The IMF SPV [updated] | FT Alphaville

The IMF SPV [updated]

Update — FT Alphaville is sad to report the untimely death of the IMF bond-buying SPV after a short but odd life of some six hours…

Original post below.


Another day, another SPV proposal for Europe. This time an IMF-backed version.

From the FT:

In a sign of the IMF’s deepening concern about the crisis, Mr [Antonio] Borges said the fund also stood ready to join the eurozone’s temprorary bailout fund in buying distressed government bonds.

“We’re offering to be co-operative and to work alongside them [the EU],” he said, noting that the IMF would have to create a special purpose vehicle to achieve this.

And here comes the first of many critiques.

Harvinder Sian of RBS reckons this isn’t a solution, just another way to boot the sovereign debt even further down the road. (Sorry to use the cliche…)

It can help kick the can down the road and see talk of a jump to a better equilibrium.

A move towards having the IMF backstop Spain/Italy (note: we do not have any formal moves in this direction, yet) would solve many of the immediate problems for the region in the sense that Europe does not have the financial capability to directly upsize the EFSF given its reliance on a narrow set of AAA countries and the reliance on the ECB is probably illegal and certainly politically problematic. Any low conditionality IMF backstop would be useful as policymakers look to restructure Greece and shore up the European banking systems.

It has in other words, the ability to kick the can down the road, and perhaps kick it down the road for a while.

A ‘solution’ is however unlikely in the face of the ESM, and this is what makes Spain/Italy a solvency problem not a liquidity problem.

Ultimately, we do not talk of solutions for the crisis because contrary to the emerging consensus which has been getting more bearish on periphery – we do not see Italy’s problems (for example) as a liquidity crisis. It is a solvency problem because Italy must adjust with a gold standard policy of austerity and deflation. More importantly, it is made a solvency problem because future liquidity and solvency assistance comes from the ESM which will for Spain and Italy (i.e. non programme countries) mean in the first instance a discussion on whether a restructuring is necessary and in all cases the ESM is a senior creditor.

As such, any country that has a meaningful probability of needing external assistance is destabilised now and its exit from official support is made tougher and lengthier given that it will be issuing junior debt over probably a couple of electoral cycles. In other words, permanent liquidity support is a solvency problem because the ESM is not really designed to help the periphery but to protect core EMU balance sheets. It should be better seen as a sovereign debt resolution mechanism.

One piece of financial engineering comes crashing into another! It’s ironic. It’s especially ironic, in fact, because we find it a difficult to reconcile the IMF buying bonds through a SPV, with the IMF’s own normal preferred creditor status. Well maybe not so much we find it difficult as the IMF’s backers in emerging markets might well resent the Fund taking on this credit risk. Notably, we doubt that the IMF’s financing structure, including its quota system and forward lending capacity, is really robust enough to capitalise the SPV and buy that much sovereign debt in any case. We’re going to shove this in the filing cabinet with the nuts idea for the European Investment Bank to set up a SPV (remember that one? It was only last week) for now.

As a footnote, Sian says news on the ESM is getting curiouser and curiouser.

Handelsblatt is reporting that the German finance ministry and European Commission are considering giving the ESM a banking license. That would give it access to private sector leverage to lend beyond the EUR 500 bn level but the real trick would be to get access to the ECB repo facilities. The ECB in an opinion statement previously seemed to rule this as illegal under Article 123 of the Treaty; so it will be interesting to see if this is turned around.

The most toxic thing that Europe can do here is to bring forward the ESM to 2012 from the original intended start date (which is politically tough) because it would not allow markets to believe that a happier path to dependency for solvency is feasible. Even if the ESM is not brought forward, it very existence is a destabilising force.

Related links:
That Mad EIB plan (and other trial balloons) – FT Alphaville
The ‘No More Lehmans’ rally (and a mad EIB idea) – FT Alphaville