Out of his Depth

From the Daily Telegraph last week:

[David Cameron] is piling the pressure on Europe to stop the collapse of the single currency by raising money through “Eurobonds”. Speaking in Manchester, he warned the financial crisis of 2008 that led to the near-collapse of the banking system “never really went away”. He is due to hold a conference call with François Hollande, the French leader, Angela Merkel, the German Chancellor, and Mario Monti, the Italian Prime Minister, this afternoon to “explore new options” to solve the crisis. Ahead of the meeting, he issued a blunt warning that Eurobonds may be needed to “put an end to speculation about the future of the euro”.

Never Waste A Crisis

From the EUObserver

BRUSSELS – The European Commission has said it will soon bring forward plans for an economic and political union it says is necessary for the creation of debt-mutualising eurobonds – one of the most controversial proposed solutions to the current eurozone crisis.
“We need to reflect what kind of European union would be required to deepen economic and political integration, for instance so that joint issuance of debt would make sense for all member states sharing the single currency,” economics commissioner Olli Rehn told MEPs on Tuesday (22 May).
He said the commission would “soon” come up with a “medium to long term roadmap” outlining the necessary deeper fiscal and economic integration that would minimise moral hazard – member states running up debt because they know it will be paid by others – and ensure “fiscal sustainability.”
“In other words,” the commissioner added, “the features of an economic and political union required to make mutualisation rational for all.”

Commonsense

Vincenzo Scarpetta, Open Europe:

The idea of Eurozone countries pooling their sovereign debt in the form of Eurobonds re-emerges every time the euro crisis suffers another turn for the worse. Curiously, the idea’s chief proponent seems to be the UK government, which has made several interventions, stressing the need for the Eurozone to move to “fiscal burden-sharing”. This puts it in the company of European federalists such as Romano Prodi and Jean-Claude Juncker, and socialists such as François Hollande.
However, the UK government, like most other advocates of Eurobonds, tends to gloss over the details. There are at least three economic reasons, and a huge political reason, as to why Eurobonds are no easy fix. Firstly, the moral hazard entailed in Eurobonds is huge. Remember, for large parts of the past decade, Greece was treated by markets the same way as Germany, and was able to borrow money at almost the same interest rates. Everyone can see the results. Secondly, Eurobonds would inevitably take away pressure for radical reform. As painful as it is, at least the Eurozone crisis is forcing Club Med countries to pursue long-overdue reforms of their pension and tax systems, labour markets, and so forth. Piggy-backing on Germany’s credit rating could take away this pressure. And linking back to moral hazard, the focus could again be on growth via debt, rather than through structural reforms. Thirdly, most of the proposals for Eurobonds would see only part of the Eurozone governments’ debt underwritten jointly, with the rest remaining national. This option would be a major economic gamble. Not only would it be extremely difficult to implement on existing debt stocks, it could also send borrowing costs on the nationally-denominated debt skyrocketing – which would ultimately outweigh the benefits of having Eurobonds in the first place. In addition, a half-way house would mean that a substantial euro rescue fund would still be required, since the Eurozone continues to lack a lender of last resort – putting extra pressure on the credit ratings of Germany and other “core” euro countries.
The first and second problems could be dealt with, in theory, by imposing strong EU budget rules. But the record of Eurozone countries of abiding by such rules – and the lack of credible enforcement mechanisms – does not inspire confidence. The third problem can only be solved by going for “full” Eurobonds, meaning no national debt at all.
However, this is where politics – and a bit of constitutional law – kicks in. German taxpayers are not ready to accept higher national borrowing costs to underwrite Greece, Portugal and Spain. Nor are they willing to accept a euro based on watered-down budget discipline. Going down that road risks a major backlash – which could lead to the Germans pulling the plug. In addition, the German Constitutional Court in Karlsruhe has already expressly forbidden Eurobonds without a change to the German “basic law”.
In any case, Eurobonds would take years to implement. The answer to the current crisis must lie elsewhere.

Rehn is just an apparatchik doing his job, Cameron is a prime minister unable to cope with his, and Scarpetta is right. Theoretically, “full’ Eurobonds could be the answer (if we ignore the insult to democracy that they represent, and if a legally and politically credible structure for their issuance could be put in place quickly enough). In the short-term, and under those unlikely circumstances, they could have the potential to calm the crisis down. Over the longer term, they will merely postpone the day of reckoning and, quite possibly, make it even worse.