In recent weeks the theme of “common issuance” of debt securities by EU Member States has become the focus of renewed attention. The timing of the various proposals reflects the pressures on weaker government issuers who have found their ability to borrow impaired (i.e. more onerous) as a result of the financial crisis.
The proposals differ substantially from each other in terms of purpose, scope and structure. At this stage of the debate, it would seem useful to clarify some of the implicit implications they carry, which are often overlooked in terms of both technical and political feasibility.
Professor Rodriguez proposes the issuance of “Eurobonds” aimed at “supporting job creation and investments that are in line with the objectives defined in the Lisbon Strategy”. Put forward as a “new European tool”, it implies that the securities are to be issued by the EU (after ratification of the Lisbon Treaty) or the European Community which benefit directly or indirectly from the “joint and several guarantee” of all 27 Member States.
The attraction of such a proposal is to enhance significantly the capacity of the EU to act directly on the management of the financial crisis rather than to rely quasi exclusively on “coordination” of measures taken at national level as was the case in the first package of measures agreed by the European Council.
Such a scheme carries, however, with it a number of implications: it would create a fundamental departure from the existing mechanism of funding the EU budget by adding “debt” to Member State’s “cash” contributions. While there is no ideological reason to oppose such a step, it should be noted that, in the past, Member States have strongly resisted direct indebtedness by the EU (though they have accepted limited “special purpose” borrowings: back to back lending for ECSC, EURATOM and EC or structured real estate financings based on contractual lease payments, which are legally and economically equivalent to direct indebtedness).
The political difficulty of getting “unanimous” agreement on a Community borrowing program should not be underestimated. Examples referred to here above were accepted because, in the case of “back to back lending”, the beneficiary Member State was clearly accountable for repayment (except for ECSC loans now discontinued) and subject to appropriate “conditionality”, while, in the case of real estate financings, the structure was mainly an attempt to preserve the fiction of avoiding the creation of EU debt.
If, as suggested by Professor Rodriguez, the purpose of the issuance of “Eurobonds” was primarily “job creation and investments”, the question of “sharing” the benefits equitably would immediately raise its ugly head: indeed, why should a Member State agree to guarantee borrowings by the EU if it did not share in the benefits of the proceeds? This question would be all the more important that such a borrowing program would only make sense if it was of a sufficient size to create a sizeable liquid market for “EU securities” aimed at satisfying the current appetite of investors for “risk free” sovereign paper.
One way to address this problem would be to suggest that, as an additional tool to manage the financial crisis, the EU would finance for the next several years part of its normal budget requirements through the issuance of debt securities. The amounts raised would reduce proportionately the budgetary cash contributions of Member States to the EU budget. Each of them could, without increasing its own indebtedness, benefit from an equivalent amount for their own domestic purposes facilitating compliance with the Stability and Growth Pact framework.
If such a scheme were to be accepted, Member States should set a ceiling on EU indebtedness: an initial amount of between € 500 and 750 billion, to be raised progressively over the years covered by the current “financial perspectives”, should fit well with the objective of funding adequate additional stimuli at national level to fight the crisis. The debt ceiling should be reviewed periodically as part of the “financial perspective” negotiations; however, a minimum amount of debt should remain outstanding (rolled over) at all times in order to maintain a viable liquid market in EU securities, thus ensuring the possibility of rapid access at all times.
Debt servicing would be integrated into the normal annual budgetary procedure in the chapter of “obligatory expenses”, the burden being shared according to the normal agreed formulae currently in use.
Though certainly fraught with considerable political difficulties, such an approach would avoid getting bogged down by endless discussions on the use of proceeds or burden sharing as each Member State would benefit in exact proportion to its current share of budgetary contributions.
Turning to the proposals contained in the paper of Gros and Micossi, it advocates the setting up of a “European Financial Stability Fund” (EFSF) that would issue debt securities under the “joint and several guarantee” of Member States. Proceeds of the issuance would be dedicated to the recapitalisation of the banking sector. An amount of € 500-700 billion is suggested for this “special purpose facility” which would be of a temporary nature (5 years).
The analysis contained in the first half of the paper, covering the need for such a Facility, is very well argued and quite compelling. The answers to the questions raised when it comes to implementation appear, nevertheless, more problematic.
