What the ECB ought to be doing now so as to end the Crisis without Treaty changes, debt buybacks, haircuts or fiscal transfers

In reply to the “Critique on the Modest Proposal” by Andreas Koutras[1]

If you think that the Euro-17 Treaty change agreed yesterday will help overcome the eurozone’s Crisis, read no further. If, however, you think that the solution lies not in Treaty changes, but requires other means, including an active role to be played by the ECB, do read on.

More than a year ago Stuart Holland and myself put forward the Modest Proposal for Overcoming the Euro Crisis. It has never been more pertinent than now. Most commentators, globally, agree on two things:

  1. This Crisis will not melt away unless the ECB adopts an active role, and
  2. The ECB will never be allowed, primarily by Germany, to intervene by printing money.

If both (1) and (2) are correct (as I am sure they are), what can be done? Our Modest Proposal answers simply: The ECB should step in not by printing money but by borrowing on behalf of the member-states. Pure and simple. Moreover, we claim, if the ECB borrows by issuing its own bonds (ECB-bonds hereafter), it will become possible to use this new instrument not only to reduce the eurozone’s overall debt burden but also to finance (together with the European Investment Bank) a New Deal for Europe.

But is it that simple? Our Modest Proposal, whenever and wherever we presented it, met with the immediate response that Central Banks do not issue bonds for a reason; that there will be no taxpayer to back them up (thus raising questions about the interest rates of these ECB-bonds); that our proposal conflates fiscal with monetary policy; that it constitutes a backdoor policy for having the ECB print the money needed by the member-states; that such a move would jeopardise the ECB’s independence etc.

We have been answering (see here for an example) these rejoinders for more than a year (with considerable success, I might add, judging by the fact that our Modest Proposal has been adopted by important organisations, such as the ECTU, and approved by assorted bankers, many former Heads of State, financiers etc.) Nevertheless, with the eurozone in such an advanced stage of disintegration, and our leaders committed to searching for solutions in the fairyland of Treaty amendments, it is important to re-examine our Modest Proposal and, in particular, the idea that (1) and (2) above can be combined by having the ECB borrow rather than print; by turning the ECB not to a lender-of-last-resort but to a debt-converter-of-last resort.

Koutras’ Critique (readers preferring to read the long text below on pdf please click A Reply to the Critique of the Modest Proposal by A. Koutras)

The impetus for revisiting various criticisms of our Modest Proposal came in the form of a recently published critique. Indeed, Andreas Koutras paid our Modest Proposal the complement of studying it and writing a piece in which he identifies what he thinks are serious flaws. For this I wish to thank him. Goodness knows Europe desperately needs open minds (and hearts) so as to, at long last, have a decent debate on the true nature of the Crisis, with a view to fashioning rational responses to it.

Koutras’ paper (click here for the pdf version and here for the web version) begins by noting, quite correctly, that the Modest Proposal consists of three policies but concentrates its analysis on Policy 1, the idea of ECB-bonds for the purposes of converting a large part of the eurozone’s sovereign debt. Quite clearly the author thinks that this is the bone of contention. Though I shall argue that ignoring the other two policies (especially Policy 3) causes a degree of confusion, I shall nevertheless go along with Koutras and engage with his assessment of Policy 1.

Koutras’ paper is structured as follows:

  1. A summary of Policy 1 (our Debt-Conversion Plan, i.e. Policy 1, according to which the ECB takes upon itself the task of servicing the eurozone’s Maastricht Compliant Debt, while simultaneously opening debit accounts for the member-states whose debt is being serviced)
  2. A piece on the use of Special Purpose Vehicles by banks prior to 2008 (which was, indeed, central to the mass financial destruction wrought by the financial sector itself)
  3. An interpretation of the ECB’s role in effecting this Debt Conversion in the context of the history of Special Purpose Vehicles
  4. A series of potential flaws of our Policy 1 in the context of the preceding analysis under the following headings:
  • i. Overdraft Facility not allowed by Article 104
  • ii. e-Bonds fail to sell?
  • iii. ECB’s Independence is in peril if Credit guarantees are given
  • iv. Countries take the losses (taxpayers)?
  • v. Pretend it is a Liquidity and not Solvency crisi
  • vi.  e-Bonds are not Plain and Boring Bonds
  • vii. Monetary Policy reversal
  • vii Fiscal Policy-Democratic Deficit

Below I address each of these headings in turn before summing up my rejoinder to this critique.

Koutras’ summary of Policy 1 is fair and accurate. (Readers not familiar with our Policy 1 are requested to do so now – see here.) So is the historical account of the calamitous role of SPVs that brought upon us the spectre of a financial Armageddon in the Fall of 2008. Where I begin to part ways with Koutras is in the way he interprets our Policy 1 through the prism of the SPV ‘experience’. To put it simply, Koutras draws a parallel between the role we envisage for the ECB and the use of SPVs by Wall Street banks. This parallel is, I think, both unhelpful and inaccurate.

To begin with, SPVs were created, as Koutras admirably explains, in order to hide debt and to shift it from a more creditable (the bank) to a less creditable pseudo-stand-alone vehicle (the SPV). Our policy suggestion does precisely the opposite. First, the operation we are proposing is bathed in light and its success relies not in the slightest in hiding anything. Secondly, it shifts debt servicing from entities that are suffering from low creditworthiness (member-states) to one (the ECB) that is credit-worthier. In this sense, the SPV metaphor is precisely wrong. Moreover, we have gone to great lengths to clarify that the proposed tranche transfer is done on the balance sheet of the ECB itself, and not some offshoot of it (an ACME-ECB outfit, as Koutras named it for argument’s sake). Summing up:

The SPV metaphor is precisely wrong (Rejoinder I, addressing point 3 above)

“The problem with shepherds is that they see sheep everywhere”, Ibn Khaldoun once wrote. And the problem with those who cut their teeth in the financial sector is that they see SPVs, CDOs etc. whenever a re-financing schedule or operation is mentioned. I understand that. For instance, when the Europeans wanted to create a bailout fund in May 2010 (in the wake of Greek Bailout Mk1), they told their blue eyed backroom boys and girls: “We need to find a way of raising money from the strong eurozone countries to fund the ones that may follow Greece into the abyss. But we do not want to allow for one cent of common debt. How do we do this?” The answer these chaps and lasses gave was commensurate to that which they knew: Create an SPV, call it EFSF, and make it raise finance from the not-yet-fallen member-states by issuing CDO-like bonds.

