23 November 2011

European Commission Green Paper on the feasibility of introducing stability bonds

The Green Paper published by the European Commission structures the political debate in the EU on the rationale, pre-conditions and possible options of financing public debt through Stability Bonds. Such common issuance of bonds by the euro area Member States would imply a significant deepening of Economic and Monetary Union (EMU). It would create new means through which governments finance their debt, by offering safe and liquid investment opportunities for savers and financial institutions and by setting up a euro-area-wide integrated bond market that matches its US dollar counterpart in terms of size and liquidity. The fiscal framework underlying EMU would similarly undergo a substantial change, as Stability Bonds would need to be accompanied by closer and stricter fiscal surveillance to ensure budgetary discipline. Some of the options for the design of stability bonds considered in the Green Paper might require a Treaty change. Regardless of any necessary time for implementation, agreement on common issuance could have an immediate impact on market expectations and thereby lower average and marginal funding costs for those Member States currently facing funding pressures.

The Green Paper does not indentify any preferred option or way forward. Instead, the documents open and structure a wide public debate on appropriate next steps and possibly more concrete steps in this matter.

The many possible options for common issuance of stability bonds can be categorised in three broad approaches, based on the degree of substitution of national issuance (full or partial) and the nature of the underlying guarantee (joint and several or several) implied. The three broad approaches examined in the Green Paper are:

• the full substitution by stability bond issuance of national issuance, with joint and several guarantees: this approach would seem the most ambitious option of all, as it would replace the entire national issuance by Stability Bonds and as each Member State would be fully liable for the entire issuance. This option would accordingly have strong potential positive effects on stability and integration. But at the same time, it would, by abolishing all market or interest rate pressure on Member States, pose a relatively high risk of moral hazard and it might need significant Treaty changes;
• the partial substitution by stability bond issuance of national issuance, with joint and several guarantees: this approach would essentially be the same as the option mentioned above, but stability bonds under this option would only cover parts of national financing needs. Therefore, Member States would continue issuing their own bonds, although at an accordingly lower volume due to the parallel issuance of stability bonds. Hence, Member States would still need to tap financial markets on their own and would be subject to market and financing conditions that would vary across Member States and might reflect their different credit quality. The risk of moral hazard would also exist under this option but in a more reduced form. As this approach would only partly cover financing needs of Member States, under this approach, as under the third one, one would have to decide about the specific volume or share of financing needs for a Member State to be provided by the issuance of stability bonds;
• the partial substitution by stability bond issuance of national issuance, with several but not joint guarantees. This approach is the most limited one of the three options, as it would only partially cover Member States' financing needs (as approach no  2 above), and as it would only be covered by several guarantees. This option would therefore probably have only smaller effects on stability and integration, and the risk of moral hazard for the conduct of economic and fiscal policies in Member States would seem very limited. This option would be relatively rapidly deployable, as the need for measures to counteract such moral hazard would be limited and as the instrument seems also otherwise fully compatible with the Treaty. To ensure a sufficient creditworthiness of such instruments, some additional safeguards, i.e. "credit enhancements" might be necessary, for example in the form of collateral provided by Member States. This approach would have certain similarities to bonds issued by the European Financial Stability Facility (EFSF). However, whereas the latter are meant to step in and help financing vulnerable Member States in the context of the sovereign debt crisis, stability bonds would be instruments available to all euro area Member States and also outside any crisis context. Their volume and potential effect on market efficiency and integration would be accordingly much larger.

The consultation is open until January 8, 2012.

• Press release
• Full Consultation paper

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