU?
How much authority should the European Commission and European parliament have over a Euro Area somewhat exclusive matter? Thank goodness the direct borrowers and indirect lenders are governments who may be trusted entirely. In the USA's TARP, SIGTARP reported to Congress that it found that "Inadequate oversight and insufficient information about what companies are doing with the money leaves the program open to fraud, including conflicts of interest facing fund managers, collusion between participants and vulnerabilities to money laundering" - strong stuff, no punches pulled, and all in glaring light of day. The Euro Area Council like the EU Council deliberations are not transparent, and of course the ECB and IMF are both NGOs whose democratic accountability (reporting) are not legendary.
When the IMF lends on the basis of an agreed austerity package it has in the past turned up the gas to provoke indebted emerging market governments to default on interest or payments so that it can claim on insurance and exert penalty interest rates. That would not be appropriate for any OECD countries, let alone for EU states. But, the question arises what if any penalties are envisaged for default. The answer is probably none since matters will not be allowed to get to that point; there is too much flexibility available. The underlying banks who borrow from their governments may face domestic penalties asserted by their national governments and regulators should they default or misapply the funds, perhaps as recommended by the IMF?
The history of TARP is instructive and should be closely examined by all involved in EFSF. The Senate Congressional Oversight Panel created to oversee the TARP concluded on January 9, 2009, concerned about refloating the property market and maintaining or raising bank lending in the economy to help recovery, "In particular, the Panel sees no evidence that the U.S. Treasury has used TARP funds to support the housing market by avoiding preventable foreclosures" and "Although half the money has not yet been received by the banks, hundreds of billions of dollars have been injected into the marketplace with no demonstrable effects on (bank) lending." These are problems already being discovered nationally, not least in the UK where there is an embarrassing mismatch between survey data among corporate and small firm borrowers and what banks are saying they are doing to lend more.
Such issues are not explicitly part of the EFSF, but the solvency of banks and therefore of economic recovery underpinning governments ability to repay loans will be of some considerable interest. IMF, ECB, EIB, EC and member states' central banks or Germany's Debt management agency do not have models however to be able to track the feed through effects. There will be a lot of finger in the air forecasting and reliance on short term data; three years is not long enough for macroeconomic data to be sufficiently revised to be accurate.
Germany's glass HQ of its debt management agency.
Regling expects the eurozone’s €440bn fund to be given triple-A rating by August to allow it to borrow most cheaply at German Bund or French Government Bond rates. Triple-A reflects long term financing solvency quality. We may be dubious about ratings for such a short term programme. Therefore the ratings will merely be an aggregation of the member states' guarantees i.e. their sovereign ratings.
One has to wonder what board, governance, staffing, systems of analysis, policy documents and procedures will be in place and by when to safely command a fund worth five times one years European Commission budget? Regarding when (more than how) the European Financial Stability Facility will operate, Regling as CEO dutifully answered: “We will be ready to act whenever the politicians tell us to act.”
We may imagine that this fund can only become speedily operational by trusting to the professional good sense of governments (the borrowers) and on how they in turn on-lend to stricken banks. Each transaction that becomes a state aid scheme for banks will require detailed assessment by Commission experts followed by discussions to reach agreement with national supervisory regulators, central banks and governments. That may or may not interfere with the speed of granting EFSF loans. The IMF will also be involved to dictate how budget austerity measures are affected and the ECB in each case to make systemic risk assessments of banking in the Euro Area.
That would be sensible if cumbersome. The cumbersomeness is why the European Commission backtracked on engaging two sets of panel experts last Autumn at a cost of a few €millions to do asset valuations of banks' loan collateral and predictive economic valuations over the cycle including competition issues. The state aid scheme assessment process and agreed legal requirements was set back a whole year at least, and now we cannot be sure exactly how it is to work. In effect, the process has been pushed back to member states.