At that time we put together our Modest Proposal (the Mk1 or 1.0 version) in order to propose precisely the opposite: No SPV and homogeneous bonds that look nothing like CDOS  – i.e. bonds that do not consist of different slices, each with a different interest and default rate corresponding to a different eurozone member-state. To ensure this we specified that bonds are issued by the ECB itself, on the model of EIB (European Investment Bank) bonds that are issued not through some SPV but by the EIB itself.

No overdraft facilities involved (Rejoinder II, addressing point 4i above)

Koutras understands our Debt-Conversion idea well but interprets, or phrases,  it in a manner that I wish to take issue with. It is, of course, true that the very idea of a Debt Conversion operation is to utilise the better creditworthiness of some party (in this case the ECB’s) in order to offer other parties (the eurozone’s member-states) interest-relief. When a creditworthy parent negotiates a low-interest rate loan by which to repay a (less creditworthy) child’s existing high-interest loan on condition that the child meets the monthly repayments, it is correct to say that the parent shifts risk from the bank to herself (and this is why the interest rate charged is reduced). But to describe this operation as the parent “selling protection” to the bank is to introduce into the equation a transaction that is simply not there. Similarly, according to our Policy 1 the ECB simply sells plain and boring bonds (in the sense that there is nothing complicated or CDO-like about them). No protection, no CDOs, not a whiff of SPVs are involved. (Of course, whether buyers will want to buy these bonds is another matter, which I discuss below.)

In the same section of his paper, Koutras quotes from Article 104, with a view to arguing that our Modest Proposal violates it:

Overdraft facilities or any other type of credit facility with the ECB or with the central banks of the Member states (hereinafter referred to as .‘national central banks.’) in favour of Community institutions or bodies, central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of Member States shall be prohibited, as shall the purchase directly from them by the ECB or national central banks of debt instruments.

Notice the keywords here regarding that which is categorically prohibited:

(a) overdraft facilities (in favour of Community institutions or bodies)

(b) credit facility (in favour of Community institutions or bodies)

(c) direct purchase of… debt instruments.

Notice too that Policy 1 of the Modest Proposal requires none of the above. Indeed, it was designed in order to preclude all of these. Let’s look at them one by one beginning backwards: We argue explicitly against the idea of ECB purchases of member-state bonds, in full accordance with (c). We also suggest nowhere the creation of either credit or overdraft facilities on behalf of member-states or other community institutions – in strict adherence to (a) and (b). In contrast, what we are suggesting is that the ECB opens debit accounts into which the eurozone member-states will be paying (as opposed to withdrawing) money. This is precisely the opposite of facilities from which member-states draw credit of one sort or another.

To sum up, Policy 1 of the Modest Proposal neither suggests that the ECB “sells protection” to bond buyers nor canvasses any form of debt purchase, bond buyback or overdraft facility for member-states. In this sense, the Modest Proposal is fully in accordance with Article 104. Koutras’ point, however, is that our scheme introduces a potential overdraft facility through the backdoor. Let us examine this claim which comes in the form of a legitimate question posed by Koutras:

“So what happens if… the government bonds start underperforming or even the sovereign stops servicing them? Does the … ECB have an unlimited liquidity commitment with the Eurozone countries? The hidden assumption of the MP is that since it is a central bank, it has its own! In the event that the sovereign cannot make any payments the … ECB would make up the shortfall for it. This would be done by printing new money or perhaps by the sovereign pawning some assets with the ECB (giving collateral). What I have just described is called an overdraft facility. If the sovereign is not able to fulfil its financial commitments the ECB offers a credit facility or an overdraft facility until the country in question recovers.

For starters, it is inaccurate to imply (via a question) that the ECB will have “an unlimited liquidity commitment” since this Debt Conversion applies only to the Maastricht Compliant part of the member-state’s debt, which is strictly finite. But let’s bypass this and move to the genuinely interesting and tantalising point; namely, that if a member-state defaults toward the ECB then the ECB will have, effectively, to extend credit to it courtesy of having to meet the repayments to ECB-bondholders itself. Clearly, in this case, we have a potential violation of Article 104 in our hands. Nevertheless, it is a violation that can be easily preventable. How? Simply by affording (as the Modest Proposal argues) the debit accounts of the ECB superseniority status. In short, by having all member-states participating in the Debt Conversion operation sign an agreement with the ECB, well in advance, that binds them to placing the servicing of these debit accounts over and above all of their other obligations. That way, even if one of the member-states, needs to restructure its overall sovereign debt, its debit account with the ECB will not be affected – unless we have massive default and the other member-states do not step in.

In any case, if public finance is the high art of the possible, it is essential to compare our Modest Proposal not to some airy-fairy, wishful-thinking-imbued,  version of the eurozone but to the really-existing eurozone. As we are exchanging these ideas, the ECB is already printing money to buy at least €200 billion worth of stressed  bonds on the secondary markets. [The claim that these purchases were ‘sterilised’, and therefore that no money was ‘printed’ for the purpose of buying these bonds, does not withstand seriously scrutiny.] Additionally, it holds another much larger swathe of government bonds in the form of collateral from (effectively) insolvent banks. The more the Crisis progresses unchecked the greater the volume of stressed bonds (which will more likely than not need to be haircut) inside the ECB’s reluctant bosom and the more money it will be printing in the context of a battle against markets it knows it will lose (just like it lost in the summer of 2010 the battle of preventing Portugal and Ireland from going under). To put the point not too finely, if our Debt Conversion proposal violates Article 104, the present reality violates it to the power of n, where n is an increasing function of time.

