The euro-zone should steer clear of issuing eurobonds or any other anti-crisis measure that seeks to eliminate different borrowing costs for nations that use the single currency, an influential group of economists said.
The European Economic Advisory Group’s annual report, launched this morning, proposes a blueprint for rewriting the euro-area’s rules that would force government bondholders to take a hit if a country runs into crisis and sets up a bailout mechanism that aims to relieve the European Central Bank of its role as lender of last resort.
The report blasts the European Union’s founding Maastricht Treaty, saying its no-bailout clause was never credible because it was obvious countries would have step in to help neighbors due to the fear of contagion. The euro zone’s future bailout fund, the European Stability Mechanism, must avoid this pitfall by laying out a clear path for a country facing borrowing difficulties, ending if necessary in default.
“In particular, the euro area should under no circumstances adopt eurobonds or similarly constructed community loans, as have been advocated by some European politicians,” the report said.
“Appropriate pricing of sovereign risk is an essential feature of well-functioning financial markets and this excludes joint liability mechanisms.”
Otherwise, the euro zone would again see its fiscally weaker countries exposed to overheating, while stagnation hits states with stronger fiscal discipline, perpetuating trade imbalances.
The economists propose a three-stage crisis mechanism.
First, states that are illiquid due to a temporary surge of market mistrust could be helped by the ESM for two years. However, the total amount of guarantees and liquidity help must be limited to 30% of current nominal gross domestic product of the aid-seeking country.
If payment difficulties persist for two years, the state is then approaching insolvency. In these circumstances, the ESM should provide 80%-guaranteed replacement bonds that the country can offer to creditors whose claims are due, but under the condition of a haircut—of 20-50%–that lowers the value of the bond.
The haircut is important because it will make banks and other owners of government bonds bear part of the risk of their investments, and should help stabilize markets, said the authors.
Furthermore, all new public debt should have Collective Action Clauses, as is being pproposed by governments after 2013. This allows a supermajority of bondholders to agree on a debt restructuring for all of a bond’s holders, allowing insolvent governments to negotiate a restructuring plan with creditors. The authors note that consequent agreements should only address holders of a particular maturity, so that owners of other debt can’t call their claims prematurely.
“It prevents a temporary payment crisis from becoming a sovereign bankruptcy,” says the report.
The third stage is full insolvency. At this point, the country can’t service the replacement bonds and needs to draw on the guarantees from the ESM. The country must therefore declare full insolvency for the entire outstandinggovernment debt.
Meanwhile, as this proposal creates a lender of last resort to help states, the report says the European Central Bank should be relieved “from responsibilities that are not appropriate for monetary authorities to bear,” referring to the purchase of government bonds.
The report proposes that the EU’s treaty be amended so that the ECB is limited to purchasing securities of “high creditworthiness and exclusively permitted for purposes of monetary policy.”
Otherwise, the ECB is making its owners accountable for the rescue of states, it argues.