In this guest post, professors Markus Brunnermeier, Marco Pagano, Ricardo Reis, Stijn Van Nieuwerburgh, and Dimitri Vayanos defend their proposal for European Safe Bonds as a way to create a pan-European safe asset without debt mutualisation.
There is an emerging public debate on European Safe Bonds (ESBies). As the authors of the original proposal in 2011 of the Euro-nomics group, we welcome that debate. From a European perspective, we feel it important that discussions are informed by a common understanding of what ESBies are — and what they are not.
A recent FT Alphaville post by an Italian regulator argued that ESBies won’t solve the euro area’s problems because they do not entail joint liability among sovereigns. Yet, back in January, an article in the Handelsblatt, accused ESBies of leading to “mutualisation through the backdoor”.
So which is it?
By design, ESBies are not Eurobonds. Nothing is shared among governments. This is a feature, not a bug. Through pooling and tranching, ESBies simply represent a repackaging of existing risks.
What, then, is the purpose of ESBies?
At present, euro area financial markets are distorted. There is no symmetrically supplied low-risk asset in abundant supply. As a result, macroeconomic shocks are amplified by endogenous flight-to-safety flows of capital. This primarily benefits non-vulnerable countries. Elsewhere, interest rates spike, and fragmentation ensues.
With ESBies, flight-to-safety capital flows would no longer occur across country borders, but rather across asset classes. ESBies therefore act as a common low-risk asset for the euro area — but without the moral hazards of fiscal mutualisation.
An additional advantage of ESBies is that they would help to weaken the link between sovereign risk and bank risk, as we show in a paper recently published in the peer-reviewed Economic Policy journal.
Appropriately designed financial regulation would ensure that banks would