More than eight years after it began, the Greek debt crisis still haunts the euro zone. In late 2009, Athens sharply corrected upward its official debt totals, triggering a crisis of confidence in Europe's already-jittery 19-nation currency bloc. Financial markets punished the euro-zone's most debt-laden members by selling off their government bonds, driving yields or annual interest rates of these countries' debt higher. Some doubted whether the euro would survive the crisis.
Their backs against the wall, euro-zone policymakers fought back with a combination of bailouts and ultra-loose monetary policy from the European Central Bank, or ECB. Together, these measures seem to have steadied the ship. But officials have a nagging fear: What will happen in the next crisis?
The question highlights an ongoing division among Europe’s policymakers. For France and other fans of deeper fiscal harmonization, stabilizing the euro zone and its still-vulnerable currency means sharing its debt risks. But for Germany’s leaders, any form of debt mutualization — turning national obligations into single European ones, to be shouldered by all constituents — remains out of the question. The euro zone's biggest creditors, the Germans, are horrified by the thought of their taxpayers paying off bad debts of others.
As a result of this deadlock, the idea of “European safe bonds” has gained ground in recent years, winning the support of the European Commission. Today an investigatory task force of the European Systemic Risk Board, an EU body hosted by the ECB, published a 300-page report on the proposal, more than a year after such plans were first announced. “Although the common currency is a success, it is not yet completed,” Philip Lane, the boss of Ireland's central bank and chair of the board, wrote in a Handelsblatt opinion piece.
The safe-bond suggestion would repackage sovereign debt issued by euro-zone countries into new financial instruments, which would each carry different levels of financial risk. The aim is to prevent a so-called “doom loop” where banks hold large amounts of their national government’s securities. Whenever this happens, concerns over a government's solvency can spread to that country’s banks, and vice versa, exactly as happened in Greece. The safe-bond proposal claims to curb this, but without making euro-zone states liable for other countries’ debts or banking systems – a solution aimed to be palatable to Germany.
To do this, government bonds issued by euro-zone countries would underlie a secondary market in new “bundled” financial instruments. These securities would come in different flavors: a lower level with risky debt, and a “senior” level with more secure, higher-rated debt. In the event of defaults, losses would hit lowest level first, and the more senior debt later, if at all.
The allure of this model? Banks would be forced to back risky debt with their own equity. Currently, EU bank regulators treat all euro-zone sovereign debt as risk-free, although in fact, ratings agencies only bestow a top ranking on bonds from Germany, Luxembourg and the Netherlands. This safe-bond model would incentivize banks to buy higher-quality debt, rather than their own country’s bonds, weakening the “doom loop” between national debt and national banks.
Mr. Lane, writing in Handelsblatt, compared the proposed bonds to a wine dealer stocking wines from many regions, and of differing quality, thus lessening exposure to any single variety.
The allure of this safe-bond model? Banks would be forced to back risky debt with their own equity.
The safe-bond idea has prompted considerable debate, and the detailed proposal seems certain to generate heated responses. Italy may be opposed to the idea: Groaning under a debt mountain, Rome seems unlikely to back a system which could make its own borrowing more expensive.
On the topic of mutualization, the Germans are unlikely to budge. Last November, Ludger Schuknecht, chief economist at the German finance ministry, said that instead of toying with complex financial engineering, Europe should focus on getting the basics right: good regulation to ensure proper risk pricing, and countries paying down their public debt.
A second suggestion — some form of pan-European protection for bank deposits — addresses a different aspect of the risk problem. But it has come up against similar objections, since it implies German savers being on the hook for bank failures in other countries.
The German government has approved the general principle of a European deposit insurance, since it could stop capital fleeing a country’s battered banking system. However, Berlin insists that all European banks must first clear up their balance sheets, something that could take many years. The problem is that the next euro-zone crisis could easily begin in the meantime.
The chair of the ECB's supervisory board, Danièle Nouy, supports a third proposal, which would set strict limits on banks’ bond-buying in order to prevent contagion between governments and banking systems. Specifically, banks could only buy a certain level of national sovereign debt, a figure linked to the bank’s overall level of equity.
Ultimately, the decision on how best to stabilize the banks will be made by euro-zone politicians. This leaves open the possibility of a fudge, and of kicking the can down the road.
Andrea Cünnen works at Handelsblatt's finance desk in Frankfurt, reporting on the bond markets. Martin Greive is a correspondent for Handelsblatt based in Berlin. Jan Mallien covers monetary policy for Handelsblatt, based in Frankfurt. Benjamin Wagener is an editor at Handelsblatt. Brían Hanrahan and Jeremy Gray adapted this article into English for Handelsblatt Global. To contact the authors: [email protected], [email protected], [email protected], [email protected]