By toonpool.com

A brief history of Eurobonds – part II

16 aprile 2020 -

‘Eurobonds’ are securities denominated in a foreign (respect to the country of issuing) currency. Then, why everybody is so concerned, especially now days, about something that exist since 1963 – when Autostrade issued in Italy for the first time 60.000 bonds denominated in U.S. Dollar? Well, the ‘Eurobond’ we are talking about is also called ‘stability bond’, a government’s bond, denominated in euro, issued jointly by eurozone states. Again, ‘what’s the point?’, we all know sovereign is issued also, if not primary, through traded securities. The point here is what is underlying the issues of common government securities, i.e. interest rates and collaterals.
In this series of articles, we will explain what Eurobonds are, why there are so many concerns around them and if they could be developed someday soon. In particular, we will go through European peculiarities and we will analyse all viable options to face extreme conditions as it is for COVID-19.

 

BACK TO 90s: THE FIRST PROPOSAL FOR EUROBONDS

“The climate which seems to reign between the heads of state and government and the lack of European solidarity pose a mortal danger to the European union. The microbe is back.” – said Jacques Delors on last March 28th[1]. It would be interesting interpreting ‘microbe’. Is it competition? Are we close to a new sovereign crisis? For sure, he wasn’t referring to the COVID-19 itself.

I will walk you through Eurobonds’ history and then give you my reading of the phrase, or Europe.

 

Delors, as I said in the previous article, is the one responsible for what EU is today. The ‘Report Delors’ called for convergence and mutualism. What was clear to him at the time – 1988 – was that the purpose of the EMU wasn’t just a monetary union, but a new continent that needed to be managed with a common idea. Hidden in the ideas of convergence, fiscal and economic policies were monetary union, political union and fiscal union.

 

Thinking to Europe as a whole, in 1993, Delors came up with a Keynesian project: investing in industries as transport, TLC, environment and energy on a cross-country level. Here one can see as the ideas of unitary market, free competition, sharing risks and profits in the area were already clear to him. But that’s not all, he also anticipated Eurobonds, these were in his opinion the way to finance those projects. He developed the frame for “growth bonds” (opposed to stability bonds, which we will deal with later), issued by countries and private investors and guaranteed by the EU budget. Shortly, capital and interests would have been managed and payed by public and private sectors, who would have gained cash flows from the projects, while European authorities would have acted as guarantor.
The role this frame gave to EIB – European Investment Bank – was as advisor and agent, since the collateral, as said, were the mutual budget and the placement was its competence. The liquidity EIB would have been able to guarantee could have been the greatest reachable and the cost of this debt facilities the lowest, given EIB and ECB reputation. This project sunk under political pressures, whose nature will be clear at the end of the next article.

 

At the time (1993) most of the countries had a Debt to GDP ratio around 40%, Germany and Spain registered a deficit, around -1%, others registered a surplus with Ireland at roughly +4%, interest rates were instead ranging from 6% to 14% where Germany had the cheapest and Portugal the most expensive debt.[2]

 

Later, on December 2010, Jean-Claude Junker and Giulio Tremonti offered a new view on how mutual debt should be used. Stability bond appeared for the first time. The mechanism they proposed consisted in EDA – European Debt Agency, a new institution – issuing European bond, guaranteed by Member States, to buy single sovereigns both on the primary and secondary market. Threshold were 40% of EMU’s GDP to raise and buy back, i.e. they would have bought back 40% of each sovereign approximately.[3] Each country balance would have resulted lighter for several reasons.

 

First, being EDA’s issuing condition levelled on a rating A, this lending facility would have been cheap for almost every state. Second, overnight the indebtedness of each were almost halved. Third, moral hazard was cut off by countries having to keep raising subsequent – over the 40% threshold – fund on the market at their own higher cost. Fourth, being so even the single-country interest rate was lower. Further other beneficiaries were ECB, not being the one responsible to buy governments’ bond on the secondary market, and investors, as being able to convert sovereigns in Eurobond were able to quantify their losses and lowering balance sheets’ volatility.
Even this project felt down under political pressures. Germany’s chancellor Angela Merkel strongly opposed to their implementation, claiming a raise in their (Germans) cost of debt following their leading role in enhancing mutual guarantee’s rating, in other words being responsible to bear the entire European default risk. It’s worth noticing that few months prior, the EFSF – European Financial Stability Facility – was born, which was able to raise up to € 250 billion through mutual guaranteed securities to rescue member states. As one can see, mechanisms [ESFS and EDA], despite serving two different aims, were quite similar, making EDA not so needed. This was true until 2013, when EFSF became ESM, which trades on the market sovereigns themselves to raise money, not lowering costs for states, to lend to states at very strict conditions. Stability-bonds, or Eurobonds, experiment thus lasted for 3 years, no less no more.

 

It is important to highlight that those years saw the rise of austerity policies and fiscal rigorism in the European toolkit. On top of that, ESM was, and is, seen as a destruction ball. Its intervention was synonym of high interests, taxes, and deficit cut. Standing the sovereign crisis, the fear of an economy breakdown was a chip on the shoulder of every governor, except for the fiscally rigorous northern ones. Being honest, these were the ones claiming for those kinds of measures.

 

However, others backed both projects. The latter was backed by Mario Monti in 2013, claiming the needs for a European debt market able to compete with global ones. The former was implemented, on a short time period, under presidency of Barroso at the European Commission in 2008 with the so-called Project bonds.

 

In 2010 European aggregate Debt to GDP were 88% and the Deficit to GDP 4%, compared to 98% – 10% and 83% – 8.5% of U.S. and G.B. respectively, resulting in a AAA bond with a 4% ytm. A great advantage considering Italy’s and Greek’s cost of debt were correspondingly 6% and almost 10%, for example.

 

Reading these lines one can see the jump from Union bond to Eurobond, from economic stimulus to fiscal levelling and austerity, from mutuality to individualism, from economic science to politics. In other words, a Union disunited by the ‘microbe’ of mere individual fiscal rules.

 

 

[1] https://www.esm.europa.eu/

[2]Kuo, «Resolution for the Eurozone Crisis».

[3]Alberto Quadrio Curzio, «On The Different Types of Eurobonds».