Will ECB-bonds sell? (Rejoinder III addressing point 4ii above)

Like hot cakes they will! Let me explain this conviction:

Koutras draws parallels with the ECB’s problematic sterilisation operations and the ‘distressed’ EFSF bond issues. I claim that these cases, though instructive, are not relevant to our proposal. Indeed, I have been arguing since May 2010 that the EFSF bonds are toxic and that soon no one would want to touch them. Moreover, ever since the ECB started buying Irish and Portuguese bonds (back in the summer of 2010) while, supposedly, sterilising these bond purchases, I was screaming from the rooftops that such sterilisation is simply not credible since, as Koutras rightly says, the insolvent banks can hardly participate credibly in this sterilisation operation (see It’s the banks stupid). But this is all irrelevant to the question at hand: Will investors buy our ECB-bonds at low, low interest rates, as I claim? Let me explain why I think they will (and why they tell me they will!).

First, (unlike the EFSF bonds) ECB-bonds will not be CDO-like in nature. Secondly, we do not expect European banks to be the main buyers but, rather, sovereign wealth funds, pension funds and private investors. The key to the success of our Debt Conversion operation is the credibility of the ECB and, in a never-ending circle, the way that the latter is reinforced by credibility of the Debt Conversion plan itself. Thirdly, the Debt Conversion Plan’s credibility will be boosted, as argued above, by the superseniority status of the member-states’ debit accounts with the ECB.

To see what is at stake in a little more detail it helps to consider an example:

An example:

Consider the case of €100 million Spanish bonds owned by, say, Mr Nagiru of Yokohama. Purchase date: 2nd May 2005. Maturity date: 2nd May 2015

As things stand, on 2nd May 2015 Spain must borrow €100 million in order to repay Mr Nagiru by issuing a new bond. Consider its cost over a 20 year period while Spanish interest rates are around, say, r = 6%. In short, in 2015 Spain will have to issue 20 years bonds of a €302.56 million face value. In short, to roll over these €100 millions for the following 20 years (come 2nd May 2015) Spain will be committing itself to an interest payment of €202.56 million (payable on 2nd May 2035).

In contrast, under our Debt Conversion plan two interest rates will determine Spain’s cost of rolling over the same €100 millions. One is the interest rate that the ECB will manage to secure in the markets when selling its own ECB-bonds (call this recb) while a second interest rate, say rs, will apply to that funds Spain must raise on its own for the part of its debt that is over and above its Maastricht-Compliant level. To make our Debt Conversion work, recb<r and rs

r. [In fact, we are convinced that recb< rs << r. But more on this below.] Let us now compute Spain’s total interest savings over the 20 year period beginning on 2nd May 2015, in this example from our proposed Debt Conversion, under different interest rate assumptions:

Spain interest savings (s) from the Debt Conversion over the 2015-2035 period = Cost of refinancing without the ECB-brokered Debt Conversion (call it C) minus the cost of servicing the ECB’s own bonds (that involves paying E into the debit account opened by the ECB) minus the repayments R of the Spanish bonds that Spain must issue on 2nd May 2015 in order to roll over the part of the debt not serviced by the ECB (i.e. the part of the €100 million over and above its Maastricht quota). In short,

s = C-E-R =

where μ  is the proportion of the country’s debt which is Maastricht Compliant – see Appendix.

The following table depicts the interest savings made possible by our Debt Conversion under different assumptions regarding interest rates recb and rs while supposing the interest rate Spain would have access to sans the ECB’s Debt Conversion will be around 6% (more or less as now). [Note that I am assuming that Spain’s μ will remain as today around 71% or 0.71.]

Reduction in interest due in 2035 from rolling over €100 million of Spanish debt in 2015


6% (0.06) 6% (0.06) 6% (0.06) 6% (0.06) 6% (0.06)


4% (0.04) 3% (0.03) 2.5%(0.025) 3% (0.03) 2% (0.02)


6% (0.06) 5% (0.05) 3% (0.03) 4% (0.04) 4% (0.04)
Total interest saved (millions) €65 €104 €138 €116 €138
Interest saved as a % of interestpayable without the Debt Conversion 21% 34.4% 43.61% 38.33% 43.61%

It is clear from the above that Spain’s long term debt mountain can be massively reduced if the ECB manages to sell its bonds at interest rates below those that Spain can fetch presently. In the first column I present a conservative scenario: The ECB only achieves an interest rate that Germany would, today, consider unacceptably high (i.e. 4%), and nothing else changes. Still, Spain’s interest mountain will have shrunk by 21% over the twenty year period under consideration. As any market trader knows, this prospect is sufficient to spearhead an exit from the current vicious circle and the creation of a new virtuous circle.

More precisely, the moment the ECB-brokered Debt Conversion plan is announced, say tomorrow morning, the prospect of a considerable reduction in Spain’s aggregate interest payments will push Spain’s own interest rates lower. Suppose they diminish to, say, rs = 5%. Suddenly the markets will see that Spain’s outlook is improving and, therefore, will become less sceptical that it may fail to repay the due monies into its ECB debit account. As soon as this happens, recb will dip to, say, 3%. The second column now reports that the aggregate interest savings of Spain rises from 21% to an impressive 34.4%. This is enough to create even more optimism about both Spain and the ECB. If so, we are about to shift to one of the other scenaria (see for example the last column) in which Spain’s interest repayments shrink by more than 40% long run. Recalling that this is an operation that applies to all eurozone member-states (that opt for it) at once, imagine the scenes of jubilation in the global markets. As the eurozone’s interest mountain collapses, both recb and the rs of each country will be falling through the floor. The (so-called) debt crisis will then become history!

Naturally, the merits of any plan depend on the provisions made in case things go wrong. Plans, in other words, must come fully equipped with decent Plans B (unlike the eurozone’s original design). Investors are, therefore, likely to ask (as Koutras does): What if these best laid plans end up in ruins? What if this virtuous circle does not take off? To utilise our example above once more, if for some unforeseen reason Spain finds it hard to repay its debts to the last cent, and has to write down a portion of them, the fact that its ECB debit account obligations have superseniority status over its remaining debts means that the ECB will be unaffected. It will only be affected if Spain’s troubles in 2035 are beyond the pale (in the conservative scenario of the table’s first column it will have to effect a haircut more than 30%, in 2035, for the ECB to have to put its hand in its pocket to repay the ECB-bonds it issued on behalf of Spain). Even then, the common knowledge that either other member-states will come to Spain’s rescue (if it needs to write down more than 30% of its debts) or that the ECB will monetise (a small part of Spain’s debts to the ECB) is sufficient to keep investors safe in the thought that ECB bonds are an excellent investment even though no member-state stands behind them.

