The word on the lips of many of the 17 leaders of the eurozone following this week's meeting of heads of state -- the 18th summit, for those who are counting -- is Eurobonds. The ideas behind them, though, are out of sync. "Europe can have Eurobonds soon," Italian Prime Minister Mario Monti insisted. "[The] taboo surrounding Eurobonds has been lifted," a European Commission official declared. Not so fast, German Central Bank chief Jens Weidmann chimed in, "It is an illusion to think Eurobonds will solve the current crisis."
So, what exactly is a Eurobond? Briefly put, it is a tool intended to collectivize debt across all eurozone countries. Right now, to raise funds, eurozone members have only one option: selling national bonds. The market determines the value of these bonds based on each country's fiscal and economic health. The problem is that as some European countries were roiled by a national asset bubble (Ireland) or experienced a decade of lackluster economic growth while racking up unsustainable levels of debt (Greece and Portugal), they became unable to tap private markets, and their existing debt became prohibitively expensive to pay back. To service their debt, these countries had to receive funds from the International Monetary Fund, the European Central Bank, and the European Commission. But with the crisis deepening and spreading to Italy and Spain, it looks like another solution is required: the Eurobond.
In theory, Eurobonds would allow debt-ridden countries like Greece to borrow at more affordable interest rates. For instance, according to the Guardian newspaper, if Eurobonds were adopted, Portugal would see its annual debt repayments fall by as much as $18 billion or 9 percent of GDP. Other struggling European countries, such as Italy, Spain, or even France, would likely see similar savings.
But even as Eurobonds relieved the crisis in the periphery, they would increase the borrowing costs of countries in better financial health. For example, according to the same article, if Eurobonds were introduced, Germany's borrowing costs would rise above the current eurozone average, costing Berlin an extra $62 billion, or 2 percent of GDP, per year to service its debt.
What prevents the wealthier countries, or more specifically Germany, from getting to yes on Eurobonds? In a nutshell, moral hazard: If Greece, Ireland, Italy, Portugal, and Spain were allowed to borrow at lower rates, the market pressure to implement deep and difficult structural reforms would disappear.
The path to European redemption, according to German leaders and the European Central Bank, must only come through difficult reforms and fiscal discipline, not the same sort of low-cost borrowing that got the periphery countries into their current difficulties. This moral hazard argument was precisely why Germany demanded a fiscal compact treaty (which maintains strict fiscal debt and deficit limits) in December in return for additional bailout funds.
There are also legal arguments against Eurobonds. At present, EU treaties expressly forbid joint debt liabilities within the monetary union. The introduction of Eurobonds would require several treaty amendments and very likely ratification by eurozone members. Eurobonds are likely also unconstitutional in Germany, and would require at least 10 legal changes, according to the Guardian. Sorting out the legal and political challenges could take years.
The Eurobonds debate also extends to the form and scope of these bonds. Since 2000, there have been at least six different proposals on how to structure a Eurobond. To simplify, we place the Eurobond discussion into three separate categories:
Door No. 1 is the maximalist definition of Eurobonds, requiring that all 17 eurozone countries completely mutualize their current stock of debt and issue common bonds. In other words, they would ensure joint guarantees, meaning that each member state not only pays for itself but also the obligations of any other country -- say, Greece -- unable to meet its liabilities. Germany hates this door, but it would do the most to mitigate market pressures on the periphery.