One problem was lack of tools, models, economics and banking data, and lack of self-belief in ability to organise any and all of that. Such self-doubts do not figure at the higher level of President van Rompuy and CEO Regling. They have yet to appoint a board for the fund. Hopefully the cost of lawyers, accountants, raters, loan underwritings, external advisors, other insurance etc. will not approach 4% as typical of M&A i.e. €7-15bn a year maybe over 3 years, which is far more than enough to ensure the big 4 audit firms and bulge bracket investment banks will be seeking to get themselves enthroned with this fund, an outcome for lack of basic infrastructure that any such enormous financial undertaking would normally put in place. Should the fund not have been simply handed to the ECB out of which adjunct the Euro Area Council could build its own fully equipped meta-treasury department?
Setting up EBRD, EIB and other such institutions takes a few years and never started with just a team of 12.
The EFSF tasks are bureaucratically and analytically onerous. It takes a good six months of every efficient work to get away an MTN program of say €50bn, which is huge, but which can only be done through very well trodden paths in effect rolling over deals with previous lenders. I would say that raising €750bn takes at least one year to get underway and all of 2 years to book. The three year timescale from lending to repayment is absurd, doubly so against a back-drop of Euro governments borrowing over €1 trillion gross excluding EFSF this year alone. All might go easier if governments pay a little extra to bondholders to insist that the €700bn of maturing bonds repaid this year should be directed in lending to the EFSF, but that's just naive imagining.
When Klaus Regling was a top German finance ministry official, he was responsible for negotiating the regulations underpinning the establishment of the euro, Europe’s common currency. Now he must road-fill big holes left by that agreement: the lack of a crisis resolution mechanism to rescue eurozone member states in a recession and financial crisis of the very type the Euro was designed to safeguard against.
As chief executive of EFSF, he may hope that this will be more show than tell and that the fund will be little used in practise as his political masters,the finance ministers of the European Union, no doubt hope. His governance, staffing and organisational infrastructure should not reflect that hope. Knowing the markets as I do, I know that they will test EFSF to destruction.
Why do we think Regling and the Euro Area Council sponsors think EFSF may be more marching than fighting? Because, Regling told the FT on the 13th, “We don’t know whether there will ever be a financial operation” and “Finance ministers hope not. But it was very important that this facility was created. It has had a positive impact on the markets.” If ever anything was that is a red rag to the markets.
German voters, we have been told many times, are worried that the EFSF could become a fiscal transfer from wealthy states of northern Europe to the profligate EU south. If the northern voters knew what keeps them employed they would welcome such transfers. Potential investors are, according to the FT, skeptical about the high credit rating that Mr Regling is confident the stabilisation fund deserves. This is just silly. Everyone should welcome the development in theory and not fuss about the ratings; who trusts ratings agencies any more anyway; publicly not the ECB or the European parliament or the EC?
Herr Regling is anxious to reassure everyone - good. He said in an interview in Frankfurt, “This is a crisis mechanism. The EFSF is a temporary arrangement ... That is very different to creating a permanent fiscal transfer mechanism.” Who will give me positive odds on that? Actually, not an obvious bet for the reason that reputational damage of borrowing from EFSF and incurring IMF austerity measures could prove a major disincentive.
Herr Regling (great name; it means formal rite of passage to put discipline into a physical change, also invocation of a spirit and head of EFSF, about which there will be an opera one day, Der Regling des Nibelungen: the man and the organisation): He is my age, 59, Chief executive of EFSF since July 1, served as head of the German finance ministry’s international policy department; played a role in the euro's introduction and in drafting the EU’s Stability and Growth Pact. At the time when I visited his economists in Brussels, when I was curious why the Euro was being planned and introduced without the help of any external consultants, they said it would be a disaster to delay the Euro's introduction, a disaster not to do it at all, and a disaster to go ahead with it! But, after 5 years we should all have learned how to reform it and make something better. It is now ten years on and we are only starting, if at all, to reform the S&GP. I calculated in 1997/8 that over the first 5 years of the Euro banks would lose €500bn in gross trading profits and eke that back out of loan margins and bank account charges from mainly small firms first, then fees from big firms later, and unemployment would rise in Europe by 5 millions against trend - proved accurate.
