Eurobonds
Encyclopedia
European bonds are suggested government bonds issued in Euros
jointly by the 17 eurozone
nations. Eurobonds are debt investments whereby an investor loans a certain amount of money, for a certain amount of time, with a certain interest rate, to the eurozone bloc as a whole, which then forwards the money to individual governments. Eurobonds have been suggested as an effective way to tackle the European sovereign debt crisis though they remain controversial.
, which could reduce borrowing costs for everybody involved".
According to the proposal EU member states should pool up to 60 percent of gross domestic product
(GDP) of their national debt under joint and several liability as senior sovereign debt, thereby reducing the borrowing cost for that part of the debt. Any national debt beyond a country’s blue bond allocation should be issued as national and junior debt with sound procedures for an orderly default, thus increasing the marginal cost
of public borrowing and helping to enhance fiscal discipline. Participating countries must also establish an Independent Stability Council voted on by member states parliaments to propose annually an allocation for the blue bond and to safeguard fiscal responsibility.
Smaller countries with relatively illiquid sovereign bonds (such as Austria and Luxembourg) stand to benefit most from the extra liquidity of the blue bond, although even for Germany borrowing costs under the blue bond scheme are expected to fall below current levels. Countries with high debt-to-GDP ratios (such as Italy
, Greece
, and Portugal
) would have a strong incentive for fiscal adjustment.
. On 23 November 2011 the Commission presented a Green Paper
assessing the feasibility of common issuance of sovereign bonds among the EU member states of the eurozone. Sovereign issuance in the eurozone is currently conducted individually by each EU member states. The introduction of commonly issued eurobonds would mean a pooling of sovereign issuance among the member states and the sharing of associated revenue flows and debt-servicing costs.
Suggested effects
According to the European Commission proposal the introduction of eurobonds would create new means through which governments finance their debt, by offering safe and liquid investment opportunities. This "could potentially quickly alleviate the current sovereign debt crisis, as the high-yield
Member States could benefit from the stronger creditworthiness of the low-yield Member States." The effect would be immediate even if the introduction of eurobonds takes some time, since changed market expectations adapt instantly, resulting in lower average and marginal funding costs, particularly to those EU member states most hit by the financial crisis. The Commission also believes that eurobonds could make the eurozone financial system
more resilient to future adverse shocks and reinforce financial stability. Furthermore they could reduce the vulnerability of banks in the eurozone to deteriorating credit ratings of individual member states by providing them with a source of more robust collateral.
Setting a euro-area wide integrated bond market would offer a safe and liquid investment opportunity for savers and financial institutions that matches its US Dollar counterpart in terms of size and liquidity, which would also strengthen the position of the euro as an international reserve currency and foster a more balanced global financial system
.
and ensure sustainable public finances. Under the proposals, eurozone governments would have to submit their draft national budgets for the following year to the European Commission by 15 October. The Commission would then be able to ask the government to revise the budget if it believed that it was not sound enough to meet its targets for debt and deficit levels as set out in the Euro convergence criteria.
calling it the "master solution" to the eurozone debt crisis. A growing field of investors and economists share this believe, saying eurobonds would be the best way of solving the debt crisis.
Germany remains opposed to debt that would be jointly issued and underwritten by all 17 members of the currency bloc, saying it could substantially raise the country's liabilities in the debt crisis. However, Barroso maintained that Germany did not oppose joint issuance in principle, but questioned the timing of it.
Euro
The euro is the official currency of the eurozone: 17 of the 27 member states of the European Union. It is also the currency used by the Institutions of the European Union. The eurozone consists of Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg,...
jointly by the 17 eurozone
Eurozone
The eurozone , officially called the euro area, is an economic and monetary union of seventeen European Union member states that have adopted the euro as their common currency and sole legal tender...
nations. Eurobonds are debt investments whereby an investor loans a certain amount of money, for a certain amount of time, with a certain interest rate, to the eurozone bloc as a whole, which then forwards the money to individual governments. Eurobonds have been suggested as an effective way to tackle the European sovereign debt crisis though they remain controversial.
Blue bond proposal
In May 2010 the two economists Jakob von Weizsäcker and Jacques Delpla published an article proposing a mix of traditional national bonds (red bonds) and jointly issued eurobonds (blue bonds) to prevent debt crises in weaker countries, while at the same time enforcing fiscal sustainability. The authors argue that while their concept is not a quick fix, their Blue Bond proposal charts an incentive-driven and durable way out of the debt dilemma while "helping prepare the ground for the rise of the euro as an important reserve currencyReserve currency
A reserve currency, or anchor currency, is a currency that is held in significant quantities by many governments and institutions as part of their foreign exchange reserves...
