Photo: New York Times Syndicate
EU leaders will talk about managing a rebellious Greece during Wednesday’s EU summit in Brussels, but there is one, even more important issue you should be watching: eurobonds.Support for anti-bailout parties in Greece has generated market angst, but EU leaders will make few decisions on how to handle the troublesome country until after the results of a new round of parliamentary elections are published on July 17.
Instead, their discussion of eurobonds will be crucial. Support for common euro area bonds has ballooned since they were first proposed as a possible solution to the crisis last year, and they hold the potential to take significant pressure off of troubled EU sovereigns almost immediately.
What are eurobonds and how legitimate of a crisis solution would they be? Click below to read our complete guide.
The least radical approach to common eurobonds would come in the shape of centrally issued bonds with 'several' guarantees. This would force each country to repay a certain amount of the debt issued based on the level of its debt burden, but would not force other countries to step to guarantee obligations from other countries in the event that one or more becomes unable to pay.
Because such an approach does not violate a clause in the EU treaties preventing countries from bailing one another out, the issuance of eurobonds with several guarantees would be permitted under the current EU treaties. Then again, the fact that these bonds don't provide for loss-sharing in the event one contributor cannot pay could compromise their credit rating and might not alleviate significant pressure from troubled EU sovereigns.
'Joint' guarantees would ensure that investors receive the face value of their bonds, regardless of whether certain members can make good on their promise to pay a percentage of those bonds.
Such pooling of debt might be illegal under the current terms of the EU Treaty, as countries are prohibited from assuming the losses of other countries. Thus, approval of such a program would likely face some political backlash, as Northern Europeans might balk at assuming the debts of their less disciplined Southern neighbours.
On the other hand, jointly guaranteed bonds would go a long way towards stemming the crisis, as it would convince investors that strong economies like Germany and France would step in to prop up their neighbours and keep the eurozone whole.
Two studies of eurobonds undertaken by the German Council of Economic Experts and the European Commission suggested that a middle solution--eurobonds with joint and several guarantees--might be a practical manner of eurobond issuance.
In each situation, stronger economies would have to pay a higher fee to borrow, while borrowing costs for weaker countries would come under control.
- Immediately, countries with sovereign debt over 60% of GDP will be able to jointly finance the debt exceeding this level via a proposed European Redemption Fund.
- Joining the fund would require acceptance of certain automatic tax and spending restrictions and would require the country to put down 20% of its borrowing in gold or foreign exchange collateral.
- If all eurozone countries participated, the fund would amount to €2.7 trillion ($3.6 trillion), with German and Italian debts amounting to 25% and 40% of the fund, respectively.
- EZ countries would sign a European Redemption Pact, outlining how they will lower their gross public debt to 60% of GDP over the next 20 years. After that point, the pact would expire.
- Stability bonds with several guarantees, where each country is responsible for a percentage contribution to each redemption
- Stability bonds with several guarantees that are reinforced with other guarantees. The commission suggested 1) assigning some countries senior status in stability bond issuance, 2) backing up issuances with collateral like gold, shares of public companies, etc., and 3) devoting parts of governments' revenue streams towards the payment of these bonds.
- Stability bonds with joint and several guarantees, where countries are not only responsible for their own percentage contribution to the bond, but also for covering the unpaid contributions of any other state.
The Commission noted that, while bonds with several but not joint guarantees could be issued under the EU Treaty, the third plan would require a change to the EU treaties because it would violate regulations prohibiting countries from bailing each other out. Further, EU leaders would have to decide on how much of a country's debt should be denominated in eurobonds.
While the Commission acknowledged that this approach entailed significant risks, it concluded that they have 'significant potential benefits.' It has subsequently supported consideration of eurobonds publicly.
Source: European Commission
Moral hazard is one of the main arguments against eurobonds, as they could reassure countries with poor spending habits that their neighbours will pick up the slack.
Thus a prerequisite for eurobonds under both plans was a strict fiscal compact, the likes of which leaders proposed as part of a new EU treaty in December.
Eurobonds are likely to be the number one topic of conversation on the table at the May 23 EU summit. Indeed, it will likely be a sore point for German Chancellor Angela Merkel, who has repeatedly argued that the eurozone currently lacks the financial integration necessary to sustain eurobonds.
However, newly elected French President Francois Hollande advocated eurobonds as part of his election campaign, and his ideas have won support from Italian PM Mario Monti and Spanish PM Mariano Rajoy, not to mention a host of other EU leaders.
While the implementation of any eurobond plan remains unlikely in the short term--a truly effective plan with joint guarantees would require modifications to the EU treaties--support for the plan could draw concessions from Germany and other countries who have pushed austerity at the expense of growth.