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Plan for a Temporary Eurobill Fund (TEF)

• Complementing with a strong European Monetary Fund (EMF)

Graham Bishop
10 November 2017

What is the Temporary Eurobill Fund (TEF)?

The TEF is a simple “plainest of plain vanilla” plan for a common institution to purchase the under-two year debt issuance of participating states. The institution would finance such purchases by issuing its own bills - matching its assets in overall volume and maturity. The TEF’s legal structure would replicate the ESM. The TEF is a replacement of existing debt, rather than a mechanism to increase debt. Indeed, by fostering better economic policies, it should encourage further falls in public indebtedness.  (More explanation in my most recent technical paper)

However, the political implications go far beyond a simple financial institution because the TEF - to paraphrase Monnet’s words – “fuses the interests of the Eurozone peoples” into a vital component of the Eurozone financial system, rather than seeking to balance national interests. That system needs a European-level “safe asset” to replace its existing holdings of a hotchpotch of national instruments that came perilously close to dis-integration in the heat of the Great Financial Crash.

The time is now ripe to begin implementing Schuman’s dictum: take some “concrete steps... to achieve de facto solidarity”

The European Stability Mechanism (ESM) is a key element in the design of the TEF[1]

If a TEF participant does eventually decide to default on its public debt, then a key part of the TEF design is that the state’s obligations to the TEF will be redeemed as they fall due out of the proceeds of an ESM programme for that state. Accordingly, no state should have greater obligations to the TEF than the ESM’s remaining lending capacity[2]. This rule will ensure that the creation of the TEF will not increase the liability of its members beyond their existing commitment to the ESM. Therefore the strength of the ESM is a vital back-stop to the TEF and any move to enhance its capability by converting it to a European Monetary Fund is welcome.

What is a European Monetary Fund (EMF)?

During the past year or so, there has been much debate about the need for a European Monetary Fund but little agreement on exactly what the term means – in precise operational definitions.

As his swan song, former German Finance Minister Schauble gave a “non-paper for paving the way towards a Stability Union”to his last meeting of Eurogroup and it sets out some powerful analysis of what could be done by the proposed EMF – or not. Many of the proposals in circulation seem to overlook the legal basis of the ESM specified in Article 136 (3) of the Treaty on the Functioning of the European Union (TFEU) – see box below – but not the non-paper.

A recent Bruegel paper by AndréSapir and Dirk Schoenmaker has begun to flesh out some of these issues though the paper’s first observation is to re-iterate the manifest gulf in expectations.

 “Both French president Emmanuel Macron and German chancellor Angela Merkel agree that the ESM should be turned into a European Monetary Fund (EMF), but they seem to disagree on what its purpose should be. Chancellor Merkel seems attracted by the idea that the EMF should be used to strictly enforce the fiscal rules, while President Macron appears to favour using the EMF as a euro-area stabilisation mechanism. While both ideas have merits, we argue in this Policy Brief that the EMF should concentrate, at least for the moment, on managing sovereign debt and banking crises, which still constitute the greatest potential threat to the euro area’s integrity.”

The authors then go on to outline their proposal “The weaknesses of EMU 2.0 can be cor­rected by turning the European Stability Mechanism into a European Monetary Fund. The EMF should be fully capa­ble of acting as the fiscal counterpart of the ECB to guarantee the financial stability of the euro area in the event of a sovereign or banking crisis, or a threat of a crisis.”

 

The TEF plan meets the relevant specifications in the `non-paper’

Germany is in the midst of coalition negotiations between the CDU, CSU, FDP and Greens but the non-paper was the product of thinking within the CDU/CSU. Currently, it seems that FDP economic policies will be even more firmly against anything that smacks of a “transfer union”. So any proposals that involve common actions in the financial markets will probably fail to gain political support from the new German government unless they meet the non-paper criteria.

Notably, the paper scorned “debt mutualisation” in the form of “Sovereign Bond Backed Securities (SBBs) as “complex and expensive financial engineering”. Even the Commission’s Reflection Paper was somewhat ambiguous and cautious about these proposals, so the chances of further progress on them now seem low.

In contrast, progress still seems possible on the plan for a Temporary Eurobill Fund. The origins of the TEF itself were conceived by a group of market practitioners[3] as an operational, practical response to the crisis for the euro that was unfolding during 2011. So the ideas focussed on market practicalities at that time. Later, this author developed them into a complete plan that was then tested by Commission President Barroso’s Expert Group[4] on Debt Redemption Funds and Eurobills in 2013/14 (link). At that time, the Group was concerned thatthe new economic goverence systems were not proven. Recent developments – and the immediate outlook - suggests the time is now ripe (See Appendix I).  

