German opposition to euro countries becoming responsible for each other’s debts is being tested by proposals for a program of European bill sales that would mirror the U.S. Treasury market.
Eurobills would be “a very good first step” toward common euro-region bonds, Olivier Blanchard, chief economist at the International Monetary Fund, said in Washington last week. Securities maturing in a year or less would pose “very little risk for the participating countries,” he said.
Euro-region countries are seeking to ease the debt crisis without lessening the pressure on profligate governments to curb deficits. Proposals for common bonds that would cut borrowing costs for countries such as Spain, where 10-year yields have held at about 6 percent for the past month, collide with German reluctance to transfer resources, and treaties that prevent member states from sharing their financial burdens.
The Eurobills proposal put forward by Christian Hellwig, a professor at Toulouse School of Economics, and Thomas Philippon, an associate professor of finance at New York University’s Leonard N. Stern School of Business, calls for a European debt management office as the monopoly seller of euro-denominated bills. No euro nation would be allowed to have bills outstanding worth more than 10 percent of its gross domestic product, reflecting the relative size of the U.S. market.
“The idea is to transpose the U.S. Treasury market to the euro area,” Hellwig said in a telephone interview. “Will it help? Yes, absolutely. Does it solve everything? That’s not our claim.”
Yields on Spain’s 10-year bonds were little changed at 5.87 percent today, 4.2 percentage points more than the 1.68 percent yield on similar-maturity German notes. The average rate on bonds that are older than one year of euro countries is 3.49 percent, according to Bloomberg/European Federation of Financial Analyst Societies index data, compared with a 0.34 percent yield on German bills repayable in March 2013 and the 2.25 percent investors get for lending to Italy for the next year.
“The choice is becoming somewhat binary,” said Steven Major, global head of fixed-income research at HSBC Holdings Plc (HSBA) in London, who floated a similar proposal in a September paper. “Moving forward means taking steps toward a fiscal union and, in this regard, euro bills are a good place to start.”
A deteriorating growth outlook is driving closer cooperation between European governments as opposition to more austerity increases. Francois Hollande, the frontrunner in the French presidential race, wants to renegotiate Europe’s fiscal pact and push for growth. The government of the Netherlands fell after Geert Wilders’s Freedom Party withdrew support for spending cuts and tax increases.
“There’s new momentum with the French election and what Hollande is saying,” said Markus Brunnermeier, a professor of economics at Princeton University. That’s bumping up against the same obstacles met by previous efforts. “The French would very much like a joint liability, the Germans don’t,” he said.
Standard & Poor’s cut Spain’s credit rating last week for the second time this year, lowering it two levels to BBB+. With the Spanish economy floundering and deposits leaving its banks, measures to support investor confidence and stabilize capital flows may include “a greater pooling of fiscal resources and obligations, possibly direct bank support mechanisms to weaken the sovereign-bank links,” S&P said.
While not all countries issue bills, euro-region sovereigns have about 570 billion euros ($750 billion) of the securities outstanding, data compiled by Bloomberg show. German Bubills make up 52 billion euros of the total, behind France, which has about 180 billion euros of BTFs, and Italy, with about 170 billion euros of BOTs, the data show. Spain has about 76 billion euros of Letras outstanding.
Only countries complying with agreed targets get to benefit from Eurobill issuance. Hellwig offers the analogy of venture capitalists, who monitor and control the entrepreneurs they back by handing out funds a little at a time, a strategy being followed in the international bailout of Greece.
While having to refinance the bills at least once a year gives a supervising agency greater bargaining power, Princeton’s Brunnermeier questions the credibility of a threat not to allow rollovers.
“Would the authority really kick out a country that was breaking the rules?” he said. “I doubt it. It would be hugely unpopular.”
He also questions whether Eurobills tackle the real issues, which he defines as the flight to safety that has sent capital pouring out of the peripheral nations and into the core, the issue of transfers in the other direction, and what he calls “the diabolic loop” of banks and sovereigns propping each other up.
Eurobills would offer banks an “unambiguously safe” instrument they could use to meet new capital requirements, according to Hellwig. He suggests European regulators view them as the main, or only, asset to be used when assessing a bank’s access to liquidity.
“We have to recognize that government debt isn’t necessarily risk-free,” he said. “The Greek crisis made it clear that Italian securities, say, are not the same as German ones, and that’s meant a lot of liquidity has been lost in the banking sector.”
Yields on German Bubills are close to zero, with the note maturing in July at about 1 basis point, or 0.01 percentage point. Italy’s three-month bill trades at about 94 basis points and Spain’s at 30.
“The key advantage of Eurobills is that they are issued centrally, because while the stressed countries can’t print their own money, the ECB can, so the bills would be paid,” said Steven Barrow, head of G10 research at Standard Bank Plc in London. “The danger is that you bring down the average maturity of sovereign debt significantly.”
Eurobills are a “sensible approach,” according to Ernst- Ludwig von Thadden, professor of finance and economics at Germany’s Mannheim University, who helped Hellwig organize a presentation at the Bundesbank. The proposal permits some risk- sharing to stabilize nations’ finances at the same time as it prevents governments from being “irresponsible,” he said.
There would be investor demand for Eurobills, said Sylvain Champonnois, a strategist in London at BlackRock Inc. (BLK), the world’s biggest asset manager. The real drawback is the politics of the proposal, he said.
“You’d have to get all the politicians on board,” he said. “You’d need the whole architecture of political agreement, treaty changes and so on, plus there would be a cost to Germany. Still, it’s also going to cost them something if it all breaks up.”
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