The Maastricht Treaty permits each European member-state to issue sovereign debt up to 60% of GDP. Since the crisis of 2008, most Eurozone member-states have exceeded this limit. We propose that the ECB offer member-states the opportunity of a debt conversion for their Maastricht Compliant Debt (MCD), while the national shares of the converted debt would continue to be serviced separately by each member-state.
The ECB, faithful to the non-monetisation constraint (a) above, would not seek to buy or guarantee sovereign MCD debt directly or indirectly. Instead it would act as a go-between, mediating between investors and member-states. In effect, the ECB would orchestrate a conversion servicing loan for the MCD, for the purposes of redeeming those bonds upon maturity.[ii]
The conversion servicing loan works as follows. Refinancing of the Maastricht compliant share of the debt, now held in ECB-bonds, would be by member-states but at interest rates set by the ECB just above its bond yields. The shares of national debt converted to ECB-bonds are to be held by it in debit accounts. These cannot be used as collateral for credit or derivatives creation.[iii]Member states will undertake to redeem bonds in full on maturity, if the holders opt for this rather than to extend them at lower, more secure rates offered by the ECB.
Governments that wish to participate in the scheme can do so on the basis of Enhanced Cooperation, which needs at least nine member-states.[iv] Those not opting in can keep their own bonds even for their MCD. To safeguard the credibility of this conversion, and to provide a backstop for the ECB-bonds that requires no ECB monetisation, member-states agree to afford their ECB debit accounts super-seniority status, and the ECB’s conversion servicing loan mechanism may be insured by the ESM, utilising only a small portion of the latter’s borrowing capacity. If a member-state goes into a disorderly default before an ECB-bond issued on its behalf matures, then that ECB-bond payment will be covered by insurance purchased or provided by the ESM.
Why not continue with the ECB’s OMT?
The ECB has succeeded in taming interest rate spreads within the Eurozone by means of announcing its Outright Monetary Transactions’ programme (OMT). OMT was conceived as unlimited support of stressed Euro-Area bonds – Italy’s and Spain’s in particular – so as to end the contagion and save the euro from collapse. However, political and institutional pressures meant that the threat against bond dealers, which was implicit in the OMT announcement, had to be diluted to a conditional programme. The conditionality involves troika-supervision over the governments to be helped by the OMT, who are obliged to sign a draconian memorandum of understanding before OMT takes effect. The problem is not only that this of itself does nothing to address the need for both stability and growth, but that the governments of Spain and Italy would not survive signing such a memorandum of understanding, and therefore have not done so.
Thus OMT’s success in quelling the bond markets is based on a non-credible threat. So far, not one bond has been purchased. This constitutes an open invitation to bond dealers to test the ECB’s resolve at a time of their choosing. It is a temporary fix bound to stop working when circumstances embolden the bond dealers. That may happen when volatility returns to global bond markets once the Federal Reserve and the Bank of Japan begin to curtail their quantitative easing programmes.
[ii] For a member state whose debt to GDP ratio is 90% of GDP, the ratio of its debt that qualifies as MCD is 2/3. Thus, when a bond with face value of say €1 billion matures, two thirds of this (€667 million) will be paid (redeemed) by the ECB with monies raised (by the ECB itself) from money markets through the issue of ECB bonds.
[iii] Any more than a personal debit card can be used for credit.
[iv] Article 20 (TEU) and Articles 326-334 (TFEU) provide that:
“Enhanced cooperation should aim to further the objectives of the Union, protect its interests and reinforce its integration process. Such cooperation should be open at any time to all Member States. The decision authorising enhanced cooperation should be adopted by the Council as a last resort, when it has established that the objectives of such cooperation cannot be attained within a reasonable period by the Union as a whole, and provided that at least nine Member States participate in it”.
The Council approval of an enhanced cooperation procedure may be unanimous or by qualified majority. But since all member states rather than only those in the Eurozone could gain from investment finance from eurobonds, which, like EIBbonds, need not count on national debt, there is a realistic prospect of its adoption.