Eurobills: On the joint issuance of European debt instruments

2013-02-21

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One of the schemes that is being contemplated in the chambers of European politics, is that of the joint issuance of sovereign debt instruments. This is currently related to the negotiations on the so-called “two-pack”, where the legislative reports from the European Parliament suggested schemes for the pooling of Member States’ debt and the consequent issuance of such financial tools. The original idea is not novel, as it relates directly to the controversy over the introduction of eurobonds. Regarding the ongoing law-making procedure on the two-pack, some media have already reported that in the context of these negotiations, Members of the European Parliament have succeeded in reaching an agreement in the trialogues with the Council and the Commission over the introduction of eurobonds.

If our intention is to labor under the penumbra of doubt and generalizations, then any financial product that has a ‘European’ patina must be referred to as a ‘eurobond’, but if our desire is to be precise and specific, then we must delve into the subtleties of these issues, to clarify the lacunas that currently exist over the understanding of this topic and to provide clear delineations between the various types of schemes or means that are or may become negotiable and/or available. The present blog post represents an attempt to address some of the misunderstandings central to this topic, in a quest for clarity and for a more solid understanding of the movements of the tectonic plates of EU-related diplomacy.

Eurobonds vs Eurobills

Starting from the semantics, it must be stressed that euro-_bonds_ are not tantamount to euro-_bills_, for these two different terms entail, in this context, a variance in maturities (maturity is a finite period during which the financial/debt instrument exists), with euro-bonds probably representing debt products with long-term maturities, in the range of 5 to 30 years (though it is possible to have longer ones); while euro-bills pertain to the shorter term of a maximum of three years.

The substantive aspect of this phraseological distinction is that the former are tools that can be used to raise the necessary capital for the development of investment projects or other strategic policies that are of a longer term character. The long maturity of such bonds, allows the issuer (the public entity in this case—the state) to remain insulated from the vicissitudes of day-to-day speculations and perhaps to be protected from cyclical macroeconomic fluctuations.

In contradistinction, short-term debt attains the function of providing liquidity for the financing of short-term projects, or as will most probably be the case for an entity that already has debt, will be deployed to pay back older debts, at best to rollover its debt stock into the future. As such, debt bills are not necessarily robust to a range of shocks endogenous to money markets, and by extent, they may be destabilized or negatively affected by general economic instability or other downturns.

In effect, this means that bills, eurobills in our case, are not a debt instrument for the realization of any serious, ambitious, coherent and compelling strategical project, but are destined to be contained to providing liquidity to cash-strapped EU Member States or to finance the immediate needs of the European entity that will issue them (most probably the Commission, once it has developed its fiscal capacity, be it sovereign or not).

Such a tool or mechanism is leagues apart from the concept many have in mind when making allusions to common European bonds, since what they really mean to suggest is having tools with which to finance strategic policies over a time horizon that extends into the remoter future. With eurobills as the best choice in the toolkit of policy-makers, it is quite hard to actually bring into being any of the laudable ideas that find currency in various political circles of our day.

About jointly and severally guaranteed European debt instruments

For the time being, all negotiations have remained captive in the logic of joint issuance of debt. The notion of “jointly-issued” implies that these proposed eurobills will not be genuinely federal debt instruments, as is often and erroneously assumed, but will rather resemble the sort of debt products that can be issued by the European Stability Mechanism and which were issued in the past by the European Financial Stability Facility, to finance the troika programmes in the bailed-out Member States (which were Greece, Ireland and Portugal at the time). These are all makeshifts that cater to the needs, prejudices and interests of the intergovernmental order within the EU (nothing to do with federalism).

Simply and succinctly, the joint issuance of debt amounts to a specific agreement among sovereign entities, to place their name on a single financial product.

Understandably, the flip-side of joint-issuance is the guarantees that have to underpin it in the absence of a single sovereign issuer, where the options are basically narrowed down to two: (i) jointly-guaranteed, and (ii) severally-guaranteed. The first means that there is an ad hoc pooling of debt, among the issuing members, while the latter suggest that each member will remain fully responsible for its own tranche of debt. Whatever the case, the guarantees remain anchored to national sovereignty.

In practice, what is now being propounded as a successful pooling of debt, is the joint-guarantee scheme, where all participating Member States will jointly issue a debt instrument and all of them will jointly guarantee its face value, yield to maturity and ultimate credibility. Put bluntly, the participating Member States that enjoy high demand for their debt products will effectively guarantee/cover other states whose debt is less attractive, with all the advantages and disadvantages along these lines.

While for many this might be better than a setting of jointly-issued but severally-guaranteed debt instruments, it nevertheless does not escape the fact that it is a tower of cards, arguably well-designed, that may not be able to withstand sustained market duress. In effect, such arrangements that are found on the multiplicity of debt tranches and guarantees, resemble the internal structure of financial derivatives, i.e. where different classes (“qualities”) of debt are bound together in some complex concoction, to produce a new instrument; an instrument that derives from them (hence “derivatives”), exists because of them, but is nothing if the best debt components of it are for whatever reason rendered obsolete, or a fortiriori if the lower tranches prove to be worthless. I shall not elaborate on how toxic such schemes are and have proven to be, for my purpose herein is to elucidate some of the largelly-ignored features of a de facto quasi-confederal debt instrument; of a makeshift that is branded as a major success, which is not, even if it certainly is a step forward.

The sovereign capacity of the Economic and Monetary Union

From the above, the judicious reader will discern that common debt instruments can only exist in a predominantly intergovernmental institutional arrangement; which nevertheless is not equivalent to a genuinely European federal design, for the underlying sovereignty of inter-governmentalism rests on the participating Member States.

To have true European debt, two prerequisites need to be met, both with far-reaching ramifications in the institutional morphology of the European Union:

1. Fiscal capacity: The European level of governance must be adequately regulated as to develop its own fiscal capacity, which is a process that is already underway, with the recent ratification of the fiscal compact, the establishment of the six-pack and soon the entry into force of the two-pack (more here),
2. Sovereign capacity: The status of sovereignty will have to be conferred to the European level that will issue these debts, otherwise the whole system will always be threatened with jeopardy, by virtue of instability in one or more sovereign Member States.

Without these two, there can be no genuinely ‘common’ debt instruments in Europe. As for the complications germane to such political issues, I shall, for the purposes of this post, reserve myself in pointing to the fact that the way these are regulated will in effect determine whether the EU will be a federation or a confederation, or some unidentifiable entity oscillating between these two; and whether the European tier of authority will be democratic or technocratic. I firmly believe that this kind of problématique deserves an analysis of its own, thus doing so here would require a tedious digression, ultimately taking us off to an inappropriate tangent.

The description of the aforementioned particularities reveals the repercussions “mere details” can have in the overall politico-institutional and economic design and order of the EU, or within the EU. To recapitulate, these debt products that are presented as “common” are nothing but replications of tools that have already been used to deal with the eurocrisis. Also the political implications of the distinction between eurobonds and eurobills need to be born in mind, so as to appreciate the insight that we are nowhere near the introduction of debt instruments that could finance strategic European policies. Finally, I may suggest that, given the zeitgeist in European politics, we will not have eurobonds before a European state exists (whether this is good or not is another issue)… So brace yourselves!