Less than a decade after various complex, synthetic, squared, cubed and so on securitized debt structures nearly brought down the financial system, here come "Sovereign Bond-Backed Securities."
Moments ago, the FT reported that in a watershed event for the European - and global - bond markets, Brussels is pressing for sovereign debt from across the eurozone to be "bundled into a new financial instrument and sold to investors as part of a proposal to strengthen the single currency area."
Call it securitized sovereign debt.
In the latest attempt by Europe to create a common bond market, a European Commission paper on the future of the euro seen by the Financial Times, advocates the launching of a market of “sovereign bond-backed securities” — packaging different countries’ national debt into a new asset.
The logic is simple: combine all the debt from strong and weak countries into one big pool, eliminating the outliers on both sides, then tranche it out, and sell it based on required yield returns.
Officials hope that the plans would boost demand for debt issued by governments with relatively weaker economies, and encourage banks to manage their risks better by diversifying their portfolios, while avoiding old political battles over whether the currency bloc should issue common bonds.
Why now? Because as has been Germany's intention all along, Berlin has been hoping to create a fiscally intergrated Europe (with a shadow government in Berlin of course), call it a (quasi) "fiscal union", and which is much more stable and resilient than the current iteration which is only as strong as its weakest link. Securitizing the sovereign debt resolves virtually all outstanding problems.
The commission paper is the latest in a series of efforts to kick-start integration inside the eurozone. Such integration efforts have stalled since financial markets became convinced in 2013 that the European Central Bank would not allow the eurozone to break up. The last successful integration project was the creation of an EU banking union three years ago.
There is another reason why now: over the next year, the ECB's QE, which has been instrumental to implement Draghi's "Whatever it takes" bluff, will start hiking rates and eventually unwinding its balance sheet, the world's biggest. That's when the European bond market may have its next freak out moment. As a result, Brussles and Frankfurt are hoping to preempt this potential unwind by coming up with today's "ingenious" solution. More from the FT:
Although the markets have warmed to eurozone debt since the height of the crisis, many analysts believe the sentiment is reliant on continued sovereign bond purchases by the ECB as part of its unprecedented economic stimulus programme, which shows no signs of letting up.
If the ECB were to back off on quantitative easing, some eurozone countries could again become vulnerable, and many officials have urged issuing bonds backed by all 19 eurozone countries would be the easiest way to keep borrowing costs low for underperforming economies.
Most importantly, however, Germany will be delighted that it won't have to shoulder a disproportionate risk burden than it otherwise should. Indeed, in the past, Germany has strongly resisted any “eurobond” proposal as it would mean Berlin is using its own credit strength to support the rest of the eurozone. However, under new plan "would not pool, or interfere with, national governments’ debt issuance — a red line for Berlin.
As the FT adds, the plans, which is expected to be completed by November, will be be presented by the European Commission on Wednesday as part of a broader reflection paper on the future of the euro.
What are next steps?
Brussels’ intention is that the market for securitised bonds could be established in the shorter term while talks continue on more far-reaching possibilities for Europe to develop a security that could replicate the role that US Treasury bonds play on the global market.
The paper notes that these more ambitious ideas for creating a “European Safe Asset” raise “a number of complex, legal, political and institutional questions that would need to be explored in greater detail” and that the whole issue of debt mutualisation in the eurozone “is heavily debated.”
The disclosed proposal also explains the surprisingly friendly attitude by Germany's Merkel toward Macron: after all this plan only works if Europe's top economies support it, and since for Germany sovereign debt securitization is the best possible outcome, the last thing Merkel would want is for the French to block the proposal.
The debate over the future of the eurozone has been given renewed impetus by the election of Emmanuel Macron in France, who is pushing for a common eurozone budget and central finance minister; Paris and Berlin have agreed to look jointly at reform options.
In addition to new financing instruments, the paper sets out a broader reform agenda up to 2019 and another set of more ambitious options for the period leading up to 2025.
One final question: who will buy this latest securitized product? Well, there is about $8.5 trillion in shadow debt (or, as they call it there, investments) in China which needs to be laundered into a new, pristeen security. We are confident that hundreds of otherwise insolvent Chinese banks will be delighted to step up and provide the funds needed to ignite Europe's sovereign securitization market, especially if it means they will be able to park even more "hot money" in Europe in the process.