ESBies versus all-out Eurobonds

Euro-nomics is a think tank created by a group of European economists with the aim of providing economic solutions impartial from the priorities of their home states. The organisation includes Irishman Philip Wall of my own alma mater Trinity College. In the past week Euro-nomics have published quite a comprehensive set of proposals on their response to the current Eurozone crisis. The key tenet of their report is the creation of a new type of bond known as European Safe Bonds (ESBies). ESBies, the group intends, would be issued by a newly developed European Debt Agency and would not require new fiscal integration legislation. They would consist of a liquid bond designed to minimize risk, issued in Euros and subject to the ECB’s anti-inflation commitment, much as generic Eurobonds might be. The new European Debt Agency would buy the sovereign bonds of member states according to the states’ relative sizes. The EDA would hold these bonds as assets on its balance sheet, and use them as collateral to issue securities.

What differentiates ESBies from Eurobonds is that ESBies are designed to be divided into two different types of security. The first security, the ESBies, would involve a senior claim on the sovereign bonds held by the EDA. The second security would have a junior claim on these bonds and would be first to absorb whatever loss is realized in the pool of sovereign bonds that serve as collateral. So any failure by a sovereign state to honour in full its debts would be absorbed by the holders of the junior tranche security. Both levels of security would be sold to willing investors on the market. Investors who want to hedge or speculate on the ability of European member states to pay their debt could trade junior tranches while investors seeking a safe asset denominated in a stable currency could buy ESBies.

So far, so good. I am a definite proponent of Eurobonds; though I consider myself Eurosceptic I am also Irish, and Ireland has taken on a colossal amount of debt rather than burn the holders of Irish bonds, ultimately preserving the security of the Euro. So I am naturally in favour of some reciprocal action on the part of the rest of the Eurozone (ie Germany) and think that the issuing of Eurobonds, EU debt guaranteed by all EU countries, is the best way forward. Any practical plan for the viable implementation of Eurobonds will find favour with me.

However one issue that concerns me is that I can’t see the market rushing to buy into these junior securities that will have to compete with other high yield products. Simply put, is the investment market so big that sovereign debt will be in demand to the extent that is required for this whole idea to work?

It is important to remember that both Eurobonds and Euro-nomics’ solution only provide a route for struggling banks to seek finance at a more reasonable rate than currently quoted on the bond market, thus avoiding automatic default. It does not in any way rectify the actual debt racked up by certain Eurozone countries. These states will continue to struggle with the burden of their debt, but they will at least have a method of financing it rather than being forced to default.