In summary, the beauty of our proposed Debt Conversion is that this inbuilt safety valve (the fact that the ECB will not need to fund its bonds from its own resources unless haircuts of more than 30% are necessary at nation-state level and other member-states do not come to the rescue) means that investors will flock to the ECB’s bond issues, spreads will fall throughout the eurozone (i.e. both recb and rs will be low) and, in a never-ending virtuous circle, member-states will have no need to haircut any part of their debt. With markets foreseeing this, investors will be queuing up around the block to subscribe to the ECB’s bond issues.

Is the ECB’s independence in peril? (Rejoinder IV, addressing point 4iii)

In an tumultuously interdependent world no constitution, treaty or charter can render anyone truly independent of the vagaries of human-induced disasters. Pretending otherwise is silly. Central Bank Independence, in this sense, must be clearly defined. When we say that some Central Bank is independent we do not mean that it can do as it pleases. What we mean is that the politicians cannot instruct it to print money on their behalf, to lower or to raise interest rates at their whim, to fund or not to fund some stricken bank depending on their judgment. The Modest Proposal poses no threat to this definition of the ECB’s independence. In fact, the Modest Proposal enhances the ECB’s current level of independence. For we must not forget that, as we speak, the ECB is forced by our politicians’ collective folly to print money (against its wishes) in order to buy Spanish and Italian bonds (against the express opinion of the Bundesbank) in the context of a war that it is bound to lose. The Debt Conversion proposed as part of Policy 1 of our Modest Proposal effectively liberates the ECB from this hopeless task imposed upon it by serially failing politicians.

Lastly, it is important to recall that the ECB’s charter assigns two tasks to the ECB’s executive board: To be the guardian of price stability and to serve the general policies of the Council. The latter creates a grey zone regarding the extent of the ECB’s infamous independence. We believe that the Modest Proposal, by furnishing the new instrument of ECB bonds, completes the ECB’s remit and gives it the tools it needs in order to do its job better and more (rather than less) independently.

Will member-states need to take any losses? (Rejoinder IV, addressing point 4iv)

Are they not taking losses now? Indeed they are. Kicking and screaming, countries that used to be considered part of the eurozone’s core are seeing their solvency questioned as good money is thrown after bad in a desperate bid to shore up the sinking EFSF-toxified ship. Our proposal will reverse this degenerative course, minimise member-state losses, and offer the currently missing hope of returning the eurozone project to solvency.

Are we mistaking an insolvency crisis for a liquidity problem (as the EU had been doing for two years now)? Are we introducing a moral hazard dimension capable of turning even the solvent into bankrupt states? (Rejoinder V, addressing point 4v above)

Confusing a solvency problem for a liquidity one was the mistake that the eurozone made with regard to its banks and, indeed, with Greece (and possibly Ireland, once Dublin had foolishly guaranteed the Irish banks’ bondholders). Koutras is right: It should not be repeated here. Thankfully, the Modest Proposal is doing no such thing. With regard to the banks, Policy 2 of the Modest Proposal broke new ground more than a year ago by suggesting that the banks are treated as quasi-insolvent and that the EFSF should become, effectively, a euro-TARP (an idea since then adopted by many, including US Treasury Secretary Tim Geithner). The question Koutras is asking is: Are we making this mistake with regard to the public finances of the member-states? If the ECB finances member-states ad infinitum what incentive do they have to put their fiscal house in order? Might the solvent ones not throw caution to the wind and opt for profligacy? My answer is: No, no, and no!

The key point here is that the ECB Debt Conversion operation concerns only the Maastricht Compliant debt. It splits a nation’s debt in two, making it easier to finance the ‘good’, or Maastricht Compliant, part of it but telling it, in no uncertain terms, that the rest must be serviced without assistance. In this sense, it creates a de facto penalty for profligacy which rewards member-states in proportion to their success in sticking to the Maastricht limit. At the same time, it gives member-states that are just above the Maastricht debt level (of 60% of GDP) every incentive needed to bring it below that level while introducing no incentive whatsoever for any member-state below that level to exceed it. Thus, the Modest Proposal, in effect, strengthens the Stability and Growth Path and removes (as opposed to reinforcing) moral hazard incentives.

In summary, the Modest Proposal manages, at once, (a) to help bring about debt relief for member-states (without haircuts or debt buy backs or fiscal transfers) and (b) to reduce moral hazard problems. I understand that it is hard to begin to wrap one’s mind around the possibility that combining (a) and (b) is possible. But it is. Keynes once, famously, exclaimed that the Treasury’s position at the time, with its constant invocation of moral hazard as an argument against debt relief, reminded him of the case of a drunkard who was dragged out of the icy waters he had fallen in due to his inebriation. The Treasury’s position, according to Keynes, was that the  drunkard should not be wrapped in a blanket because (a) the cause of his troubles was the initial overheating of his brain (caused by alcohol consumption) and (b) he will ‘overheat’ again given a chance. If our task is to save the patient, it is important to overcome this attitude. The Debt Conversion plan (Policy 1) of the Modest Proposal intends to save the patient without, in itself, either adding new moral hazard problem or removing the original causes of the troubles. In this sense, it is a necessary though not sufficient operation (just like wrapping up the frozen drunkard in a dry blanket is a prerequisite to saving him, but no guarantee he will not get drunk again and end up in the icy waters once more).

What would make it sufficient? Policy 3 of the Modest Proposal tries to answer that question and goes to the heart of the solvency issue raised by Koutras (who, however, does not discuss Policy 3). Readers can read Policy 3 here themselves and pass judgment on it accordingly. The simple idea is to combine the European Investment Banks’ (EIB) own bond financing capacity with additional net issues of ECB bonds (in the context of EIB-ECB collaborative investment projects) in order, effectively, to create two processes: (1) A process that channels global (as well as European) savings into investment projects within Europe, and (2) another process which takes surpluses from the surplus countries of the eurozone and invests them in profitable small and medium enterprises in the deficit areas, thus undoing the intra-european imbalances which are the root cause of the eurozone’s structural problems.

