Last summer the European Commission first mooted the idea of a Eurobond followed by a Green Paper looking at the different options. While this generated a great deal of buzz, the discussions died down in the wake of the European Central Bank’s long term financing obligation program at the end of 2011. Fast forward to today and the subject is moving back towards the front of the agenda.
Currently, the 17 members of the Eurozone bloc issue bonds independently as there is no common fiscal policy. Proponents such as European Union President Jose’ Manuel Barroso argue that Eurobonds offer the best solution for a more stable sovereign debt market. The view is that they would not only strengthen the financial ties among countries but also potentially create a significant market that could compete with U.S. Treasuries as a global benchmark.
Despite the advantages, the concept has not been an easy sell. Opponents, in particular German Chancellor Angela Merkel, point to the moral hazards in that beleaguered peripheral countries such as Greece, Italy, Spain and Portugal would benefit disproportionately while top-notch rated countries such as Germany would end up shouldering the burden.
Jack Kelly, investment director of global government bonds at UK-based Standard Life adds, “Although Eurobonds may be the best remedy, the intensity of the crisis has abated due to the Long-term Refinancing Operation (LTRO) and at this stage I think there will be other attempts and measures along the same lines to solve the crisis. Countries are not ready to give up their sovereignty and there are also concerns over the moral hazards that Eurobonds raise. Germany would want to see more fiscally responsible structures in place before it becomes a reality.”
The fragmentation of Europe should also not be underestimated. “One of the biggest differences between the United States and Europe is that one is an integrated union and the other has monetary union without the fiscal controls,” says Chris Bullock, credit portfolio manager at Henderson Global Investors, a UK-based fund management group. “There are large cultural and structural variations in the eurozone in terms of labor and employment laws, trade, politics, language, and the unwillingness of individual nations to give up their sovereign independence. That is a major barrier to the creation of a Eurobond.”
A Number of Proposals
The European Parliament though is forging ahead and three committees are currently exploring the feasibility of the Commission’s Green Paper issued last November on what it calls stability bonds – a more palatable term than Eurobonds.
Under the Commission plan, there are three options. The first one looks at full substitution of national issuance into Eurobonds, with each member state fully liable for the entire issuance. This is deemed to be the most attractive to policymakers, but it also poses the greatest moral hazard and would require a major overhaul of the treaty. The second option is a partial substitution, which would cover only parts of national financing needs, enabling member states to continue issuing their own bonds, although at an accordingly lower volume due to the parallel issuance of stability bonds. The moral hazard would be reduced given that member states would still need to tap markets on their own and be subject to the vagaries of financial conditions.
The last option is the “most limited” choice whereby Eurobonds would partially cover issuance of national bonds but with no joint guarantees.
There have been other variations on the theme with the German Council of Economic Experts issuing a competing proposal that also avoids using the term “Eurobond,” referring to them instead as redemption bonds. The plan is modeled on the scheme used by Alexander Hamilton to pay off the Revolutionary War debts of the original 13 American colonies.
Eurozone members would pool their debts in excess of 60 percent of GDP into a redemption fund, which they would finance jointly and commit to paying off in 20 to 25 years. The Council believes this would “give countries some breathing space” to balance deficit reduction efforts with pro-growth reforms. Each country would also be responsible for its debts up to the 60 percent level, easing German fears that the eurozone could turn into a transfer union, with Berlin picking up the tab for the other members.
Other industry groups such as the European League for Economic Cooperation (ELEC) – a network of entrepreneurs, bankers, economists and market experts – are calling for a short term fix in the form of a Euro T-Bill Fund. The fund would last only four years and complement moves to instill stricter fiscal discipline and economic reform in the EU. The proposed fund would borrow in the markets for at most a two-year term to match the borrowing profile of each country. Its capacity would be large enough to finance for the next two years all the maturing bonds of members that were unable to access capital markets on normal terms.
“There are a number of proposals in the marketplace and there are huge differences between them,” says Wim Boorstra, chief economist at Dutch based Rabobank. “I think that the ELEC proposal is a credible alternative that covers all the liquidity needs of the eurozone countries. It also buys time because it is a temporary solution which allows for other definitive and more permanent measures to be developed.”