Saturday, 6 August 2011

Eurozone Bonds perhaps, but with one less AAA guarantor?

Here is a slightly modified extract from an article which appeared here in February entitled Macro Eurozone Risk: We're all in this together aren't we?

Some have suggested that the best way around the difficulties of designing a new architecture for the EFSF or its successor would be to grant the ECB the power to issue new E-bonds, but this may have the unintended consequence of highlighting the legal flaw that the current guarantees for the EFSF are several but not joint. It would also certainly require major EU treaty changes and plebiscites in many states with highly uncertain outcomes, not something favored by those anxious to solve the current Italian debt crisis in a hurry.

Interestingly one of the main critics of E- bonds is the current ECB president as this article makes clear.

BRUSSELS (MNI) - The European Central Bank maintains its position that eurobonds with a "joint and several" guarantee would not be appropriate given the present circumstances in the European economies, ECB president Jean-Claude Trichet said.

"In the ECB, as you know, we are not in favour of European bonds in which the European countries would be joint and several. We don't consider it is something that would be appropriate in the present circumstances," Trichet told the European Parliament's Economic and Monetary Affairs Committee.

Just to be totally clear and unambiguous on the matter – never something that a central banker should really do – the following direct quotations from M. Trichet are also on the record of the European Parliament:

1."We are not ourselves in favour of issuing securities, treasuries that will be joint and several," Trichet told the European Parliament.

2. "We consider it is good that each particular state, each particular treasury has its own refinancing and has its own way of being on the market."

If E-bonds are a non-starter, and if the Germans are only committed to a pro-rated liability for anything that can go wrong within the EZ states, is it right for the CRA’s to continue to rate the securities issued by any new facility as AAA? While Moody’s and S&P analysts may possibly ponder that question, the capital markets are moving towards yet another test of the issue. But again there is a danger in thinking that they are only testing the size of the facility… more seriously they are testing the nature of the legal guarantee behind the facility, or any EZ facility.

The ultimate test for any structure that the EZ might try to devise as a way of containing the threat of further contagion hinges on how the federalists can counter the strong conviction within the Bundesbank and parts of the German government that it would be prudent to step away from the forces of encroaching fiscal unification, fiscal transfers and complete financial integration of the EZ, which would result in Germany effectively providing a safety net under the whole EZ project.

The easiest way out of this impasse would seem to be for Germany to cap its obligations and future contributions to the ECB capital structure rather than leaving the bank with an open cheque as it is committed to at present, and to seek an exit from the EFSF artifice sooner rather than later.

If Germany did exit the Eurozone experiment it would reduce the number of EZ states to sixteen and the number of AAA guarantors to four. Of the other twelve "guarantor" states many, it could be argued, are either basket cases or candidates themselves for financial rescue. So exactly how the EFSF architecture - notwithstanding the over-collateralization and credit enhancement features - is supposed to provide comfort to investors in EFSF paper is left to the reader's imagination.

What is clear is that without Germany the EFSF is a paper tiger, and that brings us back, in circular fashion, exactly to the reason why it is too onerous for Germany to continue the charade that "We're all in this together aren't we ( as long as it's all pro rata )?"

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