Whilst last week’s EU Summit statement was clear on some matters, it was vague on others. The ability (or otherwise) of the European Stability Mechanism (ESM) to buy bonds of sovereign nations in the secondary market has long been an issue of discussion. The impression given at the summit was that leaders were moving towards an agreement on this, but both the Netherlands and Finland have this morning come out and stated that they are opposed to the ESM buying bonds in the secondary market.
The situation with respect to bond-buying needs to be clarified however because currently we are experiencing something of a hiatus. The ECB’s bond-buying program effectively has been shelved, with no purchases of any significance undertaken since February of this year. This is despite the fact that yields in Spain (for example) have risen some 100-150bp higher since this time with no reaction from the ECB, which maintains that the program remains active still. But, whilst at one point the ECB’s intervention was seen as a positive, the issue of seniority has now taken over with private sector investors increasingly fearful of being crowded out by the ever growing pool of official debt-holders (ECB, IMF and EU). So, whilst it was agreed that the debt incurred for recapitalising Spanish banks would rank at the same level as existing government debt (even when transferred to the ESM), this would not be the case for secondary market-purchases by the ESM. Of course, tying up the resources of the ESM in bond purchases naturally leaves less firepower available for other capital injections should they be needed and the resources of the ESM are already looking depleted in relation to both Spain and Italy. In its current form, secondary market ESM purchases are likely to be a weak weapon against the wider solvency risks.