Eurobonds: an essential guide

Eurobonds, or collectivising debt, might sound great to Greece, but they go fundamentally against Germany's approach to resolving the crisis

Phillip Inman
theguardian.com, Thursday 24 May 2012 12.20 BST

Greece may favour eurobonds but Germany is harder to persuade. Photograph: Orestis Panagiotou/EPA

1. The issue at a glance
2. Why is it being talked about now?
3. A brief history
4. What happens next?
5. The options – and key arguments
6. What does it mean for me?
7. Key players
8. Glossary
9. FAQ
10. Some key statistics
11. In greater depth
12. One sentence killer dinner party line on eurobonds

1. The issue at a glance

Borrowing costs are rising for many of the single currency's 17-members. Italy, Spain, Portugal and Ireland are among those that must pay sky high interest rates on their debts. But what if France and Germany helped out? What if the biggest economies on the continent agreed to issue euro loans on behalf of all countries in the currency club? A euro loan, or bond, could be issued by one country, but would be underwritten by all of them. Germany would pay more for its debts and Greece would pay less.

2. Why is it being talked about now?

There is an almighty bunfight in Brussels as a growing number of eurozone leaders agree the adoption of eurobonds is the key to unlocking the crisis.

New French president François Hollande is fighting hard alongside Italy's prime minister Mario Monti and Spain's PM Mariano Rajoy to persuade the Germans, Finns and Austrians that eurobonds are a sensible move towards a closer union and a quick back-door method for better-off countries to subsidise Greece, Portugal, Ireland, Spain and Italy.

The Greek crisis has spread fears that Spain and Italy could struggle to sell their bonds without support from Brussels. Spain, in particular, which is close to spending more than €100bn (£89bn) rescuing its banks, could be shunned by private sector lenders and run out of money without support from the mothership. Brussels does not have enough in the kitty to keep Spain and Italy afloat.

The German government and central bank, the Bundesbank, are vehemently against the idea. They don't want to pay higher interest rates. More importantly, German chancellor Angela Merkel says EU treaties forbid joint debt liabilities. The German constitution would also need to be amended say others.

And the Bundesbank said recently that even if these problems could be overcome, it will encourage poorer countries to relax their reforms and it will be the Germans left on the hook for the debts if something goes terribly wrong and several countries go bust.

However, Merkel was forced by opposition MPs to examine a proposal from her own council of economic advisers that the eurozone 17 share the liabilities on debts over 60% of GDP using a so-called redemption fund. The fund, backed by euro member states' gold reserves, would be worth €2.3tn and help governments scale back outstanding debt to below 60% of economic output. Rather than turn all national bonds into eurobonds over time, the redemption fund would be limited to 25 years and would be accompanied by a pledge by states to put debt limits in their constitutions and commit to economic reforms.

3. A brief history

Discussion of how eurobonds might work has occupied EU members since the 1960s. A single currency for the six founding members was under discussion in the 1950s and a collective way to borrow using eurobonds was part of the plan. When the idea of a shared currency was resurrected in the mid 1990s, borrowing for all countries was extremely cheap and the need for eurobonds was unclear.

They are not to be confused with the eurobond market, which is a way for corporations, banks and other private entities to borrow money by issuing bonds. London is the world's biggest eurobond marketplace.

4. What happens next?

One by one European leaders are lining up to voice their support for eurobonds. Mario Monti, the technocrat prime minister of Italy, is in favour along with Mariano Rajoy, the Spanish PM. Greece, Ireland and Portugal would jump at the chance. Even British prime minister David Cameron has urged the 17 members to set aside their differences and agree to issue eurobonds. The key date is now the Greek elections on 17 June. Another strong vote for parties opposed to the terms of the bailout and the crisis will deepen, possibly forcing the EU leadership to choose between a watering down of the current deal or letting Greece leave the euro.

5. The options – and key arguments

Option	Arguments for	Arguments against	Who supports
Status quo – eurozone countries continue to issue their own loans	Eurozone members should live with the consequences of their debts, which in Greece's case is higher borrowing costs	Without sharing the costs of borrowing, weaker members of the eurozone will need bigger loans or 19th century welfare states	Germany, Finland and Austria head the list of countries that want to continue issuing their own bonds
Eurobonds – Brussels takes out loans on behalf of all eurozone members	Sharing the cost of borrowing brings the eurozone further together. Private investors would buy bonds, helping all nations stabilise their interest bill	Indebted countries let off the hook to carry on spending and racking up more debt now it is cheaper	France, Spain and Italy are cheerleaders with new French president François Hollande putting it at the top of his wish list
Redemption fund – a plan to create a common liability for national debts, but tied to privatisations, free markets and austerity	Allows indebted countries to offset some of their sky-highborrowing costs against Germany's lower rates	A complicated half-way house that satisfies no one. Likely to last only a few months before Greece breaches agreement and Germans withdraw	Council of economic advisers to German chancellor Angela Merkel and opposition SPD officials who see it as the best compromise

6. What does it mean for me?

Should eurobonds see the light of day, it could stabilise the eurozone and put an end to speculation that countries will go bust. As each nation issues new bonds to pay for welfare spending, investment, or just to repay old debts, it will be in a new eurobond and almost certainly at a cheaper interest rate.

