Eurobonds – blue or red?
Civitas, 15 August 2011
In the Matrix Morpheus (Laurence Fishburne) asks Thomas A. Anderson or Neo (Keanu Reeves) –
You take the blue pill – the story ends, you wake up in your bed and believe whatever you want to believe. You take the red pill – you stay in Wonderland and I show you how deep the rabbit-hole goes.
Soon investors could be offered both in the form of blue and red Eurobonds.
In recent days the long running Eurozone crisis has prompted some commentators to discuss the possibility that Eurobonds be issued. It has been reported that both France and Germany have ruled this out, but can the proposal that there be two types of Eurobond, red and blue, assuage the opposition?
The idea of red and blue Eurobonds was outlined by the think-tank Bruegel in May last year. Put simply blue Eurobonds would be issued by Eurozone members and would cover 60 per cent of a country’s sovereign debt. Red Eurobonds would be issued by countries looking pushing their sovereign debt above 60 per cent. The result would be two very different bonds, the blue type would be guaranteed by all countries in the Eurozone, whereas red bonds would only be backed by the issuing country.
Unfortunately there are a number of problems with the proposal, especially when viewed in light of the current crisis.
Firstly the authors of the proposal, Jacques Delpla and Jakob Von Weizsächer, clearly envisage the blue bonds to be super-safe while the red bonds will be a far inferior asset. The 60 per cent ‘blue bond ceiling’ is modelled on the rules of the Eurozone’s failed stability and growth pact (SGP) and reflects the opinion that sovereign debt is manageable around and below 60 per cent. While blue bonds would obviously be AAA-rated, the authors propose that red bonds be kept out of the banking system by ‘painful capital requirements’.
However by making red bonds financially untouchable in effect forces countries to limit their sovereign debt below 60 per cent. Ignoring the fact that very few Eurozone countries currently have debt levels below this (I will come to that below), some Eurozone countries may reject such an attempt to limit their financial sovereignty. This is one of the big fears of many European citizens and politicians who find any fiscal union unpalatable. Red and blue bonds do not provide a way out of this quagmire.
Second, and perhaps more damningly, the proposal, despite its many benefits, does not provide a way out of the current crisis. The authors deal with the issue of implementation and suggest that:
The introduction of Blue and Red Bonds could either occur gradually, with Blue and Red Bonds replacing legacy debt as it is rolled over, or in a big bang in exchange for the entirely legacy debt stock.
The authors discuss the benefits and drawbacks of both approaches, however it has to be clear to all observers of the current crisis that one benefit of the ‘big bang’ approach is that it would attempt to solve the current crisis. Sadly, the ‘big bang’ approach is fundamentally flawed. The authors state that if implemented the big bang approach:
could potentially be used for a comprehensive debt restructuring if the market view on debt sustainability in some of the crisis countries was to turn out to be accurate. However, the current IMF analysis of debt sustainability in Greece in particular comes to a different assessment right now.
Add Portugal, Ireland, Italy, Spain and Cyprus to that. Issuing red and blue Eurobonds could be deeply destabilising if investors fear that it presaged debt default on any sovereign debt above 60 per cent.
The problem with red and blue Eurobonds is not that they are a bad idea in themselves. The problem is that they do little to mitigate the fears of those who reject fiscal union, and do not go far enough in clarifying how the unsupportable debts of some Eurozone states will be handled.
Returning to the Matrix, it is clear that where the Eurozone debt crisis is concerned we are far from seeing how deep the rabbit hole really is.