Some of the features that are recommended are already present in the existing EU “Balance of Payments Facility” (that has recently been increased to € 50 Billion): in particular the guarantee structure is based on a back to back arrangement by which each Member State would be ultimately responsible for guaranteeing amounts allocated to its banking institutions by the EFSF.
There are however number of aspects that are not addressed and that create substantial practical as well as political difficulties: the most challenging aspect concerns the negotiation of the conditionality under which the EFSF would disburse funds to potential beneficiaries:
- Who are the negotiators?
- How does one establish “equitable criteria” between prospective beneficiaries?
- What would be the instruments? Equity – Quasi Equity – Debt (subordinated/senor) etc.
- Who would exercise the “ownership rights” of these instruments? The EFSF, the Member State guaranteeing repayment to the Fund etc.
- How does one reconcile the cash flow needed to service EFSF debt with the cash generated by the chosen instruments?
To overcome some of these problems one can adopt one of two approaches:
Either the EFSF is a simple “pass through” mechanism between the market and the Member States. In this configuration, the EFSF issues exclusively “debt securities” to the market in “standard form” benefiting from a “Community guarantee” and re-lends to Member States on a back to back basis. Each Member State negotiates in turn the terms and conditions of the refinancing of its domestic financial institutions. Such a scheme is a simple recasting and expansion of the “Balance of Payments Facility” structure and could be implemented relatively easily by changing its name, broadening its purpose and increasing the debt ceiling. In this structure, the advantages of “common issuance” in terms of cost to the beneficiaries are fully preserved at the same time as investors are offered a straight forward transparent instrument that meets their requirements as more fully described in the paper. Under this scenario, the issuer should be the European Union (after ratification of the Lisbon Treaty) or the European Community, dispensing with the needed of the formal creation of the EFSF.
An alternative would be to create an ad hoc entity (the EFSF) within the existing European Investment Bank Group structure that would be charged with the specific mandate of negotiating the recapitalisation of financial institutions within the EU. The know-how of the EIB and EIF could be combined to provide the necessary financial expertise in negotiating terms and conditions of the EFSF intervention and they would also monitor the program and exercise “ownership rights”. In order to underpin the viability of the program, an EU budget guarantee could be granted with regard to the riskier features of the EIB intervention (equity/quasi equity stakes). The EFSF could, if necessary, require individual Member States guarantees as part of the conditionality of their intervention as is already the case in other programs (financing of research for example).
Such a structure could be implemented under the existing EIB framework and its financing would then be assured by the EIB through its normal borrowing program that would need to be considerably extended. This scenario would be totally compatible with the “temporary” nature of the Facility proposed by the authors.
The third proposal, presented in detail by Rabobank is of a totally different nature. It aims at introducing a “common funding” mechanism (the EMU Fund) to meet Eurozone Members as well as EU Institutions borrowing requirements.
While there are unquestionably advantages to the creation of a vast transparent liquid and uniform market in EU sovereign securities, the proposal fails to take into account the diversity of the existing institutional arrangements that link the Member States between them: the EU Treaty concerns all 27 Members, the Eurozone concerns only 16 Members at the present time. It is therefore not appropriate to merge under a single arrangement, issuance by the EC, EURATOM or EIB owned by all Member States with issuance restricted to Eurozone Members, not to mention entities in which the EU is only a shareholder alongside others such as the EBRD. By ignoring these differences, the market is bound to be confused: (are EIB securities benefiting from a joint and several guarantees of its 27 shareholders better/worse than EMU Fund securities guaranteed by EMU Members?).
It would also appear to be premature to suggest, at this juncture, the possibility of a further transfer of sovereignty implied by the obligation that participating Members would have to issue exclusively through the EMU Fund. The political opposition would be both insurmountable and, under present circumstances, fully justified.
The proposal contains also a number of questionable technical details concerning implementation; in particular they relate to the very ingenious but hardly practical proposals concerning the adjustments of spreads which are central to the attempt to create an equitable “burden sharing” mechanism between participating Member States.
