I've previously mentioned the proposal of John Muellbauer, Paul De Grauwe and others for eurobonds with conditions--no silver bullet, but still I think Europe's best way out of the present mess. The idea combines a measure of debt pooling (the minimum needed to restore confidence) with incentives for better fiscal behavior and compensation for the creditworthy countries that might otherwise face higher borrowing costs. It's elegant and, I believe, workable. But Germany has said eurobonds won't happen.
In today's FT Muellbauer restates the case with presentational improvements. He suggests calling these new pooled instruments "euro insurance bonds".
Think of car insurance: just as bad drivers with accident records pay higher risk premiums, so countries with weak fundamentals would pay a higher interest rate on their euro insurance bond issue into a central insurance fund. For outside investors, however, all such bonds would trade at the same price...
Insurance companies usually demand an "excess", with drivers covering the first part of accident costs themselves, to protect against moral hazard. In the same way, countries issuing euro insurance bonds would post collateral with a central insurance fund--a eurozone debt management agency--in the form of gold and foreign exchange reserves, in proportion to their euro insurance bond debt issue...
In the event of a future default or debt writedown, the build-up of payments in the insurance fund, plus the collateral, would be available to those countries underwriting the joint euro insurance bond issue. This would negate German fears of a "transfer union".
I'm skeptical about governments posting collateral, because I don't think the threat to seize it is politically credible. Also, "negate" is too strong. But an arrangement with side-payments or "premiums" would do the job while going at least some of the way towards answering Germany's concerns.
The plan could be blended, Muellbauer argues, with the redemption pact proposed last year by Germany's council of economic experts, which Angela Merkel is at least no longer ruling out. I'm not sure why you would want to combine them, except to let Germany feel it was getting its way. The conditional eurobond is a better answer than the redemption pact--which is too severe, relies too much on non-credible sanctions, and offers too few incentives upfront. In any case, you don't need both. The conditional eurobond is the crucial innovation.
Sorry, did I say "eurobond"? I meant "euro insurance bond".
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