Confusing monetary and fiscal policy in a manner that deepens the democratic deficit (Rejoinder VI, addressing points 4vi, 4vii & 4viii above)

This criticism is not new and I have responded to it many times in the past. Here is an extract from a post last May in which I wrote:

“Your proposal” we are told in no uncertain terms “asks of the ECB to perform not monetary, which is its remit, but fiscal policy! This is not allowed! It is beyond the pale!” But is it beyond the pale? Is it true that Policy 1 falls under the heading ‘fiscal policy’ and, thus, outside the realm that is the ECB’s natural habitat? We most certainly do not think so. Let us explain:

Collective debt management in our European currency union is a kind of interface, as much monetary as fiscal policy. It is fiscal policy only when debt is newly issued. However, once it is issued, the manner in which it is serviced can be another matter. To be blunt, debt management, is part and parcel of monetary, not fiscal, policy. According to Policy 1, the ECB will not be issuing member-country sovereign debt. It will be issuing its own supra-sovereign eurozone-debt, as and when it deems right in pursuit of its own monetary policy objective, the monetary counter-inflation targeting rule.[2]

To further underline the nature of this defining differentia specifica, the ECB does not (speaking strictly) need to issue its own new debt in order to service seasoned debt. It could just as well do this by creating new money (as the Fed has been doing). What Policy 1 is proposing is that, instead of quantitative easing US-style, the ECB borrows from the market for monetary policy purposes, recoup these monies long term from the eurozone’s member-states and make money in the process (therefore strengthening its own balance sheet). How much clearer can this be? And why is this inconsistent with the ECB’s remit?

[Click here for the whole post.]


The main criticism that the Modest Proposal has encountered is that the proposed ECB-bonds have no taxpayer behind them as a ‘backstop’ and, therefore, the only backstop imaginable is that the ECB must be prepared to print money to cover potential losses. This is wholly inaccurate. Our proposed ECB-bonds are part of a Debt Conversion plan on behalf of the member-states which do have their taxpayers behind them. In this sense, the ECB bonds also have (these same) taxpayers behind them.

So, what is the difference between ECB-bonds and a jointly and severally guaranteed eurobond to be issued by some European Debt Agency? ECB-bonds do not need German guarantees for the bonds that will be issued (by the ECB) on behalf of Spain or Italy or, indeed, every member-state that chooses to participate. It is in this sense that our Debt Conversion plan remain within the letter, but also the spirit, of the Lisbon Treaty while, at the same time, removing the currently inexorable pressure on the ECB to print, print and print.

Does this mean that the ECB, under our Debt Conversion plan, will never have to print under any imaginable circumstances? No, it does not. If in twenty years some eurozone member state needs to write down more than 20% or 30% of its sovereign debt, and the rest of the member-states (or the IMF) do not come to its assistance, it is then (and only then) possible to imagine that the  ECB will have to print a very small amount in order to service the part of its own bonds that the said member-state could not service. (Certainly less than what they are printing now!) But then again, has there ever been any country in the world where there was a cast iron guarantee that its Central Bank will never have to monetise even a small part of its debt? What nonsensical mindset requires of us such a guarantee on behalf of a Central Bank? (Jan Toporowski answers this question brilliantly by referring us to the history of Nazi financing.) To argue that our Debt Conversion proposal is equivalent to having the ECB backstop the proposed ECB-bonds is no less disingenuous than suggesting that the Bundesbank was being asked by the Federal Republic to monetise Germany’s debt during the pre-euro era.  

Next, I want to stress once again the importance of ECB bonds in dealing with the deeper causes of the Crisis, as opposed to simply offering a clever financial operation for dealing with the symptoms (i.e. with debt). As we have argued repeatedly, and Martin Wolf has recently reiterated in the FT, the eurozone’s real problem boils down to its internal trade (and productivity) imbalances; imbalances that can only be sorted out my means of targeted investment in the deficit regions and, therefore, surplus recycling. The great advantage of our ECB-bonds (which Koutras’ paper neglects to mention) is that the associated debit accounts that, according to our Modest Proposal each member-state will now have with the ECB, make it possible for a net issue of these ECB-bonds to be charged to the member-state’s account for investment projects carried out by the EIB in the member-state’s territory. It is this integration of Debt Conversion and a New Deal for Europe that makes the proposed ECB-bonds such powerful tools in the fight to the death against this current debilitating Crisis.

Finally, Koutras ends his paper with the suggestion that the weaknesses of the Modest Proposal he had identified are the reason why it “…has not captured the market practitioner’s imagination or the banker’s acceptance”. Let me say that this is certainly not my understanding. First, during the past few months I have presented the Modest Proposal to hedge funds, large banks, people at the fixed income department of Bloomberg (in New York), central bankers in the US and elsewhere etc. Almost to a person they seemed quite convinced about its merits. While it is true that many initially objected in a manner not dissimilar to Koutras’, upon hearing the above explanations their objections disappeared. Which, of course, leaves the question unanswered: Why has the Modest Proposal not been adopted? The reason is to be, I am convinced, found in the realm of politics and not public finance. To put it crudely (see here for an earlier take), because those with the political power to effect it fear that doing so will diminish their… political power. Such is the, almost ancient Greek, tragedy facing Europe today: Europe resembles a stage upon which its central characters are trapped in behavioural patterns that even the last member of the audience knows will take them straight to their Fall.

Lastly, my thanks to Andreas Koutras for his critical paper. It gave me an opportunity to revisit the Modest Proposal and re-state its raison d’ être.

