Imagine the situation. Spain gets an ESM bailout, which is one of the conditions for getting OMT support. The ESM, with its senior status, buys in the primary market to support the long end of the Spanish yield curve. The ECB, with its self-proclaimed but dubious pari passu status, does the same, but in the short end and via the secondary market. Where might you think that would drive private sector investors? Would they prefer to stay in the long end, and hope to compete against a senior ESM in the case of a future restructuring or default? Or, would they prefer to use the ESM as a financing vehicle to transfer their longer duration holdings into taxpayer hands? What effect might this have on the "rescued" nation's ability to sell longer duration debt?
Obviously, I think a senior ranked ESM has the potential to drive private sector investors out of the long end of the curve in a big way. The ESM could not eliminate this danger by buying the short end, as it would then be competing with the supposedly pari passu ECB's OMT program. Hence, the ESM involvement will tend to shorten the "rescued" nation's debt maturity profile, driving them further into the arms of the ECB and the short term speculators along for the ride.
Contrast my view with the assurances of Luc Coene, the Belgian Central Bank governor:
"Only bonds with three or fewer years until they mature will be bought under the plan, and Coene said that governments would not be able to manipulate their issuance to take advantage of the new scheme.
'We will only buy the debt with the remaining maturity of three years and part of the conditionality will be that the maturity structure of the debt may not change so that they (governments) cannot put all the new debt in the short end of the market'"
Coene says the new governing body of Europe, the ECB, will be watching those sovereigns to make sure they don't shift their maturity profiles. Are we to conclude that, if they do, OMT will suddenly stop, as his statement implies? Does anyone really believe that (including the "rescued" sovereign)?
Apparently one person does:
"We will monitor the situation very carefully, but, at the same time, one assumes that countries would like to keep a structure of debt issuance which is balanced across all maturities. So there is a danger, there is a risk, but it is not at all clear that debt issuers will actually move in this direction because it has a cost, namely of unbalancing a maturity structure which was probably balanced to begin with and has taken many years to achieve."
His Ultimate Omnipotent Highness and Most Excellent Overlord of the European Realm
Patron Saint of Mediterranea
September 6, 2012