The ECB Is Playing A Dangerous Game With "Collective Action Clauses" On Bonds

There is a clause to European bond sales called a collective action clause. In fact, “all bonds issued by Eurozone member states with maturities exceeding one year, issued after January 1, 2013, have a mandatory collective action clause." This clause is the first part in a dangerous game of perpetual growth with zero savings that the European Central Bank (ECB) and the International Monetary Fund (IMF) are playing at the moment.

But firstly, what is a collective action clause (CAC)? To put it simply, it's a mechanism whereby a bond's value can be legally reduced by the issuer in times of hardship, originally very unpopular (in the '80s and '90s). Geoffrey Okamoto and others at the IMF and at central banks say that countries that were not allowed to do this to issued bonds experienced stagnation.

Normally, CACs need to be agreed to by the supermajority of bondholders; however, this may be pushed to the point of not mattering, as the single biggest bondholder will be the ECB and the domestic market will make up the rest of the votes needed. This is especially true in countries like Ireland and Italy.

The CACs were first introduced by the EU in relation to the Greek debt crisis. It was agreed to slash bond values to around a third of their original value. This then gave rise to the policy whereby all bonds in the eurozone came with this clause.1 This would lead some to see the bonds as less attractive to investors (especially in terms of Greece, Ireland, Spain, etc).

However, the ECB has another trick up its sleeve.

It’s become the investor, on an epic scale. The Fed and Bank of Japan (BOJ) purchase 20 to 40 percent of government bonds in their respective countries; however, looking at Ireland, the ECB purchased 50 percent of Irish government bonds in 2020, and there are plans to expand this policy in the future years.

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