The eurozone takes 40% of the UK's exports and stability could bring growth for them and us. UK borrowing costs are ultra low because Britain is viewed as a safe haven. This is unlikely to change, even with extra competition from eurobonds.

7. Key players

Angela Merkel
Merkel and her foreign minister Guido Westerwelle and finance minister Wolfgang Schäuble have argued strongly that eurobonds are flawed. But recent election losses for Merkel's CDU and Westerwelle's FDP could force a U-turn. Maybe the German people are more willing to tolerate higher borrowing costs and a little constitutional jiggery-pokery to keep the show on the road.

François Hollande
Hollande wants to bend the rules to preserve monetary union. He is putting pressure on the Germans to sanction eurobonds despite their reservations.

Mario Draghi
Mario is playing hardball along with the Germans. But if he has a softer side, and believes the rules should be bent to preserve the single currency, he could back Hollande's eurobond plans.

Alexis Tsipras
If the head of Greece's breakaway socialist group gains ground in new elections he could force the Germans to back down as the price of staying in. Eurobonds could save Greece from decades of high debt costs.

Goldman Sachs
The US investment bank advised the Greek government on how to use local banks to buy its own debts, thereby disguising the true level of its borrowing. Goldmans is now advising the Spanish on their debt crisis. Maybe if the whizz kids at Goldmans can successfully trick the bureaucrats in Brussels that all eurozone debts are lower than they first appeared, the Germans will be happy to back collective eurobonds.

8. Glossary

Bond: a loan that lasts for a fixed period that can range from three months to three years to a decade and beyond. It pays out a monthly fee, or coupon, and at the end of the borrowing period the headline amount borrowed – the principle – is repaid in full.

Coupon payment: the monthly bond dividend paid out by the bond issuer to the bondholder, which is a percentage of the total loan. So if it is a £2bn 10-year bond with a 4% interest rate, that means the bondholder gets £80m a year, as well as £2bn when the 10 years are up.

Eurobond: a bond issued by a sovereign state – Greece, say – but whose coupon payments and principle payments are underwritten by all EU states. More bomb-proof than a bond issued by an individual nation, therefore.

Default: when a state reneges on a sovereign bond payment, whether a monthly coupon payment or the full principle payment.

9. FAQ

What is a eurobond?

A bond is another word for a loan. A eurobond is a collective loan: part of the problem facing some eurozone countries is that they are struggling to borrow from financial markets at affordable interest rates. If instead the European commission, for example, could borrow on behalf of all eurozone member states by issuing joint bonds, the cost could be lowered for countries such as Italy and Spain, because investors could be confident that stronger countries stood behind their debts. Analysts calculate that Portugal, for example, would see annual repayments fall by €15bn, or almost 9% of its GDP, as its interest rate fell to the eurozone average.

Sounds great. Why don't they just do it?

Eurobonds might sound great to Greece, but they go fundamentally against Germany's approach to resolving the crisis. Collectivising debt removes the incentive for individual countries to put their own public finances in order. It also opens up a so-called "moral hazard" problem: if profligate behaviour goes unpunished, what's to stop any country going on the national equivalent of a giant bender and expecting Germany to pick up the tab?

If Germany's borrowing costs rose to the eurozone average, it could cost Berlin an extra €50bn a year in repayments – almost 2% of its GDP. There are political and constitutional problems with the idea for Germany too: the constitutional court has made clear that it is not willing to sanction open-ended bailouts of other countries.

Even if the Germans signed up, would eurobonds resolve the crisis?

No. They could help to calm the market panic and ease the immediate budgetary crisis of some countries, including Italy and Spain. But a eurobond would do nothing to reduce overall levels of debt, let alone tackle the underlying structural problem that countries such as Greece are simply unable to compete fairly with their eurozone partners.

Don't euro leaders usually come up with a fudge when they can't agree on something?

Yes. There are modest versions of a eurobond, where countries would still be responsible for the majority of their debts, with the commission just picking up the riskiest slice, for example. Such an arrangement might be more palatable than a full-blown collectivisation of the debt. The redemption bond fits the bill.

More modest is the idea for €230m of so-called "project bonds", which would see euro countries jointly raise finance for specific infrastructure schemes aimed at creating jobs and boosting growth. But the less ambitious the plan, the less likely it would be to succeed.

So what are the chances for the eurobond solution?

Angela Merkel and her finance minister, Wolfgang Schäuble, have repeatedly expressed their opposition. Hollande and his Germanophone finance minister, Pierre Moscovici have allies in Monti and Rajoy. Another powerful Italian, ECB president Mario Draghi, favours eurobonds, but so far Germany has paid little heed to his demands for more rescue measures.

If the Germans are right and the EU treaty needs changing to allow joint fundraising, then amendments to the treaty are the first step. Most likely a more fundamental merger of nation states is also on the cards, just as the United States did at its Constitutional Convention of 1787. A political structure to match the shared currency would mean a United States of Europe run from Brussels. New debt would be in the form of eurobonds and would be backed by the European Central Bank. France is keen to force the ECB to accept responsibility for the bonds without a political union.