European leaders are watching the Band-Aids they stuck on the eurozone’s gushing wound of debt start to peel off. The largest attempted fix, the 440 billion euro European Financial Stability Facility, finally fell off last night, after the fund announced that it would not be able to lever up to a level that could actually bring stability to the eurozone. The head of the EFSF called on the European Central Bank to do more to stabilize the situation, ostensibly passing the buck.
Today’s coordinated action by the central banks of developed nations, led by the US Federal Reserve, to lower the pricing on existing temporary U.S. dollar liquidity swap arrangements by 50 basis points, looks like yet another Band-Aid. While this will make it cheaper for European banks to access critical dollar funding, and it will lower skyrocketing bond yields of some eurozone nations, it isn’t a solution to the problem. The effects are temporary and do not address the structural fiscal problems plaguing the eurozone. And this isn’t the first time there has been coordinated action between central banks during the financial crisis. The subsequent market rallies that accompany such moves usually fizzle out after it becomes clear that the root of the problem still exists.
Solving the European crisis seems to have devolved into a binary choice whereby either the European Central Bank becomes the lender of last resort for the entire eurozone or the zone’s nations pool their debt and issues joint “eurobonds.”
The ECB choice is clearly the easiest and fastest way to put an end to this crisis in the short to medium term, but it doesn’t solve the common currency’s core problem — its lack of fiscal integration. The issuance of a common debt instrument would require such fiscal integration, ostensibly extinguishing the core problem. But are European politicians ready, or indeed desperate enough, to hand over the power of the purse, arguably their greatest power, to bureaucrats in Brussels?
There are several proposals floating about as to how the eurobond could become a reality. There are constituents in Europe that want the eurobond to totally replace all sovereign debt in the continent, therefore spreading out the funding risk to all 17 members of the euro. This would see the borrowing rates of deeply indebted nations, like Italy and Greece, drop from their record highs, while countries with strong balance sheets, like Germany and the Netherlands, would see their rates rise.
Such a scenario seems unfair to the Germans, which have repeatedly blocked any talk of issuing eurobonds. They believe that the interest rate pressure on profligate nations is the only thing that is forcing them to actually tighten their belts. But the Germans finally seem open to taking a hit in interest rates if those nations give up their fiscal authority to the EU and take on a German-like balanced budget solution.
This idea of melding the eurozone’s fiscal and monetary policies seems to be the stitch that will finally seal Europe’s growing debt wound and bind the continent together. The eurobond is simply the vehicle by which this idea is manifested, it isn’t the solution. But European leaders are still hesitant to give in. There are a number of eurobond structures floating about that seem to be more Band-Aid than stitch.
Blue and red bonds
One of those structures would see member states issuing both eurobonds and sovereign bonds at the same time. Eurobonds, which are called “blue bonds” in this case, would cover any debt equal to 60% of a member’s GDP. If a nation has a debt larger than 60% of its GDP, which most do, then it would be covered by sovereign bonds issued by each country, called “red bonds.” So Italy, which has a debt to GDP ratio of 120%, would have half of its debt guaranteed as eurobonds and the rest issued as Italian bonds. The trouble with this scheme seems obvious – those red bonds would most likely still have an interest rate that was too high for some nations to handle. While it pressures them to make fiscal changes, it may not buy them enough time to get their fiscal house in order.
Another questionable eurobond structure is one that would see some nations issuing joint eurobonds while others stick with their own sovereign debt. This would allow those member states comfortable enough to give up the power of the purse to do so, while those not so comfortable could continue issuing their own debt while keeping the euro as their national currency. The idea was discussed last weekend between German and French officials who viewed this as a faster way to get eurobonds issued. Since it didn’t force members to join the eurobond, it therefore did not require a change in the EU treaty – something that all 27 nations of the EU, including those not in the eurozone, would need to approve.
While this might get eurobonds out there faster, it wouldn’t solve the crisis. According to the German press, the French and the Germans wanted the first eurobond members to be those with triple-A credit ratings, creating what they called the “elite” bond. Such a scenario would effectively be a life raft to protect those nations from contagion, but wouldn’t be a solution to the crisis. The peripheral members of the euro would continue to face funding pressure unless they were let in the new “elite” club. Those in the club could possibly vote to keep the more profligate members from joining, which would defeat the whole idea of issuing a joint bond to stabilize the eurozone.
Total fiscal integration across the eurozone appears to be the best way to keep the monetary union alive. Whether or not the ECB evolves into a Fed-like lender of last resort is irrelevant if the eurozone’s various national budgets aren’t in sync. German and French leaders are expected to reveal part of their eurobond plan at an important EU leadership conference on December 9th. A plan that calls for a united eurozone bond should ease market fears, but any attempt to divide the eurozone could cause the euro to finally bleed out.
