Economist
February 3, 2012
The treaty establishing the European Stability Mechanism (ESM), a permanent bail-out fund for the euro zone, was signed in Brussels on February 2nd. It now needs to be ratified by the 17 members of the single currency, with the aim of coming into force in July. The ESM is designed to be a permanent successor to the European Financial Stability Facility (EFSF), and goes hand in hand with a fiscal compact designed to ensure budgetary discipline among euro-zone members. Crudely put, if a state manages its money prudently, a pot of money will be on hand to provide liquidity in case of need.
The ESM has some advantages over the EFSF, beyond being easier to say. The fact that it is being established by treaty gives it extra legal heft relative to the EFSF. The fact that the ESM will have paid-in capital, rather than relying on contingent guarantees to underpin its lending as the EFSF does, also adds to its credibility. If euro-zone leaders also decided to increase its lending capacity from €500 billion, as may happen in March, so much the better.
What should private bondholders make of the ESM? It looks like a marginal plus if you're invested in the bonds of euro-zone countries that are already receiving official help (ie, Greece, Ireland and Portugal). That's not just because the bail-out pot looks a wee bit stronger, but also because the treaty says that the ESM will not be senior to other creditors (except the IMF) in the case of countries that are already getting assistance. If these three countries end up having to tap the ESM, in other words, that won't bump other bondholders down the queue in the event of bankruptcy.
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