The Eurobonds Guide

The Eurobonds Guide

Will They Help Us Out of the Economic Crisis?

eBook - 2014
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There are many books about the economic crisis so why should this author write another one? The author's intention is to develop a better understanding to the current economic crisis that followed the financial crisis of 2008/09. Further, the author intents to provide a good solution as a response by the European Union.The first part of this book focuses on financial systems. It gives a general overview and discusses the importance of the efficiency of the financial system for the economy. On the basis of some information about the current economic crisis a combination of sovereign debt crisis, the euro project fault-lines and fragility of banks this book provides an insight into the difficult European situation, and the resulting consequences for the EU. Moreover, the author gives an overview of the current situation on the European bond market, and an introduction into the debate about a possible creation of a common European bond market. The main part focuses on the Eurobond proposals, and the common issuance of euro area Member States sovereign bonds. The aim of this work is to provide an in-depth understanding of the main models and the most discussed proposals. In the summary, the theories and solutions are discussed, that were developed from different groups in order to solve European problems.Based on pros and cons, and in connection with considerations of the author, the following three questions will be answered: What could be the role of Eurobonds in solving the current economic crisis? What could be the role of Eurobonds within the euro area financial system? Could Eurobonds be a durable and equitable solution for a common European bond market? The book ends with an outlook that envisions prospects for Europe.   Auszug aus dem Text Text Sample: Chapter 5.2.2, Euro-nomics 'European Safe Bonds' (ESBies) (43): European Safe Bonds
(ESBies) are no eurobonds, but collateralized debt obligations (CDOs) suggested from the euro-nomics group of European economists and the issuer would be a public multilateral institution, ist incentives should be aligned with those of the public. In the introduction of ESBies Professor Markus K. Brunnermeier explained, that the crucial reason for Europe's problems were a consequence of a much wider problem: the lack of safe assets. Modern financial systems rely heavily on safe assets and safe assets have three characteristics: they are liquid, have minimal risk of default, and are denominated in a currency with a stable purchasing power. He pointed out that Europe do not have a safe asset that rivals US Treasuries. In the absence of a European safe asset, bank regulators, policymakers, and investors have treated the bonds of all of the sovereign states in the euro area as safe for the last 12 years, even though they have traded them at widely different prices in the market. The euro-nomics group hint to two severe problems. Firstly, it created a diabolic loop: Encouraged by the absence of any regulatory discrimination among bonds, European banks hold too much of their national debts, which, far from being safe, instead fed never-ending speculation on the solvency of the banks. European sovereigns, in turn, faced a constant risk of having to rescue their banks, etc. In order to break this loop, and giving the euro area a chance to survive in the long run, requires in their opinion creating a European safe asset that banks can hold without being exposed to sovereign risk. Secondly, in absence of a European safe bond, the bonds of some sovereigns have satisfied the demand for safe assets and generated large capital account imbalances in the euro area. In order to counteract this progress they proposed to create European Safe Bonds. ESBies are
securities issued by a European Debt Agency (EDA) composed of the senior tranche on a portfolio of sovereign bonds issued by European states, held by that agency and potentially further guaranteed through a credit enhancement. They would not require more fiscal integration, are European, safe and freely traded bonds in market, held by European banks, investors and central banks as a natural starting clientele to satisfy the demand. The first security - the ESBies - would grant the right to a senior claim to the payments from the bonds held in the portfolio. The second security - composed of the junior tranche on the portfolio for bonds - would be sold to willing investors in the market. In contrast with the ESBies, this is a risky security (akin to an equity claim in the EDA but obviously without control rights). The success of the ESBies depends on two regulatory changes. Firstly, the ECB would grant strict preferential treatment to ESBies, accepting them as ist main form of collateral in repo (repo is a repurchase agreement where the sale of securities together with an agreement for the seller to buy back the securities at a later date) and discounting operations. Secondly, bank regulators would give a zero risk weight to ESBies, but not automatically to other sovereign bonds. The eight main benefits are based on two complementary elements: Changing bank regulation and ECB policy to reflect the risk of sovereign bonds, and supplying a large amount of a euro area-wide bond that is as close as possible to being risk-free. First benefit is that the bank regulatory changes would remove the distortions (riskiest sovereign bonds have artificially high prices) and lead to the correct pricing of the risk associated with sovereign bonds. Second benefit is the jointly changing bank regulation and introducing safe bonds. Third, the existence of ESBies
creates a benefit by itself, independent of bank regulation, the EDA would capture some of the 'safe haven' premium that investors are willing to pay in exchange for the safety and liquidity of the asset. Fourth, the large capital flow imbalances due to the search for 'safe haven', as the 'flight to quality', while stabilizing portfolios for sovereign debt and reducing the sudden reversals of capital flows across Europe. Fifth, the ECB would benefit by conducting open market operations with ESBies (in the sense of trading them for other riskier securities). Sixth, in no part of the proposal does the taxing power of a sovereign over ist citizens play a role, because the safety of ESBies is achieved by the triple virtues of diversification, tranching, and credit enhancement. Seventh, the proposal of ESBies does not require any change to European Treaties. The final advantage is that they would generate as a by-product, data on the euro risk-free yield curve. By eliminating the distortions brought about by bad regulation (bank regulation practices of accepting national sovereign bonds as risk-less for capital requirements together with the ECB's generous haircuts leads to a mispricing of sovereign bonds) creates value. The euro-nomics group conducted some numerical simulations to determine how large the benefit of pooling together different bonds would be and considered three possible scenarios facing European sovereign bonds: In the first one there is a catastrophe where all countries in the euro area have a higher likelihood of default than there has been implicit in prices in the last 20 years, and default in the periphery countries is almost certain. In the second scenario, there is low default risk for all countries except Greece, which is almost sure to default. Finally, the third scenario captures normal times, where they assign default
probabilities according to each country's current credit rating. They also assume that the recovery rate to the bondholders is lower in the worse Member States, and that if some of the larger countries defaults, this will precipitate an almost sure default in their neighbouring countries. They considered two possibilities for assigning probabilities to each of the three scenarios, and to the expected default and recovery rates. How would the ESBies be issued? They discussed three topics: the set-up of the EDA and size of the program, the maturity and different vintages of the ESBies, and the gradual introduction of them into the euro area. So, in their opinion EDA would play an important role in the European financial system, need a technically competent staff and an independent as well as knowledgeable board of directors. A second source of temptation would be to increase the amount of ESBies issued, both as a trend over time and especially during recessions. A hard upper bound would keep in check politicians that are tempted to pressure the EDA to finance persistent public-sector deficits and a hard limit of 60% of GDP, following the Maastricht criteria, may be a good starting point, although a more conservative approach may call for a smaller amount. Another reason for an upper bound that is not too high, is that if countries place all of their bonds with the EDA, this would lead to complications on both sides of the market. A new vintage of ESBies and junior tranches could happen as often as every two weeks (like US Treasuries) or as far apart as every 6 months. One feature that will arise with time is that each vintage of ESBies would be backed by slightly different collateral and in order to keep them equally safe, the tranching threshold may have to vary slightly across issues. Issues may even be 're-opened' to avoid off-the-run type
phenomena.
Publisher: Hamburg : Diplomica Verlag, 2014
Edition: 1st ed
Copyright Date: ©2014
ISBN: 9783954895731
9783954890736
Branch Call Number: Electronic book
Characteristics: 1 online resource (94 pages)
Additional Contributors: ProQuest (Firm)

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