Will eurobonds safe the euro?

Eurobonds a panacea? Not everybody is convinced (the Germans in particular). And Wolfgang Münchau and Daniel Gros arn’t fools by any means

The universal experience of financial crisis management is that the longer one waits to resolve it, the more expensive the ultimate bill will be. In the eurozone that moment has been reached. Two months ago, it was said the worst things that could happen were that the crisis would extend to Italy and Spain; and the economic recovery would stall.

Now the crisis has extended to Italy and Spain, and growth in the eurozone economy has slowed. The next plot point of the tragedy would be a return to recession. This is not a far-fetched scenario. Christine Lagarde, the International Monetary Fund’s managing director, warned with refreshing candour at the weekend that the risk of a recession was significant, and called for urgent policy action.

The crisis now has such force that it renders the existing resolution mechanisms defunct. The European financial stability facility was set up to handle small countries, such as Greece, Portugal and Ireland; it is useless as a mechanism to protect Italy or Spain. If you raised its lending ceiling to, say €2,000bn, France would stand to lose its triple A rating. That in turn would affect the EFSF’s own lending capacity, which equals the share of the triple A rated countries.

If you really wanted to provide a backstop for Italy or Spain, the only long-term solution is what is known in legal jargon as joint and several liability – in other words, a eurobond. There is no way Germany could guarantee Italy or France could guarantee Spain. The problem has become so big that the only credible guarantees are joint.

Unfortunately, the eurozone bond is not something you can introduce in an emergency meeting at midnight tomorrow. It requires new institutions. It would have to be a multistep process, just like the introduction of the euro itself during the 1990s. Eurobonds would require a change in European treaties. It would also require changes in various national constitutions.

In non-crisis mode, the European Council would set up a committee that would spend a year or two drawing up a master plan. This would be followed by an intergovernmental conference and a dramatic summit. And then it would take years to implement.

A crisis might short-circuit some of these procedures but that would require political leadership, which is sadly absent. Just witness the pathetic row among eurozone members over Finland’s bilateral agreement with Greece to secure collateral for the Finnish portion of the next Greek package. Even now, the eurozone still squabbles over the small print of a package that is essentially irrelevant to its future.

Imagine Germany, the Netherlands or Finland being asked to sign off on a eurobond tomorrow. Last week, Angela Merkel, German chancellor, ruled it out every day. Mark Rutte, Dutch prime minister, said it would require a fiscal union. Jyrki Katainen, Finnish premier, is also opposed but expects the issue to come in autumn. Wolfgang Schäuble, German finance minister, said a fully-fledged political union would be a prerequisite for a eurobond – another way of saying no.

Are they all bluffing? Only up to a point. I know that observers have become cynical, in particular about Ms Merkel’s public expression of resistance. She has opposed every crisis measure, from the first Greek loan to the extension of the EFSF’s mandate, only to yield ground later. Is the eurobond not merely the next stage in this game of early denial and ultimate surrender? Will she not soften her tone once the Bundestag agrees the changes to the EFSF?

I know there are people close to Ms Merkel and Mr Schäuble who agree that a eurobond will be the only solution to this crisis. I would not be surprised if they had even drawn up an emergency plan. But the politics is holding them back. Ms Merkel has a tough battle on her hands to secure a parliamentary majority for the extension of the EFSF. She will probably win it, but she might not win a fight over a eurobond. Her coalition would probably break up.

So, while I cannot see how Greece or Italy can remain in the eurozone indefinitely without a eurobond, I find it equally hard to see Germany, Finland and the Netherlands agreeing to it. So something will have to give. A small eurobond, covering only a small percentage of sovereign debt, looks a tempting fudge. But it would not solve the crisis. Perhaps a Social Democrat-led German government would accept eurobonds after elections scheduled for 2013. But that would be too late. Perhaps the next stage of the crisis will be so severe that everybody grows scared enough to accept it as a lesser evil. That might work, but it is not a scenario you would wish for.

The only small consolation in the short term is the European Central Bank’s extended bond-purchasing programme, which now runs to well over €100bn. I understand several members of the ECB’s council have voted against. This means the consensus is fragile, and may not be sustained for ever.

The dual uncertainty over the eurobonds and the ECB’s bond-purchasing programme suggests that investors are perfectly rational in betting against the eurozone. This means the crisis will go on, and that it will get worse and more expensive. And unless there is a dramatic reversal in the political response very soon, even a eurozone bond might not work.