Will Stability Bonds Save the Eurozone?

The question is on all investors’ lips: How to save the euro and avoid breaking up the eurozone, which would be hugely detrimental to the economy as a whole — not only the European one — and investors in particular?

While repeated high-level summits of European leaders have proved unable to solve the sovereign debt crisis, EU public servants have been exploring possible ways to foster financial stability.

The most daring proposal is the common issuance of sovereign bonds among Member States of the euro area, investigated by a green paper from the European Commission. To inform our feedback to this green paper, we recently sought the opinion of our EU and Swiss members through a survey, to which 798 CFA Institute members responded.

While a slight majority of respondents (52 percent) agrees that resolution of the euro-area sovereign debt crisis should require common issuance of sovereign bonds, many underline in their comments that new financial instruments will not cure the fundamental problems of imbalances in trade and competitiveness and over-indebtedness of many Member States. Some also believe that the significant risk of moral hazard associated with stability bonds would create further systemic threats.

In terms of structure, 64 percent of survey respondents believe the most effective approach for the common issuance of sovereign bonds would be joint and several guarantees under which each Member State would be responsible not only for its share of liabilities under the stability bond, but also for the share of any other Member State failing to honor its obligations. Also, 64 percent of respondents support a partial substitution of stability bond issuance for national issuance, in which a portion of government financing needs would be covered by stability bonds, with the rest covered by national sovereign bonds. Lastly, a majority of respondents (65 percent) support a gradual phasing in of stability bonds.

But for stability bonds to work, strict preconditions must be met. A large majority of respondents view the following as necessary preconditions for participating Member States:

• 86 percent favor significant enhancement of economic, financial, and political integration
• 88 percent support increased surveillance and intrusiveness in the design and implementation of national fiscal policies.

This debate on the preconditions is important. As European leaders are drafting an “international agreement on a reinforced economic union”, the European Parliament is pushing to include in this text the adoption of “a road map towards creating the conditions that will allow them to issue part of their sovereign debt in common, with joint and several liabilities.”

We will see how this goes and if this proposal by the European Parliament manages to win over some highly skeptical Member States. Still, this could well be the first step toward common issuance of sovereign debt in the long term.