The European Debt Mutualization Options Matrix
Heading into the EU Summit at the end of June, talks about potential debt mutualization proposals to deal with the eurozone debt crisis had gained momentum. Ultimately, as Barclays points out, the Summit produced an agreement in principle to achieve banking and fiscal union in the medium to long term. However, this commitment was lacking detail and as we pointed out earlier, is now critically exposing once again the fundamental flaw of disunited and self-interested European union of idiosyncratic nations. While the decision to give the ESM the 'capability' to recapitalize banks directly solidified the medium-term commitment to a financial markets/banking union, there were no specific announcements/agreements from the EU Summit on various debt mutualization possibilities for the near term. If the eurozone debt crisis worsens, such that Spain loses market access and needs to be put into a full program (which a 7% yield and recent auctions suggests), policy makers will be required to give some serious thought to alternative plans, and in particular an accelerated move towards some form of debt mutualization - those options are laid out simply here (in all their unlikely transfer-of-sovereignty scenarios).
Barclays: Eurozone Debt Mutualization options, A Comparison
Market developments might relatively quickly push policy makers to consider various debt mutualization proposals, which will likely require significant transfers of sovereignty. In addition, most of these proposals come with varying degrees of challenges in terms of time to implementation, effectiveness of firepower, costliness to core countries and moral hazard. Of all the proposals, we find the ESM gaining a banking licence and leveraging itself at the ECB to be the most practical solution, especially in reaction to an acute funding crisis. However, legal considerations could prevent this from happening in the near term. Among the remaining potential choices, we believe Euro T-bill and Debt Redemption Fund proposals also look promising.
Our approach here is to attempt to analyze the proposals separately by taking into account all of the criteria. The ultimate goal for the eurozone in the long term (ie, around 10 years) would be a fully fledged Eurobond solution once the economic and fiscal integration of Europe is in place. And this would require strong implementation of existing frameworks/plans such as the fiscal compact and European Semester stability plans by all eurozone members, but also an ultimate development of a fiscal body at the eurozone level (such as a central treasury/budget office), which would imply completion of transfer of sovereignty. As such, proposals such as ESM gaining a banking license and Euro T-bills can be seen as initial milestones on a roadmap for Europe, which will ultimately lead to a Debt Redemption Fund or fully fledged Eurobonds.