Markets Insight
June 26, 2014 7:58 am
Europe rethinks how to cure its debt hangover
Austria part of trend that could make restructurings more common
A government reneges on state guarantees. Losses are inflicted on bond holders. Other investors worry they might be next.
This was not Argentina but Austria, one of Europe’s most prosperous and conservative democracies.
Rather than taxpayers footing a bigger bill, Vienna plans legislation allowing it to “bail-in” €890m of subordinated debt which had been guaranteed by the state of Carinthia. While Michael Spindelegger, Austria’s finance minister, played down the broader implications, investors in Europe’s weaker banks were put on notice: you could be on the frontline in the next bank rescue.
Austria’s actions are noteworthy not just because of Vienna’s apparent capriciousness – rating agencies warn of downgrades for other Austrian banks. The Hypo case is part of a trend to put in place practices and mechanisms that could make debt restructurings more commonplace in Europe – for public as well as private sector debt.
Reckless credit splurges
European policy makers have long recognised the continent’s debt problem. The euro’s launch in 1999 encouraged reckless credit splurges, especially in countries on its periphery – such as Greece, Ireland and Spain.
When the eurozone crisis erupted in 2010, however, the idea of imposing losses on creditors was strongly resisted. Partly, it was pride. Jean-Claude Trichet, then European Central Bank president, had witnessed the consequences of debt restructurings when he chaired the Paris Club of international creditors in the late 1980s. For him, unblemished creditworthiness was part of being an advanced European economy.
There were worries that a premature Greek default would trigger an even bigger financial crisis. The IMF amended its rules so it could continue to support countries if there was a high risk of “international systemic spillovers” even when it feared debt levels were not sustainable.
Four years on, the landscape has changed. Fears of a eurozone collapse have disappeared and Greece’s debt restructuring in 2012 showed contagion effects were manageable. “Collective action clauses”, which make it easier to bind recalcitrant investors into a restructuring, have become standard in new eurozone government bonds – and should help avoid Argentine-type problems.
This week’s IMF paper proposed revoking the 2010 amendment and broadening the range of options for struggling countries to include earlier debt maturing extensions, or “reprofiling”, as a softer option.
Taxpayers protected
When it comes to bank rescues, Austria’s Hypo case was not as wilful as it might seem. Rather, it fitted with the principle of minimising taxpayers’ involvement when banks go wrong that is written into Europe’s post-crisis regulatory regime.
It is “pushing in the same direction” as the IMF initiative, says Alistair Wilson, credit analyst at Moody’s. “It is all about trying to find more effective resolution when borrowers lose access to markets or are unable to service debt.”
Europe’s approach is not out of line with the rest of the world; there is global agreement on tackling banks “too big to fail”. But debt restructurings may become more of a Europe story not just because of its high levels of indebtedness. The ECB is less inclined than US or UK counterparts to use inflationary “quantitative easing” to erase problems left over from the post-2007 crises.
More frequent restructurings could see investors demanding higher yields. So far there is scant sign of that happening. As everywhere else, markets inEurope have rallied as low official interest rates have driven investors into riskier assets. But higher borrowing costs are not inevitable if a more realistic approach to debt problems strengthens economies – and there is method in politicians’ actions.
This was not Argentina but Austria, one of Europe’s most prosperous and conservative democracies.
Plans announced this month to wind down Hypo Alpe Adria, a midsized lender from Carinthia, attracted little international attention. But they could have significance beyond Austria’s borders. They offer an illustration – or warning – of how Europe will address high levels of indebtedness which continue to blight economic growth prospects.
Austria’s actions are noteworthy not just because of Vienna’s apparent capriciousness – rating agencies warn of downgrades for other Austrian banks. The Hypo case is part of a trend to put in place practices and mechanisms that could make debt restructurings more commonplace in Europe – for public as well as private sector debt.
Reckless credit splurges
In Argentina, debt restructuring has just become a lot more complicated after the government lost a lengthy legal conflict in the US with “holdout” creditors. The fallout could affect other sovereign debt workouts. But a rethink, coincidentally unveiled this week, by the International Monetary Fund of its approach to country bailouts in the light of the eurozone crisis could have the opposite effect, giving it more flexibility when governments get into trouble.
When the eurozone crisis erupted in 2010, however, the idea of imposing losses on creditors was strongly resisted. Partly, it was pride. Jean-Claude Trichet, then European Central Bank president, had witnessed the consequences of debt restructurings when he chaired the Paris Club of international creditors in the late 1980s. For him, unblemished creditworthiness was part of being an advanced European economy.
But there were also real fears of contagion. The ECB blocked Ireland from imposing losses on senior bond holders of its bust banks to protect the wider European Union banking system.
Four years on, the landscape has changed. Fears of a eurozone collapse have disappeared and Greece’s debt restructuring in 2012 showed contagion effects were manageable. “Collective action clauses”, which make it easier to bind recalcitrant investors into a restructuring, have become standard in new eurozone government bonds – and should help avoid Argentine-type problems.
This week’s IMF paper proposed revoking the 2010 amendment and broadening the range of options for struggling countries to include earlier debt maturing extensions, or “reprofiling”, as a softer option.
Taxpayers protected
When it comes to bank rescues, Austria’s Hypo case was not as wilful as it might seem. Rather, it fitted with the principle of minimising taxpayers’ involvement when banks go wrong that is written into Europe’s post-crisis regulatory regime.
It is “pushing in the same direction” as the IMF initiative, says Alistair Wilson, credit analyst at Moody’s. “It is all about trying to find more effective resolution when borrowers lose access to markets or are unable to service debt.”
Europe’s approach is not out of line with the rest of the world; there is global agreement on tackling banks “too big to fail”. But debt restructurings may become more of a Europe story not just because of its high levels of indebtedness. The ECB is less inclined than US or UK counterparts to use inflationary “quantitative easing” to erase problems left over from the post-2007 crises.
More frequent restructurings could see investors demanding higher yields. So far there is scant sign of that happening. As everywhere else, markets inEurope have rallied as low official interest rates have driven investors into riskier assets. But higher borrowing costs are not inevitable if a more realistic approach to debt problems strengthens economies – and there is method in politicians’ actions.
Copyright The Financial Times Limited 2014
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