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Wednesday, August 24, 2011

Collateral Thinking

The eurozone's embarrassing collateral-for-loans spat continues, with member states disagreeing over whether Finland should be allowed to get collateral from Greece in return for giving Athens fresh loans. Who should guarantee the guarantees remains the thorny question.

To re-cap:
Under a special deal with Greece, agreed on the sidelines of the 21st July summit, Finland would get collateral of some form, in a bid to appease taxpayers at home. The exact nature of the collateral wasn't agreed, and as it turned out, the creditor countries had very different interpretations of the exact meaning of the deal. It was almost as if they hadn't thought it through properly (shock horror!)...

Unfortunately for the Finns, the deal between Athens and Helsinki now has to be ratified by all eurozone governments. The reason is simple: since the collateral that Greece will post with Finland will probably come from the bailout funds (Athens is a bit short of cash) it will be other eurozone countries that actually underwrite the collateral that Finland has demanded. Hardly surprising, not everyone is happy - Austria, the Netherlands, Slovakia, Slovenia and also Germany have all rejected the collateral agreement, calling it unfair.

This has left the eurozone in yet another tricky situation. If everyone asks for collateral, the second Greek bailout will go down the tube, as Greece won't be left with enough cash. But if the Finnish deal isn't approved, Helsinki has threatened not to participate in the bailout - or it may be forced to go back on its word to taxpayers, in turn leading to a political backlash at home.

So now what? Here's the latest from the five main protagonists.


With the anti-euro "True Finns" party (which continue to lead in the polls) breathing down its neck, the Finnish government is sticking to its guns, with Prime Minister Jyrki Katainen unequivocally answering "yes" when asked if Finland would pull out altogether of the second Greek bailout if it were denied the requested collateral, adding,
"It is our parliament's decision that we demand it as a condition for us joining in."
Finnish government representatives have repeated the “no collateral, no loans” mantra - at least when speaking to a home audience (internationally, the tone has been more accommodating). And with the Finnish Presidential elections coming up - in January 2012 - no candidate is keen on explaining to voters why the government has 'sold out' to Europe (sounds familiar?). That would be a gift for the True Finns.

However, the Finnish are also pragmatists and derailing international agreements doesn't come naturally to them. As Katainen has pointed out,
"Of course the Finland-Greece collateral deal cannot block the [bailout] package, but in any case we demand that collateral."
In fact, in recent days, he has stressed that he's flexible on the nature of the collateral (gold, cash, land, etc). But there needs to be some sort of collateral nonetheless, begging the question whether the eurozone can reach a minimalist deal that will allow Katainen to save face.


In a letter to the Dutch Parliament, Dutch Finance Minister Jan Kees de Jager insisted that the Greco-Finnish agreement needs to be ratified by all eurozone member states and the IMF - signalling that it would veto it:
"Finland has unilaterally announced the bilateral agreement. Because of that, the incorrect image has emerged that there would be a legal agreement between Finland and Greece...To execute the current proposal is unworkable."
The Dutch Social-Democrats, whose support is needed for the second Greek bailout to go through the Dutch Parliament, added,
"It can't be the case that the Finns obtain guarantees at the expense of the Netherlands. That's not acceptable and if it comes that far, the Netherlands should veto it."

And there's not much love from Vienna either. The Austrians don't necessarily consider collateral a precondition for lending more money to Athens, but if Helsinki obtains it, then everyone should get it. Austrian Finance Minister Maria Fekter said,
"It's not a viable option when Finland makes a deal with Greece to receive 20% collateral and all the other euro countries should pay."
Last week, Austria put forward an alternative plan, under which the amount of collateral would be inversely proportional to each country’s private banking sector exposure to Greece. Countries (including Austria) whose banks have little exposure to Greek debt would be allowed to get collateral from Greece, while countries whose banks are heavily exposed (Germany and France spring to mind) would not get any collateral at all. A bit cheeky, but not entirely unreasonable.


Slovakian Finance Minister Ivan Miklos - clearly not a fan of the eurozone bailouts in the first place - has made it clear that he considers it
"unacceptable for any country to not have the collateral if other countries have it. Because if this is a loan, and that is what everyone is calling it, the debtor should have no problem offering collateral for the loan."
Incidentally, Prime Minister Iveta Radičová said on Monday that Slovakia will be the "last country" to ratify changes to the EFSF - the eurozone's temporary bailout fund - and to agree to the establishment of its permanent successor, the ESM. The Freedom and Solidarity (SaS) party - a junior partner in the Coaliton government - doesn't support expansion of the EFSF. Negotiations between the parties are ongoing. Speaker of the Slovakian Parliament and SaS leader Richard Sulík said,
"I'm not aware of any reason why Slovakia ought to rush to be the first to put itself in a position that's not good for us. Let the rest of the EU reach agreement or not, we'll follow up with discussion then."