There was always a tension between the ideal project of the `bond market vigilantes’ seeking to protect their capital and what was thought to be politically possible given the state of public opinion in the various parts of the Eurozone. The TEF plan has been designed to balance these tensions by means of an evolution of small - but concrete – steps. Crucially, if these steps do not develop as hoped, then TEF issuance can be halted and all outstanding bills will have matured within two years. If the experiment works, then the Eurozone will have created quickly a global-scale financial instrument with many internal benefits. (See full analysis in my most recent technical paper.)

Schauble’s non-paper specifies three core principles. The comments below each of them assess how well the TEF satisfies that principle:

(1)We must keep fiscal responsibilities and control together, to avoid moral hazard.

Avoiding `moral hazard’ is probably the top priority for any plan that involves Eurozone states in any form of collective issuance. The term sounds complex but US economist Paul Krugman defined it rather simply and pithily as ‘any situation in which one person makes the decision about how much risk to take while someone else bears the cost if things go badly’.  The Maastricht Treaty “no bail out rule” (TFEU Article 125) epitomises the concept “The Union (or a Member State) shall not be liable for or assume the commitments of central governments…”

The Expert Group examined this concept exhaustively and concluded that the TEF would avoid any such hazard as it would replicate the ESM’s structure. “The Pringle judgment, where the Court of Justice has confirmed the conformity of the ESM Treaty with Article 125, only confirms this conclusion. The ESM is not based on joint and several liability of Member States, but only on pro rata commitments to pay in callable capital.” Correspondingly, the TEF would NOT breach “the no bail out rule” as its legal structure replicate the ESM.

The proposed governance structure would also anchor ultimate decision-making with the Finance Ministers of participating states. Using the same voting structure as the ESM, they would decide on the Fund’s exposure to any given state – recalling that the short maturity of the bills means the liability could be reduced to zero within two years if necessary. So the TEF would function as an `early warning radar’ for the ESM. If a period of difficulty turned into a major crisis, those same decision-makers could decide collectively to offer an ESM programme (with the normal strict conditionality) to pay off any exposure of a state to the TEF, leaving the liability under the control of exactly the same ministers – but now wearing an ESM hat - who are democratically-accountable to their own taxpayers. Result: Control of the situation will be entirely in the hands of the political authorities whose citizens will be liable pro rata for their share of any loans – but only up to the limit of the callable capital of the ESM.

(2)We need better instruments to foster the implementation of structural reforms.

The TEF governance structure is designed explicitly to encourage `good behaviour’ and penalise `bad behaviour’ through a progressive enhancement of market discipline. The key is that successful reforms will manifest themselves in improved public finances. However, given the stock of existing debt that must be rolled over, let alone any new debt, states will always want to issue shorter term bills. 

Participating governments must commit to issue all new under-two-year debt through the TEF and the decision-makers will set an exposure limit state-by-state for, say, the year ahead that reflects the cash needs implied by the EU-agreed budget. For many states, this pooling will provide an interest-saving `carrot’ but one that should be de minimis. However, the `stick’ might be substantial as any over-run of cash requirements would then have to be funded by that state in the longer-term bond markets.

In a normal world of a positive yield curve, the state will then automatically pay a penalty interest rate. That penalty will rise sharply if a state deviates seriously from sound economic polices – as judged by the `bond market vigilantes’, rather than weak ministers. If an EMF were given powers eventually to enforce debt re-structuring, then the vigilantes would become increasingly concerned as they perceived policy veering off course. (See full analysis in my most recent technical paper.) The TEF creates a carrot and (automatic) stick approach to encouraging better budgetary results.

(3)We need credible stabilization functions to deal with global or domestic shocks.

The TEF was originally conceived to deal with the problem of a state losing market access to roll over a maturing bond issue. Providing the TEF decision-makers were convinced that a “domestically-shocked” state was making a sound policy response, they would permit the issue to the TEF of sufficient of the state’s bills to pay off the bond redemption on schedule.

However, the TEF strategy has a second strand beyond pooling under-two-year new issuance: potentially buying in older bonds as they fall into the category of under-two year remaining life. If the decision-makers have made such purchases, then the TEF will probably own the vast majority of an older issue as it comes to maturity. (See full analysis in my most recent technical paper.) The non-paper explicitly discusses the use of Collective Action Clauses embedded in all EU government issues since 2013. If – as would be very likely – the TEF owned more than 2/3 of an issue, then it would be simple to extend the maturity of that particular bond to any desired date. So the TEF can provide a credible stabilisation function in two ways – at least initially.

