06 December 2010

A E-bond: a good idea? Certainly not!

Jacques Attali, the former advisor to French President, François Mitterand, has been a strong advocate of E-bond issuance for some time, in particular in his book “Tous ruinés dans dix ans? Dette publique: la dernière chance”. This idea was repeated at the Luxembourg for Finance conference in June 2010 attended by Jacques Attali and Jean-Claude Junker, Prime Minister of Luxembourg and President of the Eurogroup.
Today, in the Financial Time, Jean-Claude Junker and Giulio Tremonti, the Italian Finance Minister, floated the idea of an E-bond. Under the premises that
© Markets & Beyond
Europe must convinced markets and European citizens of the irreversibility of the Euro, their reasoning is as follows:
  1. The issuance of E-bond in sufficient quantity would provide investors with a deep liquid secondary market, second only to the US Treasury market.
  2. Up to 50% (read at least!) of EU members sovereign debt issuance would come from E-bonds.
  3. Up to 100% of debt issuance would come from E-bonds in case exceptional EU members could not access capital markets under “normal” conditions.
  4. Sovereign debt could be switched to E-bond at a discount to reflect the credit risk which in turn should strongly incentivize countries to reduce their deficits.
  5. A single e-bond market for the Eurozone sovereign debt would reduce the necessity for emergency interventions in the secondary market.
  6. “A new market would also ensure that private bondholders bore the risk and responsibility for their investment decisions”. Investors (read banks) would have a better collateral with the ECB by switching from sovereign debt to E-bonds whilst they would take a loss on conversion; this would also ensure transparency regarding solvency ratios.
  7. In case of difficulty, the new mechanism would allow borrowing states to be able to secure  funding at better rates than presently and not to be exposed to short term speculation
  8. Profits coming from conversion discounts would accrue to the European Debt Agency (“EDA”) that would in turn permit lower rates for borrowers. And the taxpayer would not be in line.
I am afraid in the real world, there is no win-win situation. Let’s review this fairy tale:
  1. Fine. In normal market conditions, this might translate in a lower cost of funding, not by a lot, maybe a few basis points, everything being equal.
  2. So, they are talking about moving debt from one place to the other: Debt will not be reduced whilst one of the keys to the crisis is over-indebtedness.
  3. In case of crisis, more debt could be issued under the EDA, and less at the sovereign level; again, no debt reduction but more debt.
  4. Well, I would be interested to know how the discount would be decided/calculated, since if transparency there is, this is quite a key point (more later). And I do not see why countries would be more incentivized to reduce their deficits via the discount mechanism than currently when they are under tremendous stress.
  5. The intervention in the secondary market by the ECB was implemented (1) to manipulate the cost of borrowing of the sovereign states and (2) to allow banks to get rid-off of bonds resulting from bad investment decisions. This the path Europe decided to follow, rejected any other solution, as displeasing they might be for their ego.
  6. No need of a new market: just let bondholders take a haircut right now. And I do not see any difference for banks taking a haircut in the current situation or via a discount mechanism on conversion. Opacity has not been the result of markets but of continuous intervention by the ECB and refusal by politicians of an organized Greece default and possibly the failure of several banks, meaning shareholders wiped out and bondholders severely affected.
  7. Indeed, they would access the market at better rates, since Germany would pay for it via the E-bonds. These E-bonds would result in an increasing cost of financing for virtuous European countries to benefit profligate ones. Believing that the E-Bonds would be at German rate is just plain foolishness.
  8. Yes, the EDA would benefit buying at a discount from PIGS countries, but what about Germany or The Netherlands? The EDA would buy at a premium, hence a loss.
 All this mechanism does not address the point: European economies must deleverage. Jacques Attali, a very clever man, sells his idea by stating that the EDA would have no debt and could therefore borrow huge amount of money… Well, hold on and what about existing debt? Would it have disappeared? Would the economy had grown much more? Would the European population suddenly increased much to maintain the per capita debt? Come on, this idea is just to institutionalize the mutualization of the sovereign debt across Europe and its associated costs which in turn would force a fiscal integration (without a social integration, it does not make much sense anyway).
This proposition aims at fostering a European integration much farther whilst the root of the problem -the one-fits-all does not work- is not addressed, and make the euro irreversible.
European politician are not ready to admit their failure. Dogma instead of pragmatism still governs Europe, sadly.
Financial Times: E-bonds would end the crisis