European bond auctions have been hogging the spotlight lately, and not in a good way. With bond yields rising here and there, the idea of joint euro zone bonds has resurfaced as a potential savior for the region. If you didn’t get a chance to read my older entry discussing what Eurobonds are, here’s a quick rundown:
A Eurobond is basically a collective bond issued by the 17 euro zone member nations. In other words, this joint bond pools all the government debt of the euro zone nations in a single package. Pretty neat, huh?
Because Eurobonds contain debt obligations from both debt-ridden economies (such as the PIIGS) and more fiscally stable nations (such as Germany), the collective credit rating of the Eurobond would be somewhere between AAA and junk bond status. This implies that heavily indebted nations like Greece and Italy would find it less expensive to finance their debt.
Sounds good, right? Well, not for Germany! You see, the downside to having Eurobonds is that it would be more costly for higher-rated economies to pay off their obligations since their precious AAA rating would be watered down by the low rating of other countries.
With Eurobonds, each euro zone member nation would be liable for each other’s debt, making Germany worry that other nations might be fiscally irresponsible. I’m pretty sure you’ve had your experience dealing with freeloaders and that’s exactly what German Chancellor Merkel wants to avoid!
However, European Commission chief Jose Manuel Barroso has been adamant that Eurobonds may be the only option for the euro zone. He believes that it would be a great sign of camaraderie, governance, and convergence on the part of euro zone governments and their commitment to the euro.
Yesterday, Barroso unveiled three potential proposals for Eurobonds. The three options are:
- Restructuring the system so that all national bonds would be replaced by “Stability Bonds”. This structure would mean that ALL euro zone countries would guarantee the bonds.
- Issuance of common eurozone bonds, but only to a certain level. If a country wants to issue bonds beyond this level, they would have to sell their own national bonds of which they would be solely responsible for.
- The last option is that countries would only be responsible to guarantee their own share of the bonds. This is would mean that would if one country were to default, another country would not be obliged to cover the debt. Obviously, this is the most limited option.
In any event, Germany will most likely push for a system where local governments will have to give up their absolute control over their budgets. A fiscal-policy union would be created to ensure that each euro zone member would adhere to the same set of fiscal policies. Failure to follow these rules would most likely result in a funding timeout where a country would not be able to issue Eurobonds.
The pressure is growing on Germany to back off its stance in order to pave the way for this “powerful weapon” and to help end the European debt crisis. Bond yields continue to rise, with Spanish 3-month bills hitting 5.11%, the highest since the inception of the euro.
Meanwhile, a German bond auction of 10-year bonds had surprisingly disappointing results, as they were only able to sell 3.9 billion EUR of the 6.0 billion EUR offering. This means that investors are shying away even from German bunds, which are considered to be the “safest” in the euro zone.
Furthermore, the lack of any progress in the implementation of the EFSF program has led to bickering between ECB and European government officials. All this uncertainty is fuelling pessimism into the markets, allowing the euro to slip down the charts.
Let’s see how the market reacts in the event that Germany eases up on its stance on Eurobonds and proposals actually push through. One potential scenario is that this uplifts risk sentiment, giving the euro much needed support. Of course, there’s no telling how long or if this will ever push through. For now, all we can do is pray that European leaders get their act together and finally put an end to this debt crisis.