Eurobonds: Right Idea, Wrong Institution


We’ve seen it happen in the US: states strapped for cash selling off municipal bonds to assuage their creditors. Could eurobonds be the solution to sovereign debt crises in Europe?

Pimco knows a thing or two about the bond markets, so I asked Tony Crescenzi for his thoughts. "The notion of a eurobond has not been popular for Europe because it would speed up the fiscal union that many say is necessary to sustain the monetary union."

Eurobonds, or bonds that are originated by individual member states and backed by all the states, are touted by some as the solution du jour to some of the EU’s most pressing financial concerns, including Greece’s sovereign debt. According to many economists, it’s not so much an issue of whether or not eurobonds could, in theory, stymie some of the debt; it’s whether or not the structure of the EU can support the relief they might provide.

For EU bonds to have credibility, Brussels would have to have taxing authority similar to Washington and a fiscal purpose for those bonds,” said economist Peter Morici, noting that Brussels would have to take over some of the government responsibilities now handled by member states.

For a government institution carefully constructed to avoid the centralization of power like the EU, the concept is inherently problematic.

Stephen Gallo, Head of Market Analysis for Schneider Foreign Exchange, agrees that eurobonds could work—but with several important caveats:

First, he said that eurobonds should not be linked to the notion of a centralized European Treasury, like that in the US, no matter how much closer Europe gets to behaving more like a political union over time. Again, it’s a matter of structure.

“We don't by any means want Europe and the euro area copying or mirroring the US model!” he warned, adding that a centralized treasury without state autonomy over issuing debt or spending money could result in fiscal woes like many US states are in right now.

“Centralized Treasury causes money to be wasted, rather than apportioned or spent carefully,” he said.

Besides, said Morici, “The UK, Germany and others are not about to give the EU Parliament that kind of authority.” According to him, the contributions of the member states will continue to be reached by consensus.

Gallo said that, rather than thinking of eurobonds as ready solutions, they should be used as “a post-crisis vehicle to raise financing once reforms for some member states are in place and being implemented, and once macroeconomic governance of the euro area has been streamlined.” He cited Germany as a good example: the German government issues eurobonds then uses the proceeds to swallow peripheral losses.

In addition, Gallo said that once the framework has been established, eurobonds would be a good tool to cover euro area member states' borrowing requirements — up to the 60 percent of GDP debt rule in the Maastricht Criteria. Any debt issued over and above 60 percent by individual member states would be financed by sovereign bonds at prevailing market interest rates.

The best part? According to Gallo, “this would mean that euro area member states are only on the hook for their peers' debt (in the event of a default) — up to 60 percent of GDP but not beyond.”

So what about Greece?

“Speaking about Eurobonds as a solution to the Greek sovereign debt crisis is similar talking about the missing pieces in EU institutions — the ability to tax EU-wide to provide for health care and the like and then redistribute tax revenues on the basis of need,” Morici said. “Don't hold your breathe on that.”

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