German Labour Minister Ursula von der Leyden - who is also a prominent leader of German Chancellor Angela Merkel's CDU party (see picture) - broke ranks yesterday when she suggested that Greece should post either gold or stakes in state-owned companies as collateral in return for further loans. However, her proposal was quickly dismissed by the German government. Also, in a meeting with CDU MPs, Merkel voiced her opposition to the Greco-Finnish agreement, reportedly saying,
"It can't be that one country gets extra collateral."
So, in short, eurozone leaders have landed themselves in a right old mess. You have to wonder why no one saw this coming on July 21st.


Anonymous said...

In a (probably futile) attempt to seek some clarity here, if Greece gets loans from the EFSF as part of a second bail-out then presumably the EFSF, which is not an EU body but a Special Purpose Vehicle set up in Luxembourg by the eurozone states:


will borrow more money from international investors to lend on to Greece.

The EFSF has already borrowed a total of €13 billion through the three bond issues listed here, which are a form of Eurobonds:


And it has lent on €3.6 billion to Ireland and €5.9 billion to Portugal, a total of €9.5 billion:


The bonds issued by the EFSF are rated AAA, because each of the eurozone states is required to guarantee 120% of its pro rata share of the repayments due to the bondholders.

That is, if for example Greece failed to fully repay loans extended to it by the EFSF, and the other eurozone states then had to stump up to fully repay the EFSF bondholders as they had all guaranteed, then Finland might have to pay up to 120% of its pro rata share of the repayments due to the international investors, especially if other eurozone states failed to keep their own guarantees.


"A12 - Would the EFSF default if one of its borrower countries defaulted?

The credit enhancement mechanisms under the Framework Agreement are designed to exclude such a situation. If a country were to default on its payments, guarantees would be called in from the guarantors and payments could be made from the cash buffer. The shortfall would be covered by the:


Grossing up of guarantees (120% over-collateralisation)

Loan-specific cash buffer

Cash reserve

If a guarantor did not respect its obligations, guarantees from others could be called in to cover the shortfall. All guarantors rank equally and pari passu amongst themselves."

So it seems to me that when Finland demands that the Greeks provide 20% collateral on the Finnish share of any EFSF loans extended to Greece, it is in effect saying that:

a) It is still prepared to guarantee its pro rata share of the repayments due to the EFSF bondholders; but

b) It is no longer prepared to participate in that "credit enhancement mechanism" whereby it guarantees 120% of its pro rata share; and

c) Instead it wants Greece to take over that extra liability it had previously accepted in principle under the EFSF "over-collaterisation" arrangement.

And as the "over-collateralisation" under the EFSF agreement is clearly illegal under Article 125 of the Treaty on the Functioning of the European Union, and as arguably the compensatory "collaterisation" under a bi-lateral agreement between Greece and Finland is similarly illegal, it could be a case of two wrongs more or less making a right.

Anonymous said...

Finns did not vote for "collateral" in elections. They voted for "debt restructuring." That is what "the left" promised before elections. After elections "the left" changed "debt restructuring" with "collateral" and after elections not a single word has come out about debt restructuring.

Open Europe blog team said...

Thanks anonymous. Good point. We’re not claiming that Finnish voters voted for collateral, but they did vote for a change in EU policy of some sort.

Open Europe blog team said...

Thanks for the comment anonymous (the first one). Very detailed attempt at clarifying the situation. It could be that Finland is looking to compensate for this over-collateralisation risk. We would highlight though that all eurozone governments have agreed to change this structure (when they agreed to increase the lending capacity of the EFSF to €440bn), although it is yet to be fully approved by all national parliaments. Despite some concerns it does seem as if this EFSF increase will be approved, with most parliaments looking to do so within the next month or so. Once the changes are approved the EFSF loans will have an over-collateralisation of 165%, but their AAA rating will essentially come from the fact that AAA rated countries will guarantee around 102% of the loans.

(See here for a good explanation of this agreement: http://ftalphaville.ft.com/blog/2011/06/21/600681/europe-calibrates-its-bailouts-comforts-markets/)

We’d expect this new structure to be in place for the disbursement of any of the second Greek bailout loans, so any logic behind the Finnish deal should be taken in this context. So it could more along the lines of the increase reliance on AAA countries which has encouraged Finland to seek this level of collateral. The ultimate motivation does still seem to be political though, with the government being given little manoeuvring room by the parliament.

Anonymous said...

Collateral? Now, that's a term we're all familiar with. The banks require collateral from us - why not require collateral from them? Novel concept. Why wasn't this required at the bailout onset, starting with the very first bailout - including Fannie Mae, Freddie Mac, and Ginnie Mae, in addition to the Big Boys in the private sector? Accountability should apply to everyone, not just the taxpayers. (Oregon, USA)