, which could reduce borrowing costs for everybody involved".
According to the proposal EU member states should pool up to 60 percent of gross domestic product
Gross domestic product
Gross domestic product refers to the market value of all final goods and services produced within a country in a given period. GDP per capita is often considered an indicator of a country's standard of living....
(GDP) of their national debt under joint and several liability as senior sovereign debt, thereby reducing the borrowing cost for that part of the debt. Any national debt beyond a country’s blue bond allocation should be issued as national and junior debt with sound procedures for an orderly default, thus increasing the marginal cost
Marginal cost
In economics and finance, marginal cost is the change in total cost that arises when the quantity produced changes by one unit. That is, it is the cost of producing one more unit of a good...
of public borrowing and helping to enhance fiscal discipline. Participating countries must also establish an Independent Stability Council voted on by member states parliaments to propose annually an allocation for the blue bond and to safeguard fiscal responsibility.
Smaller countries with relatively illiquid sovereign bonds (such as Austria and Luxembourg) stand to benefit most from the extra liquidity of the blue bond, although even for Germany borrowing costs under the blue bond scheme are expected to fall below current levels. Countries with high debt-to-GDP ratios (such as Italy
Italy
Italy , officially the Italian Republic languages]] under the European Charter for Regional or Minority Languages. In each of these, Italy's official name is as follows:;;;;;;;;), is a unitary parliamentary republic in South-Central Europe. To the north it borders France, Switzerland, Austria and...
, Greece
Greece
Greece , officially the Hellenic Republic , and historically Hellas or the Republic of Greece in English, is a country in southeastern Europe....
, and Portugal
Portugal
Portugal , officially the Portuguese Republic is a country situated in southwestern Europe on the Iberian Peninsula. Portugal is the westernmost country of Europe, and is bordered by the Atlantic Ocean to the West and South and by Spain to the North and East. The Atlantic archipelagos of the...
) would have a strong incentive for fiscal adjustment.
European Commission proposal
On 21 November 2011 the European Commission suggested European bonds issued jointly by the 17 euro nations as an effective way to tackle the financial crisisFinancial crisis
The term financial crisis is applied broadly to a variety of situations in which some financial institutions or assets suddenly lose a large part of their value. In the 19th and early 20th centuries, many financial crises were associated with banking panics, and many recessions coincided with these...
. On 23 November 2011 the Commission presented a Green Paper
Green paper
In the Commonwealth, the Republic of Ireland and the United States a green paper is a tentative government report of a proposal without any commitment to action; the first step in changing the law...
assessing the feasibility of common issuance of sovereign bonds among the EU member states of the eurozone. Sovereign issuance in the eurozone is currently conducted individually by each EU member states. The introduction of commonly issued eurobonds would mean a pooling of sovereign issuance among the member states and the sharing of associated revenue flows and debt-servicing costs.
Three approaches to eurobonds
The green paper lists three broad approaches for common issuance of eurobonds based on the degree of substitution of national issuance (full or partial) and the nature of the underlying guarantee (joint and several or several).- Full eurobonds with joint liability: This option suggests to fully replace the entire national issuance by eurobonds, each EU member being fully liable for the entire issuance. According to the European Commission "this would have strong potential positive effects on stability and integration. But at the same time, it would, by abolishing all market or interest rate pressure on Member States, pose a relatively high risk of moral hazard and it might need significant Treaty changes."
- Partial eurobonds with joint liability: The second option would pool only a portion of borrowings, again guaranteed by all. This means EU member states would still partly issue national bonds to cover the share of their debts beyond a certain percentage of GDP not covered by eurobonds. The Commission does not state a specific volume or share of financing needs that would be covered by national bonds at the one hand and eurobonds on the other. However, the proposal is similar to that of the German Council of Economic ExpertsGerman Council of Economic ExpertsThe German Council of Economic Experts or ' is a group of economists set up in 1963 to advise the German government and Parliament on economic policy issues. Every year the Council prepares the annual report which is published before or by November 15...
that proposed a European collective redemption fund, which would mutualize the debt in the eurozone above 60%, combined with a bold debt reduction scheme for those countries, which are not on life support from the European Financial Stability FacilityEuropean Financial Stability FacilityThe European Financial Stability Facility is a special purpose vehicle financed by members of the eurozone to combat the European sovereign debt crisis. It was agreed by the 27 member states of the European Union on 9 May 2010, aiming at preserving financial stability in Europe by providing...
