Eurobonds: The 'solution' that just won't stick

@CNNMoneyInvest November 23, 2011: 7:20 AM ET
Eurobonds could help bring down rates in higher debt-ridden countries, but it would increase borrowing costs in other eurozone nations.

Eurobonds could help bring down rates in higher debt-ridden countries, but it would increase borrowing costs in other eurozone nations.

NEW YORK (CNNMoney) -- When it comes to ideas to solve to Europe's debt crisis, nothing seems to stick.

On Wednesday, the European Commission is expected to detail three options for issuing eurobonds.

But don't hold your breath. Experts still aren't convinced any of them will work -- or even garner enough political support to potentially move forward.

The idea of eurobonds has been floating around for months, with little support from the stronger eurozone countries, like Germany.

"Until Germany goes for them, these plans are non-starters," said Michael Hewson, analyst at CMC Markets in London. "We can talk about it until we're blue in the face, but it's just conjecture until Germany backs it."

The first approach the EC is offering up is to convert all national government bond issues, including those currently outstanding, to a common eurobond that is backed by all 17 countries in the eurozone.

"Economically, this is the most promising option," said Jürgen Odenius, international economist and investment strategist at Prudential Fixed Income. "But political interests aren't lined up in support of this proposal."

Europe: The crisis that just won't quit

While that would drive down borrowing costs for debt-laden countries such as Greece, Italy, Portugal, Ireland and Spain, where yields are soaring, it would also boost rates in Germany and Europe's other AAA-rated countries, where rates are significantly lower.

Because the credit risk would be spread across the eurozone, countries like Germany, which boasts a lean gross debt level of just 80% of its entire economy, would be taking on the debt loads of Greece, which totals more than 160% of its economy, and Italy, which runs a debt-to-GDP ratio of 120%.

German Chancellor Angela Merkel has come out strongly against the idea of a eurobond, even calling it the "absolutely wrong" way to defuse the European debt crisis.

Europe's healthier nations are "unwilling to engage in such a venture because they become liable" for the debt service payments of entire regions, including Greece and Italy, without having a say in their future fiscal actions and policies, said Odenius.

"It's like taxation without representation," he added.

Without Germany's support, this optimal approach to the eurobond could not be implemented.

But beyond needing Germany's support, it would also require changes in the European Union's treaties. Those changes would need to be ratified by each of the 27 member states, and that process would likely take years, experts said.

The EC's second approach would also require a change in EU treaties, making it another unlikely option. Under scenario No. 2, eurozone countries would be allowed to issue common eurobonds up to a certain limit, such as 60%, of their annual GDP. Beyond that level, individual governments would be responsible for issuing and backing their own bonds.

Because this plan would also require fiscally responsible countries like Germany to be liable for a portion of other countries' debt, it would most likely be met with the same resistance as the pure eurobond plan.

Plus, this type of structure doesn't address the Europe's structural debt problems over the longer term, said Hewson.

Prudential's Odenius added that this option would also result in a massive sell-off in the portion of existing debt that wouldn't get converted into a eurobond, therefore potentially wreaking havoc on bondholders, including Italian banks and other financial institutions.

Finally, while the EC's third suggestion doesn't face a political brick wall, since it doesn't require changes in EU treaties, experts are wary about its overall effectiveness.

This approach would have countries provide some guarantees on newly issued bonds, but it would not combine the liabilities or get rid of national bonds.

This approach is most similar to the bonds that are currently issued by the eurzone's €440 billion European Financial Stability Facility fund, said Odenius.

Already the credit worthiness of the EFSF 10-year bonds is deteriorating, as the yield spread rapidly widens over German bonds. Last month, the spread was around 55 basis points, and now, it stands around 200 basis points, said Odenius.

"The credit of this type of eurobond will only be as worthy as the average euro area, and if a large part of the region is suffering liquidity problems, these instruments will have a limited effectiveness," said Odenius.

Full coverage of Europe's debt crisi

So European officials can continue to theorize options to stave off a worsening debt crisis and contagion, but experts say investors are impatiently waiting for one single solution: intervention from the European Central Bank as the lender of last resort.

"The ECB will eventually be drawn into this crisis in earnest, and it will have to provide a full, unlimited commitment to act as a backstop to the countries experiencing a liquidity crisis," said Odenius. "These efforts would need to be paralleled by an International Monetary Fund program with comprehensive conditionality. This process could be facilitated through ECB loans to the IMF."

Without that, the eurozone could be forced to bear a breakup, but experts don't expect it to come to that. To top of page

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