Eurozone Sovereign Debt: A Menu of Bad Options


Welcome to the world of European sovereign debt restructuring proposals — where politicians dream of making the world other than it is by act of Parliament.

Today's installment begins with a discussion of two policy options for handling European sovereign bonds in the wake of the Eurozone's debt crisis.

Tracy Alloway, at The Financial Times Alphaville blog, maps out two divergent policy options that are currently under discussion.

The first, which is "beloved by ze Germans", is called Collective Action Clauses (CACs).

CACs act as a mechanism to force creditors to share in losses if a serious credit event should occur.

In other words, CACs are a way to haircut bondholders—to force them to share in losses, rather than having the option of being made whole through a bailout agreement.

The Germans favor this option, presumably, because it would limit the liabilities of the economically stronger nations in the Eurozone—in the event that they should be forced to assist a weaker nation in economic crisis.

The second option is the creation of collectively issued E-bonds.

E-bonds would be issued by all the nations in the Eurozone, and would therefore allow for a pooling of risk.

The striking thing about the two proposals—when viewed jointly—is this: their intent, as well as their effect, would seem diametrically opposed to any rational human being.

Tracy Alloway has covered the mechanics of sovereign debt in Europe in great detail, depth, and nuance.

(Alloway cites a detailed analysis by a Bank of America Merrill Lynch analyst named Ralf Preusser in her most recent article.)

But I can't stop thinking about the broader picture.

What's bothering me is this: Analysts are discussing these two policy options as though they were incremental variants of related proposals.

Nothing could be farther from the truth: These are policy proposals that represent radically divergent worldviews—from matters as diverse as finance and economics to the autonomy of the nation state.

On the one hand, CACs would encourage creditors to price in a greater risk, and to demand higher yields for lending money to less creditworthy states. On the other hand, the E-bond would pool risk, by binding weaker and stronger states together in debt obligations.

These are totally incompatible views of the way the world functions. And it's difficult to imagine how these two perspectives can be reconciled through traditional incremental negotiation.

It's enough to make you wonder if this kind of ideological schizophrenia is an early warning sign of a broader crackup.


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