Aiming over time at the creation of a unified EU sovereign bond market is a worthy goal and should yield significant cost savings in debt servicing. Its precondition seems however to be the completion of the process of extending EMU to the vast majority of Member States as is foreseen by the Treaty for Members who do not have a derogation (Denmark/UK). With regard to this point, I wrote earlier this year in a commentary on the de Larosière Report:
“A parallel debate, being carried out this week end by the European Council, on the impact of the crisis on intra European solidarity raises the question of the accelerated admission of new Members into the Eurozone on more flexible criteria, which could, in turn, have far reaching implications on the subject of the Report. Indeed, one should compare the cost of support by the Union of countries experiencing difficulties - each retaining their monetary sovereignty - with the alternative cost of their integration into the Eurozone. It is not forbidden to believe that this latter option might prove more advantageous for all parties concerned. Accelerated integration would be reminiscent of the bold proposal of Chancellor Kohl to recommend parity between the East and West German Mark at the time of reunification; in present circumstances it is precisely boldness that Europe needs. To the expected outcry that such a proposal would generate from orthodox monetarists, one can oppose the following arguments:
- Depreciation of the Euro versus the US dollar might be considered positively in these difficult times (cfr. The British Pound).
- The economic weight of Eastern European countries is relatively small (in relative terms far less than the weight of the GDR compared to the FRG).
- The current benign inflationary climate limits immediate risks, allowing further economic convergence within rather than from outside EMU
- That budgetary discipline will be all the more taken into account that the tools of monetary sovereignty have been transferred to the ECB.
- That such an enlargement might encourage the last recalcitrant Member States to join EMU, giving considerably increased power to the Union on the international political economic and financial scene.
A refusal of Union solidarity, or the imposition of excessively onerous conditions for joining the Eurozone, would carry the risk of a break up of the Union, just at the very time when the single currency could prove itself to be a most efficient tool in the fight against protectionism.”
Accelerated completion of EMU would greatly facilitate further integration of economic and fiscal policies and lay the foundations of a Union-wide regulatory framework. In turn this would create the appropriate conditions for implementing successfully a program of “common issuance” on behalf of Member States.
In the interval it might be appropriate to update the existing “Balance of Payments Facility” referred to here above. Last February, I wrote the following on this subject:
“It might therefore be an appropriate time to reactivate and revamp the dormant “balance of payments” assistance program of the EU, re-baptising it to reflect its accessibility to all Member States (Eurozone Members do no longer have individual “balance of payments” problems). Such a facility should be of a significant size (EUR 200 billion?) providing appropriate visibility to the added value provided by the EU to its members. Enjoying the highest AAA rating, EU issuance would reduce the cost of borrowing of weaker Member States, thus to limiting their deficits. Structured as a “pass through” vehicle while benefiting from the EU guarantee, it would not impair the Community budget, unless a borrower defaulted; such an event remains highly unlikely for a Member State, even in such a difficult period of crisis.”
Common issuance of EU Sovereign debt securities is an important step in the process of completing arrangements to reap the full benefits of the creation of the Euro which constitutes one of the most outstanding successes of the European construction. In particular it has largely protected the European citizen of the dire consequences that would have resulted from the superimposition of a currency crisis on top of the financial and economic crisis.
This discussion of some of the proposals relating to “common issuance” that are currently being circulated aims at bringing some clarity to the debate as well as identifying some key political and practical aspects that must be addressed in order to overcome deeply imbedded resistance to change in such a sensitive domain. In particular it is appropriate to reconsider the fundamental “ideological” opposition to EU indebtedness which currently severely limits the flexibility of deploying, at EU level, adequate policy tools in an efficient and coherent way to meet the challenges of the financial crisis.
This is, of course, only one aspect of the more crucial debate concerning a deepening of the Union or, conversely, an accentuation of the current trend to reinforce the powers of Member States. Significantly, a representative group of European citizens, gathered in Brussels over the past weekend, strongly advocated the need for “more Europe” and asked the President of the European Parliament and of the Commission to take this request fully into account after the forthcoming European elections.
The crisis offers a unique opportunity for new bold and imaginative initiatives which, in many ways, will determine the future prosperity of the Union.
Brussels, 11th May 2009
Paul N. Goldschmidt
Director, European Commission (ret); Member of the Advisory Board of the Thomas More Institute.