But don’t you see, Jean-Claude Juncker?
We already have eurobonds, of a kind.
FT Alphaville has argued before that Europe’s future mechanism for handling sovereign debt stress may ‘mutate’ bonds issued by national governments after 2013 into what would effectively be eurobonds, in a legal sense, by virtue of the critical collective action clauses implanted into them by European law. That could create an alternative to what are otherwise attractive national procedures for restructuring debt, especially debt issued before 2013. Hence a two-tiered bond market.
It was a pretty complicated argument, though.
Now Luxembourg’s prime minister has gone and simplified it, making haircuts even more central to the eurobonds idea, from a whole other direction. And perhaps it should intrigue, rather than infuriate, those worrying in Berlin over Germany’s financial support for the eurozone.
Here’s Juncker’s case for what he’s calling ‘E-bonds’, alongside Giulio Tremonti, the Italian finance minister. Their candour about the link between the bond and debt restructuring is, well, striking (emphasis ours):
Time is of the essence. The European Council could move as early as this month to create [a post-EFSF European Debt Agency], with a mandate gradually to reach an amount of outstanding paper equivalent to 40 per cent of the gross domestic product of the European Union and of each member state…
First, the EDA should finance up to 50 per cent of issuances by EU members, to create a deep and liquid market. In exceptional circumstances, for member states whose access to debt markets is impaired, up to 100 per cent could be financed in this way. Second, the EDA should offer a switch between E-bonds and existing national bonds.
The conversion rate would be at par but the switch would be made through a discount option, where the discount is likely to be higher the more a bond is undergoing market stress. Knowing in advance the evolution of such spreads, member states would have a strong incentive to reduce their deficits…
And do note that emphasis on existing bonds, not the new bonds issued from 2013 that would come under the Stabilisation Mechanism. This is very different in the scope it gives restructuring compared to the ESM.
Which is why we’re a little bit puzzled to see German officials attacking the very mention of eurobonds on Monday. The objection seems clear: Germany would presumably backstop the EDA and E-bond issuance on the precedent of the EFSF, watching bund yields march higher on the contingent credit risk that’s thereby created. It’s a risk that’s already being priced in, to be sure — and perhaps means 100 basis points either way in ten-year German yields, according to RBS rate strategists on Monday.
On the other hand, what are the risks to the German yield curve of the destruction of around half of German banks’ capital if the eurozone was broken up? Or if (say) the European Financial Stability Facility’s lending capacity becomes so debased that only a direct fiscal transfer will satisfy markets, should it come to a Spanish or Italian crisis?
In fact — the market belatedly repriced the risk of the peripherals being in debt but unable to devalue inside the currency union following the Greek crisis. You could say that German credit is also now merely being realistically reassessed in terms of eurozone effects for the first time.
So the crisis is actually about the least-worst way for Germany to bear this risk, by this late stage. Hence why it might pay for German officials to take another look at eurobonds after all — especially given that the alternative they’ve already created (as above) is looking mighty unstable.
Related links:
The Merkel Crash - FT Alphaville
A big-bang solution to the eurozone - Voxeu
A hopeless Europe, unable to cope - FT