Light treaties, heavy orthodoxies

Luis Martí, in Madrid | Amidst the recent rain of proposals for the euro zone remake and opinions about its melting down, all seasoned with half truths, two studies, one by the European Commission, requested by the Parliament, and the other commissioned by the Council of Economic Experts that advises the German government, have been published. These rigorously examine the feasibility of Eurobond-based formulas.

The Commission’s study was published as a Green Paper, the type of document which is destined to provoke a debate before any legislative proposal. In it, taking in account guarantees, moral risk and legal set up, the Commission specifies three possible modalities of issuance of “Stability Bonds.

The most complete modality requires a joint guarantee from all the member countries on the joint issuance of bonds that would substitute national issuances. The moral risk would be the greatest because, protected against any risk, certain countries could throw themselves into audacious expansionary policies thanks to the capped financial costs they would face. The mere possibility of irresponsible behaviours would force the implementation of this modality within a severely strict framework of budgetary discipline. It is obvious that the solidarity of the guarantor countries can only be justified, politically, if the debt guaranteed is the result of reasonable budgetary plans and these are coordinated within the group.

The formalisation this type of bond clashes straight on with the 125-way TFEU, and even though –at this point–  European politicians’ improvisations evidence little respect for the Treaty, a project of this sort would have to be set up properly and submitted to the long procedure of ordinary revision (the 48-2-5 way TEU). The document sketches the delicate political commitments that could be necessary so that countries accept an external interference in the sovereign process of the production and approval of budgets. It does not exaggerate when, in certain passages, it describes this innovation as “dramatic”.

Another modality develops a proposal launched a few months ago by the Brueghel European studies center, which introduced two types of bonds: those called “blue” that would enjoy the joint guarantee, and the “red” ones that would exclusively represent national risk. The joint guarantee could cover up to, for example, 60% of GDP. The moral risk –the stimulus for budgetary indiscipline– would correspond proportionately to the amount in blue bonds, but on the other hand, the pressure exerted by the market would be greater.  This proposal would require amendments to the Treaty. As it would be less ambitious than the first, it would leave it up to the markets to determine the credit risk of the national issuances and thus the valuation of the particular country’s fiscal policy.  The Brueghel proposal even suggests a certain degree of discriminatory treatment towards red bond issuances.

The third modality simply consists of a partial substitution of national bond issuances with collectively guaranteed bonds. Their credit rating would be, at most, the pondered average of all the credit ratings of all the guarantors. It’s difficult to anticipate the importance for the issuing country of the spread between its premium risk and the average premium risk the market will assign to these bonds. The moral risk is very limited because the fiscal policies would not count on the perfect safety net that a joint guarantee provides –for this reason it would also be difficult to establish the strict fiscal discipline framework required by the first two modalities. Although it would not be necessary to modify the Treaty, this modality is weak and would contribute little towards the resolution of the crisis.

The Bini-Smaghi proposal, although mentioned by the Commission only in a footnote, would be of greater efficacy and would amplify this third proposal by offering a collective guarantee to all national debt sales. It would do so by creating a single auction agency for the entire euro zone and applying, in fact, a debt brake by imposing the opinions and suggestions of the Council on the stability program of each country, suggestions that would then become imperative decisions. This proposal seems to combine the advantages of lower issuance cost with a discipline mechanism associated to the annual programme debate. It is a shame that the Commission has not explored this apparently viable possibility, which could be re-directed by a simplified revision process (the 48-6,7 way of TEU).

But also, the document mentions in one of its sections the modality presented in one of the chapters of the 2011/12 Annual Report of the Economic Experts Council of Germany. Compared to the previous options, this one is temporary. It proposes that member countries return to the starting point established in the Treaty by eliminating over a period of five years their debt excess above the 60% mark. Each country would transfer its excess to a Debt Amortisation Fund that would issue bonds with joint guarantee from the member countries and would apply the resources obtained to assigned claims.

The countries would sign a specific reimbursement programme of the new debt over a period of 20-25 years, guaranteed with part of their reserves and the irrevocable involvement of some sort of tax figure. The notion of strict fiscal discipline is present in the obligation of each member country to introduce a debt brake clause in its constitution, to strengthen the commitment to the 60% limit, and let an independent European organisation (one wonders why the report proposes the Court of Justice and not the European Commission) verify it. If the logic of the Council of Experts is correct, its model could pass the inevitable constitutionality test in Karlshure.

It’s interesting to note, incidentally, that the present Spanish debt excess would reduce its assigned claims to the fund far below Italy, Germany, France or Belgium. The threat to this model would come from the markets. I will not be easy –having witnessed their recent behaviour– that the markets accept a five-year pause to see if the fund works.


It would be of little use to consume pages and pages on comparative analysis of the strong and the weak points of each proposal. However, in a few words, the viability of any model requires two unavoidable characteristics: that it can be implemented quickly and that it is decisive in stopping the volatile behaviour of the markets.

The third proposal of the EC is the only one that could be initiated in a short period of time but a guarantee framework that is collective can hardly be the base for the introduction of a strict commitment in economic policies.

All the other proposals require a more or less long period to begin with. All of them need arduous negotiations among countries with regards to the role played by the guarantees and the disciplinary budget framework; one way or another, they all require a modification of the Treaty that, with most certainty, cannot be introduced by means of a simplified procedure; plus, over all of them –except for maybe the Amortisation Fund of the German experts– looms the unknown variable of the German Constitutional Court.

The temporal dimension is, in itself, an unfavourable factor. The markets only react to immediacy.

In other words, the truly efficient proposals need the variable that is most scarce during a crisis, i.e. time, while discreet objectives reduce the efficiency of the quickest options.


This is the trouble the euro zone is in these days. Germany and France promise modifications to the Treaty in the next meeting on December 9, although we suppose, based on the insistence of the German leaders, that the Eurobonds –whatever their variation– are not included on the agenda. The emphasis seems to be on some practical system of controlling the EU’s budget and debt, absolutely indispensable to make up for the grave deficiencies of Maastricht and the Stability and Growth Pact, but negotiable –it can not be an adhesion contract– and so having a doubtful incidence, here and now, on the markets.

The situation is critical, particularly when the Anglo-Saxon media, whose influence over the markets and other media is clear, is selling discouragement and while a ratings agency –a sector plagued by errors of judgment during the crisis to a point of scandal, a sector that now seems to grant itself the right to judge the economic policies of the continent’s democracies– warns that the whole euro zone is held under suspicion.

In the meantime, European politicians lately seem to be taking turns in manifesting, one after another, that the ECB is completely out of their perimeter of action, that it is independent and should act under its exclusive responsibility. This being true, in the midst of the overwhelming confusion there are those who feel obliged to dictate insistently what the ECB should not do. In moments of extreme crisis, however, it would be legitimate to reconsider the orthodoxy. For example, to be a last resort lender suggests in extremis interventions of the central bank. To be the monetiser of public deficit implies the permanent availability to rescue an undisciplined public sector.

To confuse the two situations for the sake of a dogmatic orthodoxy may possibly obstruct the only practicable road towards regaining normalcy. The somewhat arcane comments made by Draghi suggest that he shares this same concern.

About the Author

The Corner
The Corner has a team of on-the-ground reporters in capital cities ranging from New York to Beijing. Their stories are edited by the teams at the Spanish magazine Consejeros (for members of companies’ boards of directors) and at the stock market news site Consenso Del Mercado (market consensus). They have worked in economics and communication for over 25 years.

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