Daily Management Review

Novel Idea Seems to be Coming of Age – one that Could Revolutionize Europe's Debt


11/09/2016




Novel Idea Seems to be Coming of Age – one that Could Revolutionize Europe's Debt
The 19-nation currency bloc can be provided with a single “safe asset” that's not linked to the fate of any individual member by the European Safe Bond is, in theory, a parcel of euro-area government debt of different risk grades. One of the things that caused the sovereign debt crisis was the previous perception of all European government debt as safe, when it clearly wasn't.
 
Since a group of economists including Princeton University professor Markus Brunnerneier first proposed it in 2011, the idea to fix that via so-called ESBies has been doing the rounds in academic circles for a number of years now.
 
However serious attention from policy makers is only now being accorded to the idea. The concept is being studied by an expert panel of the European Systemic Risk Board, reporting to European Central Bank President Mario Draghi. The Brunnermeier's concept was mentioned as one way forward for the region last week at a speech at Harvard University by ECB board member Benoit Coeure.
 
Expets have defined how that concept works. The debt of euro-area governments is bought by a designated public or private institution. The ECB or a European agency like the ESM or the private sector could get the task done. Then the corresponding products are sent off into the world after that body would then repackage those bonds into a security with very safe (senior) and less safe (junior) slices.
 
Brunnermeier explained in an interview in Frankfurt that there's no mutualization of liability across countries as countries continue to issue their own bonds. The political hurdle at which previous suggestions, like Eurobonds, fell, would be helped cleared by that.
 
The point is that, rather than into one particular nation, investors can buy into the euro area as a whole with such a system. Consequently capital fleeing to the safest (say, German) debt at the first sign of trouble can be stopped with that at least in theory. The link between government fiscal policy and the health of their domestic banks can also be helped to be broken by it.
 
“Now, when there is flight to safety, it goes across borders. In this arrangement, you will see re-channeling of the flight to safety that goes to senior from junior tranches and hence stabilizes periphery yields,” Brunnermeier says.
 
Brunnermeier has been busy gathering up support for the idea. He plans to send out questionnaires to market participants across Europe to gauge interest and he presented the plan on the sidelines of last month's annual meetings of the International Monetary Fund in Washington, D.C.
 
It is complex, admits the system's inventors. Let alone the question of acceptance of it by governments who may have interests in maintaining the status quo, there's even no guarantee of acceptance by the market. Yet, since Germany gets a system that still takes account of sovereign risk and Europe's periphery gets a debt instrument with greater credibility with this idea is the banking stone of Brunnermeier and his colleagues who have identified a grand bargain that could be made in this manner.
 
“Somehow, that bargain needs to be struck,” Brunnermeier says
 
(Source:www.bloomberg.com) 






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