Today, 29% of Euro Area unemployment is in Spain. Will the EFSF make a dent in that or elsewhere? Will Regling and the EFSF in the detail of its operation in effect change the workings of the Stability and Growth Pact and form the basis for permanent reform? Is Regling up for this?
Regling worked as an economist for 35 years, including for the European Commission and the IMF. He was well known in Kanzler Helmut Kohl’s government in the 1990s and has close ties to many senior officials in Berlin therefore as well as Brussels. Maybe he can carry enough persuasiveness backed by €750bn to bring about reform?
On the European principle that what ten Americans do one European can do, EFSF will operate from a Luxembourg office with about 12 staff, with Germany’s debt management agency serving as the “front office”. Even the UK's FI Ltd. to oversee arm's-length ownership of RBS and LBG banks have three more staff than this! Has ever so much money been managed by so few? €750bn is more relatively 'free' funds than IMF, BIS or most central banks have, and they need more than 12 people just to set up and maintain the simplest of their computer systems! EFSF will obviously be a spreadsheet, email and otherwise paperless office. Any advisors bidding to provide some heavyweight analysis in support of EFSF will have an easy procurement process to negotiate. In an office of 12 nothing is done except on a buddy system grapevine.
Malta will provide €400m. If I know Malta that will not come without a few jobs for Maltese, at least 2 surely? But, if extended to the 18 other guarantors, on that basis, the staffing alone should be 1,000, and by then we might get a serious organisation doing seriously detailed work?
The EFSF has been described all round as a “shock and awe” package to reassure markets over mounting sovereign debt. But, money and bond markets are not in the game of receiving reassurance, however; they are in the game of cage-rattling the Euro system to seek to keep bond yields volatile to profit by.
As far as the financial markets are concerned, provisions have been built into the facility to ensure that it would gain triple A status from the credit rating agencies and could borrow at most favourable interest rates. Hmmm, what is the risk management policy, the EFSF ALCO and risk officers, the computer systems for tracking, and all such matters that any rating agency would look at before rating a banking organisation. Of course, this is only supposed to be on the model of an SPV (Special Purpose vehicle) as in a securitisation issue i.e. a few lawyers and accountants supported by external bankers, more lawyers and accountants and auditors that keep London busy.
EFSF even will have standby liquidity for smoothing cash-flows just like a real SPV, a cash reserve but built up from fees charged to countries using the facility while, as another cushion, member countries have guaranteed to pay up to 20% more than their agreed shares of the fund. We can imagine 5% fees (say €20bn - €35bn), which would be a substantial standy fund, but might defeat the object of providing cheap funding? A 1% fee is hardly enough to do more than pay for will pay for external advice, underwriting and insurance costs.
Investors have questions have questions about the structure of the EFSF who is their counterparty and then about the solvency of EFSF's debtors and the precise details of each guarantor's guarantees. The prospectuses (not prospecti) will be hundreds of pages on which will ride the security for hundreds of millions per page perhaps? It is not suddenly a ten pager if EFSF has a triple-A rating tomorrow. How long will it keep that, and what is the probability of a series of downgrades over the next three years? There are only a few people capable of answering that question systematically.
Herr Regling said ministers have promised to do whatever is needed to make sure he gets triple-A. There's the rub. What can that be and is there a limit? Total guarantee means the contributing governments have to take the potential debt onto their books - that they don't want. The whole point of this is that it should be off-budget, off-balance sheet, hence the SPV format, an insolvency-remote vehicle. But, that is achieved usually not by guarantees for all losses but by assessing the underlying and here we enter the world of macroeconomics as well as each borrower country's banking sector relative to the economy in which it operates. Are the 12 staff of EFSF individual professional geniuses or just bureaucrats?
Will IMF forecasts or ECB liquidity guarantees furnish sufficient underwriting to each borrower state's central bank or finance ministry? We have a complexity here of risk and constitutions and time factors and governance all of which needs to be explained in excruciating detail. Lenders to EFSF have their own ALCO rules and risk assurance process to navigate. Even the ECB could not issue standby postdated encashable cheques or depository credit to the value of €100s of billions, could it?