Appendix: The Maastricht Compliant Debt Proportion μ

Suppose that a member-state’s total public debt equals D. Then, if μ denotes the proportion of D that is Maastricht Compliant, then μ equals 1 as long as D ≤ 0.6Y (where Y is the nation’s GDP) or μ is given by the ratio 0.6Y/D if D exceeds the Maastricht limit of 0.6Y). Diagrammatically,

[1] Email address [email protected], website:



  • Yani:

    Only you and Nikos Lygeros make any sense to me. I am not interested in ideology; I am interested in intellect and smart solutions:

    • “I am not interested in ideology; I am interested in intellect and smart solutions”

      I wish it was different , but reality boils down to what you say . Let’s hope that necessity will bring up all the right ingredients .

      Democracy is spectacular , fantastic , extraordinaire … and then everybody is fooled by his illusions and prejudices …

      Democracy is ****$$%^^ when everybody care more about his convictions to be right than the wellbeing of his/her neighbor .

      I couldn’t agree more .

  • I may be a constant skeptic about ANY good intentions of politicians in Europe to solve this crisis, because I fully believe that reshaping the Eurozone, vis-a-vis destroying Europe’s Social Contract is exactly the elites’ intention. Reading from the “dithering” article: “◦How the resolution of the banking crisis can be utilised, politically, in order to re-shape the eurozone” seems to me, nearly a year after the article was written, to be the unmistakable reason this crisis is being drawn out.

    And this comment, also from “dithering”,
    …to prevent a chain reaction of bank failures throughout the EU, the ECB, the EFSF (under new rules) and the surplus countries will come to the banks’ assistance and help them clean up their mess in the aftermath of a major banking crisis.
    will be exactly what we’ll see, once workers have been completely disenfranchised from
    any democratic control over their country’s finances.

    • Very astute comment my friend. I know cannot get sidetracked into the ideological aspects of this clusterfuck but sometime soon we should reclaim our place on the “battlefield”.

  • BTW Yani:

    The reason I posted Lygeros’ presentation (aka a mathematician’s approach) is to point out the obvious.

    Lygeros tells us that the astute mathematical way in problem solving is to generalize a particular problem three times. The commonality(with the original problem)subset found in the 3rd generalization is the basis for solving such particular problem.

    So, take Greece as the particular case to be solved. Greece has some local peculiarities but also Germany(aka Merkel) as the problem ( be it Teutonic incrementalism, obstructionism or simple ignorance).

    When you generalize Greece in the context of the EU(2nd generalization), the same commonality remains the German inadequacy. When you further generalize Greece’s problem within the global context (3rd generalization), Germany is Omni-present. From a pure mathematical perspective, fixing Germany is the cure to all 3 different levels (local, neighborhood, global)

    Therefore the solution is quite simple: Germany needs to be subdued or eliminated as a leading voice.

    It does not matter anymore who created the problem. We all know it’s an American problem of 2008 which keeps mutating. Pointing fingers or assigning causality at this point does not make a bit of difference.

    The objective is clear: Kick Germany out of the decision making process and begin to implement a synergetic solution that results in a “win-win” for all participants (country, Europe, World).

    • Dean,

      should you not have written “Kick current German government out of decision making process”?

      Germany is one of the largest ingredients of Europe, both economically and politically, but also in terms of populace. I suppose that every democratically thinking person would not want to see a whole nation kicked out because of the folly of its government; this way one would think that Greece would also have to be expelled from decision making processes in the EU.

      The reason I admire Yani and I aspire to his proposals is that not only does he show high intellectual capabilities but because he combines them with a strong democratic view as well. And I have never seen any writing of his, that encourages the fall of Germany as a nation-state.

      Instead of bringing Germany to its knees, what should be done would be to help German people understand that their government from the beginning of the crisis has been taking a path of destruction both for Europe as a whole but for themselves as well.

    • Pkars. True.

      But you also need to understand my more aggressive approach which is a direct result of German misdeeds befallen on my people.I hold all Germans responsible for their government.

      Manners don’t matter at this stage. And I don’t consider that teaching the German citizens baby steps is my job. I couldn’t care less what they do or who they are as long as they adopt an immediate and permanent “hands off” approach to Greece where their amateurish involvement has resulted in a monumental mess.

      Yani is an academic and a very nice person by all means.

      I have a different nature and I am not seeking your approval nor I am here to win your heart as a politician.

      My job is to protect my people and lead them to a certain extent. For such a task I need neither to be pleasant nor accommodating; just effective.

    • Smart Dean? Who is supposed to pay your bills then? Do you honestly believe one country is willing to pay fo the problems of others and will not want to influence decisions?

    • Pkars:

      I am sorry but you don’t get it.

      Germany has paid nothing for Greece so far and has has no intention of paying anything either in the future.

      Yet it has thrown my country in misery while arrogant Germany is pondering her options.

      Even you should understand that such can not stand and that Germany will fully deserve what’s coming to her.

    • I believe Dean’s last comment above was aimed at PCARX and not me (pkars). Please try to notice the difference, as the last thing I would want is to be identified with PCARX and his posts. I fully disagree with him/her, whereas I agree with many of Dean’s comments in this blog.

      Now that we have cleared this out, trying to take the German people (in fact all European peoples) on board is not just a matter of political correctness. It is a matter of strategy as well, as it would be very difficult to divert the path of destruction the political leaders are taking without wide public support across Europe.

    • Dean Plassaras:

      You wrote that Germany has paid nothing for Greece so far and has has no intention of paying anything either in the future.

      I have to correct you.
      Greece received between 1986 and 2006 46,5 bn euro from other European countries. Today it is about 60 bn euro. The most money came from Germany.
      The Germans pay 86 bn euro from 2007-2013. Greece receive 25 bn euro. Thus, the Greece got many gifts from other European taxpayers.

      In addition, you wrote that the Germans have the wrong positions and have to be kicked out.

      This sounds like the 16 other member states have a complete different agenda.

      I know the positions of the Dutch, French, Austrians and Finnish. I don’t want to go to deep into this, but there are only slight differences compared to the German government.

      regards Marcus

    • To Dean and Pkars

      The reality is exactly what Dean has described . The actions of government of Germany still is firm and steady . And by looking at the effects of its deeds on Europe , it is certainly not pro Europe .