. - Partial eurobonds without joint guarantees: According to the third option that is similar to the blue bond proposal, eurobonds would again cover only parts of the debt (like option 2) but without joint guarantees. This could impose strict entry conditions for a smaller group of countries to pool some debt and allow for the removal of countries that do not meet their fiscal obligations. Due to "a mechanism to redistribute some of the funding advantages ... between the higher- and lower-rated" governments, this option aims to minimize the risk of moral hazard for the conduct of economic and fiscal policies. Unlike the first two approaches, this would involve "several but not joint" government guarantees and could therefore be implemented relatively quickly without having to change EU treaties.
Suggested effects
According to the European Commission proposal the introduction of eurobonds would create new means through which governments finance their debt, by offering safe and liquid investment opportunities. This "could potentially quickly alleviate the current sovereign debt crisis, as the high-yield
Yield (finance)
In finance, the term yield describes the amount in cash that returns to the owners of a security. Normally it does not include the price variations, at the difference of the total return...
Member States could benefit from the stronger creditworthiness of the low-yield Member States." The effect would be immediate even if the introduction of eurobonds takes some time, since changed market expectations adapt instantly, resulting in lower average and marginal funding costs, particularly to those EU member states most hit by the financial crisis. The Commission also believes that eurobonds could make the eurozone financial system
Financial system
In finance, the financial system is the system that allows the transfer of money between savers and borrowers. A financial system can operate on a global, regional or firm specific level...
more resilient to future adverse shocks and reinforce financial stability. Furthermore they could reduce the vulnerability of banks in the eurozone to deteriorating credit ratings of individual member states by providing them with a source of more robust collateral.
Setting a euro-area wide integrated bond market would offer a safe and liquid investment opportunity for savers and financial institutions that matches its US Dollar counterpart in terms of size and liquidity, which would also strengthen the position of the euro as an international reserve currency and foster a more balanced global financial system
Global financial system
The global financial system is the financial system consisting of institutions and regulators that act on the international level, as opposed to those that act on a national or regional level...
.
Tighter fiscal rules
Presenting the idea of "stability bonds", European Commission president Jose Manuel Barroso insisted that any such plan would have to be matched by tight fiscal surveillance and economic policy coordination as an essential counterpart so as to avoid moral hazardMoral hazard
In economic theory, moral hazard refers to a situation in which a party makes a decision about how much risk to take, while another party bears the costs if things go badly, and the party insulated from risk behaves differently from how it would if it were fully exposed to the risk.Moral hazard...
and ensure sustainable public finances. Under the proposals, eurozone governments would have to submit their draft national budgets for the following year to the European Commission by 15 October. The Commission would then be able to ask the government to revise the budget if it believed that it was not sound enough to meet its targets for debt and deficit levels as set out in the Euro convergence criteria.
Reactions
Italy and Greece have frequently spoken out in favor of eurobonds, the then Italian Minister of economy Giulio TremontiGiulio Tremonti
Giulio Tremonti is an Italian politician. He served in the government of Italy as Minister of Economy and Finance under Prime Minister Silvio Berlusconi from 1994 to 1995, from 2001 to 2004, from 2005 to 2006, and from 2008 to 2011....
calling it the "master solution" to the eurozone debt crisis. A growing field of investors and economists share this believe, saying eurobonds would be the best way of solving the debt crisis.
Germany remains opposed to debt that would be jointly issued and underwritten by all 17 members of the currency bloc, saying it could substantially raise the country's liabilities in the debt crisis. However, Barroso maintained that Germany did not oppose joint issuance in principle, but questioned the timing of it.
Next steps
Following the release of the proposal, the European Commission has launched a broad consultation on the Green Paper, which will close on 8 January 2012. The introduction of eurobonds matched by tight financial and budgetary coordination likely requires changes in EU treaties, which is widely expected to be discussed at the 9 December EU summit.Critics
The planned introduction of Eurobonds has been criticized by economists for economic reasons. Beside economic grounds, mainly legal and political reasons are mentioned which could prohibit the introduction of Eurobonds: Article 125 of the Lisbon Treaty states explicitly that the European Union and its member states are not liable for the commitments of other members. Since Eurobonds would possibly contravene Article 125, it may have to be changed prior introduction.External links
- The blue bond proposal (May 2010)
- Eurobonds: The blue bond concept and its implications (March 2011)
- EC Green paper on stability bonds (November 2011)