Q&A on the Modest Proposal's policies involving the ECB and the EIB

20/07/2013 by

A reader has sent us a set of questions regarding Modest Proposal 4.0 and, in particular, (a) the role of the ECB in converting the Maastricht compliant part of member-state public debt, and (b) the EIB’s involvement in our Investment-led Recovery Program. His questions allow us to clarify the proposed policies. 

As I read this, a bank, say, holding Italian debt now paying 5.5%, converts this bond into an ECB bond, which will pay “an interest rate set by the ECB just above its bond yields.” Say, 2.8 to 3%. What is the incentive for the private bondholder to take this loss?

Our proposal here is that the ECB services the redemption of bonds, upon maturity, pro rata to Italy’s Maastricht Compliant Debt. No loss is to be taken by bond holders; none whatsoever. E.g. if Italy’s debt to GDP ratio is 120%, then 50% of the maturing bond will be paid for by the ECB and that sum will charged to Italy’s debit account with the ECB at an interest rate a shade above that which the ECB’s own bonds will fetch in the money markets. Effectively, the ECB offers Italy a conversion loan for part of the maturing bonds. If risk loving existing bond holders do not want to buy into the ECB bonds, that’s their business – and that will be free to continue buying Italian bonds (which they probably mix in their portfolio with ECB bonds, in order to achieve a balance of risky and higher returns bonds).

Furthermore, if Italy’s debt-to-GDP ratio is 120%, then your footnote implies that only 50% of the face value of the ECB bond is guaranteed by the ECB. Is that right? 
No, as explained above, 50% will be paid by the ECB using monies borrowed by the ECB (thus the ECB bonds).
If so, is this percentage guarantee fixed at the time of purchase, or does it decrease if Italy’s debt-to-GDP ratio increases? 
Given that the ECB will be able to get yields on its own bonds less than 2%, Italy’s effective debt-to-GDP ration shrinks, as the total interest it must repay over the next ten or twenty years falls. And if this happens for all of Periphery, the debt crisis is over.
What about the Italian bond now held in a debit account by the ECB? Does Italy still have to service this at 5.5%?
Italy will pay an interest rate just a touch above the ECB-bond yields. Around 2% under current market conditions. Thus, the substantial reduction in the net present value of Italy’s debt.
The same objection can be raised to your EIB proposal: very low interest loans to finance specific projects are supposed to be repaid by the revenue streams from the completed projects, but the track record of, say, the Athens subway in producing new revenue proportionate to the amount of outside capital invested is not encouraging.
There is a misunderstanding here – both of our proposal and of the facts on the ground. First, the Athens Metro has not benefitted from EIB funding. But the Rio-Antirio massive bridge has. And it is repaying its loans from the EIB in full. This is, partly, why the yields on EIB bonds are currently at 1.7% – because the vast majority of the projects it funds pay for themselves. Our proposal is that the EIB, in conjunction with the EIF, are unleashed from the constraint of co-financing with national governments (that are currently quasi-insolvent) and, instead, backstopped (in the unlikely case that they need to be backstopped) by ECB operations.
Who will monitor these loans, on which political calculations are likely to outweigh economic calculations?
As we argue in the Modest Proposal, the answer is: the EIB! This is precisely what it has been doing for years, with great success and a sterling record. If the proof of the pie is in the eating, there has been a lot of eating of the EIB pie…
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