      Pro – Europe , i will admit though , that is quite vague as a term . Let’s just say that , Germany is trying to exploit as much as possible the political and financial power that has at this time , while maintaining the option to create a smaller Europe . We all understand , as regular participants in this blog , that this is not in favor of Germany as well .
      Then again Germany is a vast sum of conflicting interests itself . German working class will definitely lose under the current circumstances .

      If we assume that Germany is a democratic republic , then german citizens have their own share on this mess as well . As much as Greeks are responsible for voting these opportunistic , idiotic , yes men on power .

      Describing something good or bad , let’s not forget , it’s a relative term . Let’s assume that , under the current regime where interests of countries in need are not served , and project in the future the next two years , Italy , Spain , France and many other countries will be literally destroyed . These abrupt changes are not exactly reversible.

      In contrast , a co-operation between countries with similar problems will make them more enduring , within such a hostile financial environment . Given that their mere interest is served . So , this sounds good for these countries .

      I understand that this approach is simple . I don’t see things globally and neglect the inter-connectivity .

      But can you answer me the following ?
      A country is following a financial policy that is not good for itself . For what? We all agree that this does not lead to a stronger , more unite Europe . Then for what ?

      Then again , Germany and France are getting all the contracts and properties in Greece. Someone is winning out of this mess .

  • Yanis,

    Are you concerned by S&P’s threat to downgrade the credit rating of the ECB?

    • Not really. What matters is that Europe, with the ECB in a central role, announces a rational plan that investors can see is rational. Then it matters little what S&P say. Just as it mattered little that they downgraded the US…

  • from:

    “The idea that creditors should not suffer a loss when their investment goes wrong is the reason we are inflicting unparalleled economic and social misery on Europe. The austerity measures, the rescue funds, even the European Financial Stability Facility, derive from this principle, the principle that whatever happens, we must not penalise the banks. Every national bailout is in fact a bailout of the banks. Add it to the bill.”

    “By cementing the complete subservience of European political life to the market, the Markozy deal does an extraordinary disservice to our continent and our society. But it doesn’t stop there. The deal also suggests automatic sanctions on countries that allow a budget deficit of over three per cent of GDP and inserts a rule into eurozone countries requiring a balanced budget. Unlike creditor amnesty, this is at least a commendable economic and political principle – but it directly overrides the principle of national sovereignty.”

    “Nicolas Sarkozy has been offered joint press conferences with Angela Merkel, complete with a torrent of barely-conscionable photographs of them kissing. But these presentations are merely theatre. Everyone knows France is an afterthought. We are seeing the takeover of European national sovereignty by Germany, which will effectively wield a veto against individual states’ budgets. The national angle is easy to overstate, however. Germany is merely the handmaiden of the financial markets, which got us into this place and now sit like vampires turning their own catastrophe to their advantage.
    The markets reacted with sluggish enthusiasm to news of democracy’s acquiesce. Spain’s ten-year bonds were down 5.2% while Italy’s fell to 6.3%. With commendably comic timing, however, Standards and Poor intervened to put major European economies on watch. Only the best will do for the markets, you see. They won’t be pacified until they have total immunity set in stone.”

  • This post was really wonderful to read! Indeed many thanks to Mr Koutras that gave Yani the opportunity to further explain his proposal.

    Some points that I feel that require further clarification:

    1. In the response to 4ii, the example with Spain is really very explanatory and covers the case of a ‘generic’ nation-state. I would also like to see the two extreme cases of Germany and Greece as well. How would the implementation of Policy 1 affect these? Would Germany be able to keep borrowing at rates as low as today? On the other hand, would Greece still need a massive write-down of debt, and what, if any, could the effect of this be on ECB-bonds?

    2. In the response to 4vi, vii & viii, you write “It is fiscal policy only when debt is newly issued”. I am wondering if the net issues of ECB-bonds required for Policy 3 is considered “newly issued”, thus involving ECB in fiscal policy. Could this be a problem that you would need to workaround in order to be more persuasive?

    3. In the conclusion I don’t fully understand the sentence “Our proposed ECB-bonds are part of a Debt Conversion plan on behalf of the member-states which do have their taxpayers behind them. In this sense, the ECB bonds also have (these same) taxpayers behind them.” Do you mean the taxpayers of all member states collectively or the taxpayers of the member state on whose behalf a specific ECB-bond is issued?

  • Finally an economic analysis to an economic problem! The so called leaders have forgotten that the people that should be solving these problems are the those who actually have some experience and knowledge on the matter. Κ. Βαρουφάκη σας είχα κάνει μια ερώτηση σχετικά με την πρότασή σας, ελπίζω να μην το έχετε ξεχάσει

  • Yanis,

    Why aren’t you MORE concerned about those raving(v=t)mad lunatics. I think they are part and parcel in this post-Global Minotaur world to get rid of the Euro once and for all; the fact the Euro won’t budge relatively to the Dollar must be of some concern here, I mean, over there… To compare CRA’s with the other players in this game of chess between the US and the EU those CRA’s are nothing but pawns (with some CIA director behind every little step they are allowed to make, why not?!), small yet pivotal for both defense and offence!

    As you stated in your book, the US became safe haven post-Lehman, nonetheless it being the place where the grand theft took place. Hence new money went there it got an awful whipping a little earlier, New York. I for one think this US down-rating to be part and parcel (like it when you drop these words) of the Wall Street banksters in trying to get those flows of capital back. Somehow they are succeeding, don’t you agree?

    Furthermore the SEC published a list what position those Wall Street banksters got in regard to their CDS portfolios. In total JP Morgan Chase, Morgan Stanley, BoA, GS and Citi sold $11.469 trillion in nominal worth of the mass destruction weapons, only to buy $11.728 trillion of those. In other words, they are shorting for approx. $ 259 billion of it.
    That is a nice premium for a couple of years manipulating the EU bond markets. Our director Financial Stability at DNB (our central bank in the Netherlands) Aerdt Houben stated it to be of the utmost importance to know what you don’t know. How exactly are the American banks mixed up in this Euro-mess?

    • On this I disagree Dean. Democracy demands no exceptions and will survive no exclusion of anyone. The present autocracy in the EU will not be corrected by denying Germany a place in the decision makeing process but only by giving a place within this process to the voters from all over Europe who have been frozen out. And this includes the German voters who are being misled by their leaders just as badly as Greeks and the Irish by theirs.

