European bonds: For and against
A Heathrow departure lounge is not the best place to consider the pros and cons of common European bond issue. But when I get to Brussels, there will be plenty of officials debating the subject in the lead-up to the eurozone finance ministers' meeting this evening.
The chairman of the Euro group, Jean-Claude Juncker and the Italian finance minister, Giulio Tremonti, talk up the merits of common European sovereign bonds - or E-bonds - in today's FT.
There are some positives, which were widely discussed when the rules for the euro were being drawn up.
One is to provide deeper markets for European sovereign bonds. Another is to express the irreversibility of the euro and the strength of the countries' common commitment to make the single currency work. Another advantage - not discussed at that time but sorely missed by the ECB - would be to give the central bank a way to ease monetary policy by buying bonds, without appearing to prop up individual governments or underwrite their borrowing.
The authors keep returning to another motivation for the proposal - that it would "halt the disruption of sovereign bond markets" and "ensure that private bondholders bore the risk and responsibility for their investment decisions". That is not so clear. Or at least, not until we know the precise terms under which such a market would operate - or the obligations that it would impose on governments.
There is the suggestion that investors would be offered the option of converting national bonds into E-bonds, at a discount reflecting current market differentials.
This would provide welcome liquidity to institutional investors who are stuck holding peripheral bonds they can't get rid of. But the conversion would also crystallise their losses. It's not obvious that they would be any keener to buy more Spanish or Greek debt in the future than they are today.
This gets us to the big unanswered questions in the article, which explain why Germany remains opposed to the idea (it was German opposition that scuppered E-bonds at the start of the euro.)
The first is how you could possibly create a bond market for which all European Union member countries were responsible, without changing the treaties on which the single currency is based. Apparently, the E-bonds would have a different credit rating to national bonds (and enjoy "a higher status as collateral for the ECB".) But that suggests they would be collectively guaranteed by the members (and we're talking the entire EU here, not just the eurozone).
If so, that would surely demand a much greater degree of fiscal and political cohesion than is being contemplated formally in any of the taskforces now beavering away in Brussels.
There would be "discipline" to the extent that the cost of issuing the bonds for any individual country would depend on their current standing in the markets. In this variant of the proposal, governments would only be able to issue around half of their debt in the form of Eurobonds - so they might continue to pay higher rates on the rest. There would thus be less moral hazard than moving to common Eurobonds across the board. But the 50 per cent limit could be raised to 100 per cent in "extraordinary circumstances" - ie a crisis. More generally, the authors surely hope that the bonds will make it easier for European governments to borrow - otherwise there wouldn't be much point in doing it.
In the absence of true centralised control of budgets (which Germany clearly favours), someone will have to explain to me how a proposal that "insulates countries from speculation" will also "foster fiscal discipline". A common European bond could do either of these things. I cannot see how it could achieve both.
We know which option Germany favours - more discipline by markets, and more discipline from the euro system itself. Possibly, Messrs Juncker and Tremonti would prefer their market discipline to be more of a one-way street. Investors must take responsibility for their decisions - but governments should be "insulated" from the consequences.
Update 1356: A colleague reminds me that the Bruegel think tank has a different version of the E-bond proposal. It would overcome some but not all of the moral hazard concerns, but it would definitely involve important treaty changes. One attraction over today's proposal is that it would explicitly classify the Eurobonds as senior to the national ones. Countries would only be able to issue the common bonds up to an agreed ceiling - say 60 per cent of GDP. This would add some market discipline, by increasing the marginal cost of funds above that limit. But you would still be 'insulating' countries from their poor credit ratings, to the extent that their average cost of borrowing is likely to fall.>