How is all this to be short circuited and manageable by a staff of 12, or let's imagine Seven Samurai and five support staff? The main work to be done by Germany's Debt management agnecy and the EIB (European Investment Bank).
Herr Regling sought to reassure the markets that the German constitutional court in Karlsruhe will not decide to uphold complaints that the facility violates the German constitution and EU treaties. Right! Legal Risks; must be page 612 of the prospectus. He admitted that doubts about the court’s future ruling were an important point for the rating agencies. Right, Moody's, Fitch and S&P have risk models, not for what happens before EFSF gets triple-A and starts borrowing, but afterwards when suddenly some loans might be called in early? But, Regling thinks a ruling against the facility is “highly unlikely” to have any practical effect on potential bondholders, because German participation in the scheme had been formally approved by the Bundestag in Berlin.
And some early motions failed, but that's not to say further motions could not be put. If the EFSF does lend to any government, it will be at a premium to its cost of borrowing: Regling said this would be “comparable” to the charge on Greece of 300 basis points when it borrowed €110bn from eurozone governments earlier this year. OK, but then in assessing the on-lending as bank state aid, the rule is no favours; market rates, and the hope must be the prevailing market rates come down, and then that the loans are fixed-rate for three years, which could mean substantial profit for the EFSF, could it? yes, the premium would accumulate and should be repaid to governments guaranteeing the funds loans, Herr Regling said.
The EFSF will operate in Luxembourg with a dozen staff, and Germany’s debt management agency (Bundesrepublik Deutschland Finanzagentur, used to managing up to €40bn a quarter issuance in packets of €5bn) will function as a “front office” for the EFSF, issuing any bonds, while the European Investment Bank (€232bn capital, €103bn loans to infrastructure projects and small firms, 1,000 staff) will provide “back office” accounting and legal functions. let's hope the EFSF does not become a lender generating €700bn in borrowings and loans - would overwhelm these hitherto cuddly and ethical if somewhat prosaic banking institutions. It would be unpleasant to witness them haggling across the table from a bunch of salivating investment bankers like me. Here for the less scrupulous salesmen is the EIB's org chart:
At German insistence, eurozone governments agreed to give the EFSF only a three-year life. Herr Regling said the facility would close after three years if it made no loans, which sounds like the best incentivisation to make loans. “If there is a financial operation its life will be extended until the last loan is repaid,” he said. Herr Regling told the FT the fund is a temporary crisis mechanism but could be extended beyond its intended three-year lifespan if any loans to eurozone governments remained outstanding beyond June 2013.
Governments can borrow if they agree to adopt reform programmes designed by the IMF, European Commission and the European Central Bank. This extends the role of both the Commission and ECB in ways that I expect borrowers would fiercely wish to resist, hence any borrowing will be a clear signal of desperation! Furthermore, borrowing states will pay a charge comparable to that levied on Greece when granted an emergency bail-out this year, i.e. 300bp! “It does not mean there is an ATM machine. Everyone agrees that countries only get money when they accept conditionality,” Regling added. With the results of stress tests on European banks imminent, Mr Regling said the fund would not be used directly to shore up ailing banks, but governments drawing on the facility can use the money for bank recapitalisation. And, presumably, to replace funding provided earlier? But, again, the issue arises that borrowing from EFSF may be such a last resort that any states borrowing from it will suffer downgradings in every other respect, because this would signal extreme cash-flow problems, and therefore the cost of doing so could be unpredictable and many times higher across the rest of the economy?
Greece is already in such a junk rating position. Can we imagine Spain, Portugal, Ireland or Italy going down this route. I suggest not.
The Spanish Cajas simply doubled their liquidity recently from ECB to about €130bn instead of seeking it from the Spanish government, who might then think to apply to the EFSF. herr Regling does not believe in transparency and would therefore resist political oversight such as by the European Parliament, but it is very unlikely that we will not all know who needs this pricey money despite IMF conditions as soon as any requests are made!