(If the situation were such that the state had to enter an ESM programme, then converting the ESM into an EMF might well incorporate the power to lengthen maturities of a state’s entire debt with a single bond-holder vote. However, policy-makers should be aware of the risk of de-stabilising the financial institutions – such as banks, life insurance companies and pension funds – which hold this debt. They would suffer a sudden and major loss in the value of a significant portion of their assets.)

NOTE: the TEF would have no “fiscal capacity” function.

The political philosophy underpinning the TEF plan

The TEF plan is not designed to reach a specific, bold objective immediately. Instead, it just starts a process – to quote Schuman’s famous dictum from his 1950 Declaration - of building “concrete steps... to achieve de facto solidarity”. The TEF plan can steadily build confidence and trust – amongst the nations, institutions and peoples - so that the ultimate results could be increasingly notable over, say, the next decade. But it starts with an apparently small technical step: issuing under–two year maturity public debt through a common institution.

The TEF plan would build confidence and trust by following the EU’s traditional Monnet method. In May 2107, ECB President Draghi gave an inspiring speech “The Monnet method: its relevance for Europe then and now”. It was on the occasion of the Award of the Gold Medal of the Fondation Jean Monnet pour l'Europe. Draghi applied the Monnet method to the current situation in terms of:

o   Effectiveness

o   Insistence on subsidiarity

o   Sense of direction

o   Concern for democratic backing

As the Monnet method underpins the entire political structure of European integration, it may be useful to test the TEF plan against these yardsticks to check that it flows with the EU’s long-standing political grain, as well as with the grain of the markets.

·         Effectiveness: Draghi quoted Monnet “cooperation between nations, however important it may be, does not resolve anything. What one has to seek is a fusion of the interests of European people, not just to preserve a balance among those interests”. This is the test of effectiveness in policymaking. The Great Financial Crisis has forced the `Eurozone people’ to recognise that properly functioning banks and financially stable governments are in their own - direct and personal - best interest. That fusion of inter-national, personal interests is the key to the legitimacy of effective steps towards a sufficient degree of financial integration of the Eurozone to deliver effective results.  The TEF is a clear, effective concrete step in that direction.

·         Subsidiarity:No Eurozone government can create by itself a financial instrument for the whole Eurozone that is of truly global scale, and no government whose currency is the euro can create a “safe asset” to buttress the Eurozone’s financial system and provide a cheap, secure savings vehicle for all Eurozone peoples. Only the Eurozone collectively can pool sovereignty to provide such a massive, essential public good in a “limited but decisive area” – as Monnet put it.

However, it remains the sovereign choice of each government whether to follow the advice of the EU/Eurogroup on its economic policy. If the financial markets subsequently prove unwilling to finance that state’s proposed longer-term debt issuance, then it remains the sovereign decision of that government – as a matter of subsidiarity – to give up access to further finance and then bear the consequences. That government’s morally hazardous decision cannot bind the other states to breach the no-bail-out rule.  The degree of assistance the other EZ states may then choose to offer is their own decision – but they will have an effective mechanism in the EMF should they choose to offer assistance. The TEF epitomises subsidiarity – the Eurozone only does what Member States cannot do.

·         Sense of direction: Draghi said that “Monnet always emphasised a clear sense of direction for the European project– a sense of what the end goal of the integration process should be. Simply put, to avoid being stuck in half-built houses, we need their final blueprints.”

Remarkably, that sense of direction may now be returning. The wave of populism seems to be receding as the painful economic reforms undertaken since the Crash are suddenly beginning to bear fruit. The economic sentiment indicator is now at the highest level in two decades. The euro is no longer seen as at risk of dis-integration and Bulgaria seems to be seeking to become the 20^th member because it is now ready and willing – at least economically.

So the perception of a half-built house may be giving way to seeing the vision of a complete house that fuses the financial interests - a “limited but decisive area”- of the Eurozone peoples to deliver an improvement in their personal lives. The TEF can be one of the mechanisms to deliver that fusion of interests.

·         Democratic backing: Draghi explained this in terms of accountability and transparency but these are difficult concepts to explain to the `man in the street’ about to vote in, say, the Brexit referendum – to cite a recent and unpleasant personal experience. Such `men’ have no knowledge of careful explanations to far-off Parliaments in some remote place called Westminster-Brussels.  As one person in 500 million, they have to trust their elected representatives, rather than have someone act purely as their delegate. A noticeable part of society seems to have lost this trust - a basic problem for democracy, and not just the EU.

