The European Union may have managed to stanch the bleeding—for the moment—on Irish bonds.
Bondholders seem to have been placated by a joint statement from five of Europe's most economically powerful nations: Germany, France, Italy, the U.K., and Spain. The statement said that bonds issued before the middle of 2013 would not be affected by changes to the EU's bailout program.
Earlier this morning, reports had surfaced of the possibility of haircutting Irish bondholders, which sent the Irish debt markets skittering.
In the words of the Wall Street Journal:
"Worries about possible debt default by the Irish government had flared up in recent sessions and investors had demanded record yield premiums to own the country's 10-year bonds rather than benchmark German debt. Part of the fear was driven by an initiative from Germany that could eventually lead to bondholders bearing part of the pain in any future bailout of a European country."
One imagines the earlier German remarks, which were backed by the French, must have shaken up the camaraderie of European unity more than somewhat. The Irish, as you might guess, were not happyabout it.
The initial strategy offered by the Europeans was to point to an existing bailout fund to calm investors nerves: "Olivier Bailly, a spokesman for Mr. Barroso in Brussels, said European officials were 'carefully assessing the situation on a daily basis' and that 'in case of need,' the European Stabilization Mechanism, a borrowing facility of 750 billion euros, or $1 trillion, set up last spring in the wake of the Greek debt crisis, would be available."
Apparently, this was not enough.
Now that some of Europe's most powerful finance ministers are singing from the same hymnal—however resentfully—the situation is improving. A bit.
But, even as the emergent risks of a market collapse appear to have stabilized, the long-term outlook is still problematic. As PIMCO CEO Mohamed El-Erian pointed out today in his piece in the Financial Times:
"Most fundamentally, advanced economies are not wired to operate at elevated levels of sovereign risk, be it Portugal’s 5 percentage points spread over German five-year bonds, Ireland’s 7 percentage points or Greece’s 11 percentage points. The longer these spreads persist, the greater the decline in investment activity and employment."
How bad might things get? According to El-Erian, pretty bad:
"If things are left as they are the risk of further social unrest will rise, while tax revenues will collapse at a time when budgets are already under enormous strain. Meanwhile, institutions holding government bonds (particularly banks, pension funds and insurance companies) will have to confront the fact that they are sitting on large losses, and do so either on their own or through mounting downgrades by rating agencies."
Prepare to read a lot more about this story—and its attendant economic and political discontents.
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