  • Yani,
    I take it that through this comprehensive response to Mr. Koutras, you assume response to my very similar objections as I have been raising them in various instances in your blog.
    Here are briefly my response to your arguments relevant to the objections that I have been raising.

    You ask the ECB to play a proxy role as debt issuer on behalf of EZone states. You claim that it will command low interest rates on those newly issued bonds.I still see no convincing explanation on how you arrive to that conclusion. Given the current evidence and what the MP asks from the ECB I see no good reason why the ECB-issued bonds might be selling like “hot cakes” at low interest rates (by low I assume at or below German or US bonds )
    I am re-iterating my responses to your arguments.
    1. ECB has a sterling reputation.
    – No it doesn’t. Not in the bond markets and not for raising capital or managing debt on behalf of EZ states. Never done before by ECB or by any other central bank in history if I am not mistaken.
    2. The ECB-Bonds will have super seniority over EZ state zones.
    – This is irrelevant if the EZ state’s creditworthiness were in question on payback time. With your proposal you are introducing two highly correlated debt obligations for a eurozone state. The one towards the ECB and the one towards its other creditors for the over the 60% GDP debt they might be raising in the market.This is a very CDO like case (with one trance having seniority over the other) and it has very little chances to convince the market to lend to the ECB at very low interest rates on their bonds. The moment the market believes that a state will have trouble paying back its other creditor’s, at the same moment will also sell the ECB ones. Interest rates on those will rise as well.
    3. Others states might step in to help the state if it could not fulfill their debt obligations
    – This is what is happening today with every state that has failed so far with the IMF ,EFSF and the likes stepping in to lend. It hasn’t convinced the market the slightest that things are better for those states. I do not see how it will convince anybody today, that the new ECB bonds having other member states helping prospective insolvent ones in the future as a backstop are worthy for low interest rate.
    4. ECB as LOLR (lender of last resort) aka printing money.
    – Although it is clear that you are trying not to throw the spotlight on that prospect, this is actually the ONLY property that only a central bank and nobody else possesses. Actually this is the only reason as to why anybody would think of ECB differently compared to any other potential debtor. I do not think this is a strong seller though for obvious reasons and that’s why you also I suppose do not want to sell it as such. Thus, it is also a weak argument in using it for justifying low interest rate on the so called ECB bond.
    5. Spanish bonds example.
    -You use an extended example discussing a hypothetical scenario with the Spanish bonds. This of course is not an argument that can support your hypothesis of the low ECB bond rates. This is an example that uses as a given the low ECB bond interest rate to show the potential benefit of the debt conversion over the current interest rate that Spain gets in the market. It cannot be used as an argument to support the idea that the ECB -bond will get a low rate or we would be talking of a typical example of circular reasoning.

    Don’t want to occupy more of your space. I hope I have provided sound reasons as to why I think your expectations have not been convincing up until now to my eyes at least. You’ve stated here and in your previous posts/comments that the largest bond traders in the world have confirmed you personally that they would give their right arm to purchase ECB paper ( I assume you mean the ones we are talking about here). It would be helpful to share publicly available sources that this is discussed so as to better understand the reasoning behind that. If Bill Gross for example saw that favorably as an idea why not lobbying for it through his shop?

  • The paradigm of economic thought remains deeply montaristic hence all the hype about hyperinflation and all the taboos about eurobonds. This is deepley rooted in some centuries of derailed economic analysis whereby from a glass dome filled with nothing but a bunch of clever cloggs you end up through entrepreneurship with cars and industries.Nobody aknowledges that we grow only by depleting natural resources and what our entrepreneurship does is putting them into use, By the same token, nobody wants to take the “sword” and cut the knot of debt or at least reduce it considerably by e.g. forgiving bilateral state loans as if it had never happened before especially after all major transitional periods in the International Division of Labour when a new hegemonic power was taking the place of another (case of USA/Great Britain).We all keep on talking about how to create more obligations be that in a technically sound manner.Is that the only way?I know the other way is polical but so is economics.In the good old days they were called political economy no matter how today we believe that the essence is in the detail of an equation.I think Yanis, Modest, commendable as it may be, should become Bold.Time is up for smooth solutions.

  • Please excuse my pedantry, but since the Lisbon treaty forbids the ECB from acting like a central bank, the ECB should be called the EB, without the needless “C” in the middle. This way, there is no confusion 😉

  • I saw Yani’s twitter on melancholy and I sought a soothing remedy from Socrates. But when I realize how miserable I am failing #4, my melancholy has turned into bona-fide despair:

    Πολύ διδακτικό εάν αντιμετωπιστεί υπό το πρίσμα των σημερινών εξελίξεων είναι το ακόλουθο τμήμα της κληρονομιάς του μεγάλου Έλληνα φιλοσόφου, του Σωκράτη.

    Όταν τον ρώτησαν να τους δώσει τον ορισμό του μορφωμένου ανθρώπου, δεν ανέφερε τίποτε για τη συσσώρευση γνώσεων. «Η μόρφωση είπε, είναι θέμα συμπεριφοράς»…

    Ποιους ανθρώπους λοιπόν θεωρούσε μορφωμένους;

    1. Πρώτα απ’ όλους αυτούς που ελέγχουν δυσάρεστες καταστάσεις, αντί να ελέγχονται από αυτές…

    2. Αυτούς που αντιμετωπίζουν όλα τα γεγονότα με γενναιότητα & λογική…

    3. Αυτούς που είναι έντιμοι σε όλες τους τις συνδιαλλαγές…

    4. Αυτούς που αντιμετωπίζουν γεγονότα δυσάρεστα και ανθρώπους αντιπαθείς καλοπροαίρετα.

    5. Αυτούς που ελέγχουν τις απολαύσεις τους…

    6. Αυτούς που δεν νικήθηκαν από τις ατυχίες & τις αποτυχίες τους…

    7. Τελικά αυτούς που δεν έχουν φθαρεί από τις επιτυχίες και την δόξα τους…

    Σωκράτης (469-399 π.Χ.)

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