Changes to the ESM – why does it matter?

21st June, 2011

The replacement to our current bail out fund will be the European Stability Mechanism (ESM). Up until yesterday this fund had preferential creditor status. This meant that if debt of a participating country was involved in a default the ESM funding was protected first. This meant that the ‘haircut’ would be concentrated on private sector debt. Makes sense because the ESM funding was ‘backed up’ by member state economies.

Except for one thing. Why would the private sector buy bonds if all of the haircut would be incurred by them?

This meant that once a country entered the ESM it would be very hard for them to get out. This is why the change of this status yesterday by Finance Ministers is really important for future ‘bailout’ countries. This also marks (I think) a huge policy development in another area as it represents a further diluting of burden sharing aspirations.