LONDON/BRUSSELS - Policymakers looking to persuade Germany and other wealthy euro zone countries to pool their debt with less well-off neighbours may need to keep things short and simple.
A persistent shortage of triple-A rated bonds has kept momentum for a pooled euro zone sovereign bond alive despite opposition from Germany. The euro zone’s largest economy has so far rejected any proposal that could potentially leave its taxpayers on the hook for the debts of other countries.
Plans for a synthetic common bond, comprised of debt from the 19 euro zone countries, have stalled since they were first unveiled by the European Commission (EC) last year, prompting officials to look at other options, including short-term euro bills.
European Central Bank (ECB) policymaker Ewald Nowotny flagged the possibility of creating euro bills, jointly guaranteed by euro zone member states, in February and officials at the Commission, the bloc's executive body, have discussed them as an option for strengthening Europe's capital markets, according to an industry source.
Such debt could mature in one year or less.
No real progress on creating a joint "safe asset" -- so-called because there is not meant to be a risk of default -- is expected until after a new Commission is formed following elections to the European Parliament in May.
Even then, expectations for a quick breakthrough are low. The Commission proposal to create a Sovereign Bond-Backed Securities or SBBS, has not been discussed by EU states since an internal Franco-German paper on eurozone reforms in June said SBBS had "significantly more disadvantages than potential benefits and should not be further pursued."
A DANGEROUS FIRST STEP?
A proposal for short-dated euro Treasury bills was first aired in 2011 by Graham Bishop, a consultant on European Union (EU) financial regulation who had been appointed in 2013 by then Commission President Jose Manuel Barroso to an expert group advising on possible joint issuance of debt. The group was dissolved in 2014.
Bishop said the short-term nature of his proposal, which involves setting up a new body, dubbed the Temporary Eurobill Fund, made it an ideal testing vehicle. Under his proposal, a common bill with a maturity of two years would be issued. He is working on another version with a maturity of six months.
"Simply, governments have to commit their short term funding under two years via the fund – perhaps by treaty commitment,” said Bishop, vice chair of the European Movement in Britain, a group which campaigns for greater European integration and for reform of the EU.
"The bill is made up from a pool of bills from the euro area and then reissued.”
Under Bishop's proposal, member states which break EU fiscal rules would be excluded from the Fund and member states would not be liable for the debt obligations of others.
Analysts said euro Treasury bills made sense, particularly for banks, which need high grade sovereign debt to fund their operations and are concerned about a dwindling supply as Germany and the Netherlands, both triple A rated sovereigns, issue less.
"Given the political opposition to a euro bond, a safe euro zone bill full stop would be seen as a good step in the right direction," said David Owen, chief European economist at Jefferies in London.
Critics, however, said euro Treasury bills would create pressure for governments to share liability.
"Once such a so called 'safe asset' is in place, calls for mutualisation will be inevitable. Therefore, we should not even start going down that path," said German EU lawmaker Markus Ferber, who leads the largest conservative grouping in the economic committee of the European Parliament.
THE DOOM LOOP
The potential benefits of a common euro zone bond were highlighted during the euro zone debt crisis, when banks’ reliance on debt issued by their home government created a so-called ‘doom loop’ in which concerns about the creditworthiness of indebted European countries coloured investors’ view of their banks and vice versa, amplifying market tensions.
Despite the introduction of tougher banking regulation and oversight in the wake of the crisis, the doom loop remains. Indeed, European banks have used cheap credit from the ECB to buy more government bonds.
Italian lenders hold close to 20 percent of Italy's roughly 2 trillion euro debt pile and concerns about the government's spending plans sparked a nasty sell-off in sovereign bonds last year, raising the banks' cost of funding.
Graphic: European banks' exposure to home government bonds https://tmsnrt.rs/2VwBxUG
The average European bank now has sovereign debt exposure equal to 170 percent of its core tier one capital, a key measure of a bank's financial strength, according to a Deutsche Bank analysis. That is more than triple the exposure of U.S banks.
Graphic: Europe banks more exposed to sovereigns than U.S. https://tmsnrt.rs/2CPzwvc
In addition to reducing bank stability risks, EU officials want to increase the offer of euro-denominated assets viewed as safe to make the euro more attractive to foreign investors and counter the dollar's dominance as a reserve currency.
Graphic: Allocated share of global currency reserves https://tmsnrt.rs/2WEJZ4k
The share of the safest, triple-A rated sovereign bonds that come from the euro zone has dropped from about half before the financial crisis to around 25 percent currently, as the rating of public debt in several euro zone states deteriorated.
Bishop said the idea of a euro bill would be easier to sell to sceptical states now than it was 10 years ago because the yields of short-dated bills have converged, so the cost of participating for the likes of Germany, whose Bunds are considered the safest European assets of all, would be low.
A spokesman for Germany's finance ministry declined to comment.
Asked about a safe asset at last month's ECB news conference, President Mario Draghi said the final decision was up to the politicians.
"This doesn't detract at all from the argument that it's absolutely rational to have a safe asset at European level," he said.
Graphic: Yields on euro zone bills now and in 2011 https://tmsnrt.rs/2WEwh1m