However, there is a mechanism that enables a significant portion of the Eurozone peoples to have a highly effective voice. For those with savings to finance their now-lengthy retirement, they enjoy the freedom to withdraw their savings from any intermediary that they distrust – whether bank, mutual fund etc. These intermediaries are simply the agents of the citizens – driven first by the safety and, secondly, by the transparency of relative performance of the investment.

In practice, that forces these institutions to be the `bond market vigilantes’ who conduct a rolling referendum on the policies of governments and withdraw the citizens’ savings if necessary - acting as the citizens’ representative.  On occasions, they may be forced to act as `delegates’ if citizens actually cash in their mutual funds or deposits. Greece is the perfect example: the existence of readily-available non-Greek “safe” euro assets enabled Greek citizens to halve their bank deposits and thus cut bank holdings of Greek government debt. That rolling referendum on the financial polices of a corrupt Greek political system forced a century’s worth of reforms in just a few years.

In the fullness of time, the TEF’s bills should be available via the internet to ordinary citizens who can then satisfy their own personal interests by holding a “European” asset that is the highest credit quality, is simple to understand, is very cheap to hold and can be liquidated at virtually no cost so that it can be used in an instant payment system. That would be an outcome that the Eurozone peoples should applaud as it will also facilitate such a political day of reckoning - if the need were to arise.

Of course, there also needs to be the more conventional accountability and transparency via the national finance ministers acting at the TEF Governors in an initial inter-governmental stage. The person holding the post of overseeing the European Semester and Country Specific Recommendations will emerge as the Minister of EU Economic Affairs.  In parallel, the person holding the post of President of the TEF will emerge as the holder of the purse strings of governments that need to borrow – a classic function of a Minister of Finance. An eventual combination of these posts would then produce a person who is recognisably the de facto Minister of EU Finance. As a matter of practicality, that person could only hold office “at the pleasure” of the European Parliament. But this can only happen when the Eurozone peoples see their personal interests so fused that they see this outcome as the only effective protection. The TEF’s bills would be a simple mechanism to enable the citizens of a particular Member State to exert real democratic pressure on an inadequate government.

 

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Appendix I: Expert Group on Debt Redemption Fund and Eurobills - 2013/14

When the Group was preparing its Final Report of 31 March 2014,the new post-crisis economic governance co-ordination was in its infancy – only the second round of the European Semester/Country Specific Recommendations was underway. Now the sixth round is starting and progress is evident on many fronts – growth, unemployment and (especially relevant) public finances. Budget deficits were above 3% then, but the new autumn 2017 forecast of the Commission puts them under 1% in 2018 and 2019. Importantly, public debt levels look set to fall to 85% of GDP – down by 10 percentage points since the 2014 peak when the Group was preparing its Report.

At that time, the Group concluded that “Given the still very limited experience with the EU's reformed economic governance framework, it may be considered prudent to first collect evidence on the efficiency of this governance and, if deemed necessary, further strengthen this governance framework, before any decisions on introducing joint issuance are taken.” Much evidence is now in, and the process is clearly bearing fruit. That is not to say that everything is rosy, but the direction of travel should is positive.

The Group’s legal analysis concluded that the “economic” requirement of all participating states to bind themselves to issue all new under-two-year debt via the TEF would require an Inter-Governmental Agreement between the relevant states. NO change to the TFEU would be necessary.

The European Commission would be required to provide information and services to the TEF but not take any part in the key decisions as these would be strictly reserved to the Governors (the Finance Minsters). However, the Commission would need to be empowered to provide these services and the Group concluded that “The other legal base to be examined is Article 352 TFEU (the flexibility clause). In short, recourse to that clause requires there to be a need for Union action to attain one of the Union’s objectives as set out in the Treaties, within the framework of Union policies, and an absence of an express competence in the Treaties for such action. Also, the Court of Justice has made it clear that any measure adopted on this base must stay within the general framework set by the Treaties and not amount, in substance, to a modification of the Treaties.” Article 352 can be operated under the “enhanced co-operation” rules.

If the Expert Group re-ran its analysis today, the chances are that it would conclude that the time is now sufficientlyripeto warrant further – perhaps both small and reversible – steps by launching the Temporary Eurobill Fund as the plan demonstrably runs with both the grain of the markets and of the EU’s political structure.

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