1. Hans-Bernd Schäfer Bucerius law school, Hamburg Consequences of Different Eurobond Proposals
Sovereign Risk and the Euro: Lessons from the Crisis - Bologna, October

2. The legal structure of the European Monetary Union and why Eurobonds were not a crisis instrument

3. The Institutional Framework of the Euro
Price stability has a categorical priority over any other policy goal
The European Central Bank is a bank for banks but not a bank for the state(s) unlike most other central banks
Neither the EU nor any member state can be made liable for state debts of any member state or public body.

4. Article 127
1. The primary objective of the European System of Central banks (hereinafter referred to as the "ESCB") shall be to Maintain price stability. Without prejudice to the objective of price stability, the ESCB shall support the general economic policies in the Union.

5. Art. 123 No State financing by the Central Bank
Overdraft facilities or any other type of credit facility with the European Central Bank or with the central banks of the Member States in favour of Union institutions, bodies, offices or agencies, central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of Member States shall be prohibited... .

6. The European central bank
-cannot give a direct credit to a state
-cannot buy government bonds on the primary market
-----
-Can buy government bonds on the secondary market for reasons of monetary policy
-Can it buy government bonds on the secondary market to help a distressed country fiscally?

7. Art. 125 („no bail out clause“)
The Union shall not be liable for or assume the commitments of central governments,regional, local or other public authorities, other bodies governed by public law, or public undertakings of any Member State... .

8. Public Debts in the Eurozone 200-2012, percent of GNP
Source: Eurostat

10. Interest Rate Spreads (over German Gov. Bonds)

11. Why not mutualize all public debts in the Eurozone by a swift change of the TFEU?
This was one proposal of the EU-Commission in 2012

12. Relation between EU law and national law
EU-law trumps national law including national constitutional law
and it is directly applicable
That is national courts must apply European law. Member States must enforce it.

13. The relation between EU-Law and core principles of national law

14. In France:
French Constitutional Council (Conseil Constitutionnel) referred to rules and principles that are
‘inherent to the constitutional identity of France’ that cannot be disregarded ‘except when the constituting power consents thereto’
Thereby transforming Directive 2001/29/EC of the European Parliament and of the Council of 22 May 2001

15. Ireland: Any European legal changes implying a substantial transfer of sovereign powers to the EU requires a referendum. Also Ireland makes use of “protocols” stating that it will not accept a particular ruling on the content of a particular European legal norm.

16. Germany
constitutional court defined two exceptions for Germany in the 2 Solange Decisions.
Ultra Vires decisions of the European Court of Justice
Identity infringement of constitutional core principles (human rights, democracy)
Gave access to every citizen in questions of the Euro, if core principles of democracy are concerned

17. The Commission’s proposal (2012) of mutualizing all debts or proposals
with a change of the TFEU
would most likely be unconstitutional in Germany and would have required a change of the constitution, which explicitly allows that.
The crisis management would have been delegated to voters and courts

18. II. Eurobonds Beyond Crisis management
The blue bond-red bond proposal with Eurobonds as blue bonds
European Safe Bonds (ESBies)
The pro rata liability proposal with a common interest rate for borrowers
The pro rata liability proposal with different interest rates for borrowers
The mutualization of all debt and the blue bond-red bond proposal with Eurobonds as red bonds

19. reduce the debt burden of a distressed country ?
Can the proposal
reduce the debt burden of a distressed country ?
provide more safe assets?
stabilize the Euro against one way speculation against its existence? Diabolic loop

20. cause additional reckless lending or borrowing?
lead to a mutual gain by a lower liquidity risk premium?

21. The Liquidity Premium
Liquidity risk and liquidity risk premium
Size of the liquidity risk premium in the Eurozone
The trade-off between the risk premium for Eurobonds and national bonds
Under reasonable parameters for the function there exists a threshold size for the Eurobond market, which makes Eurobonds a win-win constellation.

22. III. Prudent and risk taking lending and borrowing on a national government bond market

23. National Bonds with default risk
Credit constraint =
Sl Sh
Bond Market Size
Interest rate=risk free interest rate plus risk premium
Risk free interest rate
Government bliss point of indebtedness

24. Effects of a bail out (ex-post solidarity (Tirole 2015))
Third countries minimize the sum total of spillover costs and bail out transfers.
The expected bail out allows reckless lending and borrowing above the debt sustainability level.
The expected bail out reduces interest rates .
The bail out leads to a subsidy of creditors, it privileges large and system relevant creditors

25. C. National Bonds with bail out
Credit constraint
without bailout
credit constraint with bail out =
Sl Sl +B Sh
expected bail out Bond Market Size
Interest rate=risk free interest rate plus risk premium
Risk free interest rate

26. III. The blue and red bond proposal (Delpla and von Weizsäcker)

27. D. The Delpla/Weizsäcker proposal
Credit constraint =
Sl Sh
Bond Market Size
Interest rate=risk free interest rate plus risk premium
Risk free interest rate

28. The Delpla/Weizsäcker proposal
Credit constraint =
Sl Sh
Bond Market Size
Interest rate=risk free interest rate plus risk premium
Risk free interest rate
Blue bonds Red Bonds

29. Lending under the blue bond and red bond proposal
Blue bonds are restricted to the debt service capacity of any country in in bad economic situation
The proposal
reduces interest rates for blue bonds

30. increases interest rates for red bonds
cannot reduce the debt burden of a distressed country
Imposes little additional risk on any guarantor and does not lead to open or hidden transfers
provides no additional incentives for risky borrowing
Reduces the liquidity premium, if the blue bond market is big enough
Provides more safe assets in the Eurozone
Might be time inconsistent

31. Legal Requirements
European law, Change of Art. 125 TFEU, big change with referendum in some countries (Kaemmerer 2016)
National Constitutional Law, could be unconstitutional, would require a constitutional change (Amtenbrink 2016)
International law: The pari passu rule, but probably no violation of it (Waibel 2016)

32. The blue bond/red bond proposal would not reduce the debt burden of a distressed country
It would lead to a mutual gain of all countries IF
The time inconsistency problem could be solved
Proposals:
Direct Access of a European debt agency to parts of the tax income
Bills instead of bonds

33. IV: The European Safe Bonds Concept (ESBiES)
Markus Brunnermeier (Princeton)
Esbies have similar properties as Eurobonds
But without guaranties and joint liability.
Safe assets
Reduction of the liquidity premium
Diabolic loop is dampened
No additional moral hazard

34. Legal reqirements of the ESBies proposal
No change of TFEU necessary
No changes of National Constitutions necessary
Establishment of a European debt agency necessary

35. V. Pro rata bonds without joint liability and a single interest rate for all debtors
Proposal of the European Commission 2012

36. Pro rata bonds (Proposal by the European Commission)
-Lead to a steady transfer from the stronger to the weaker country.
-The problem of ex-ante solidarity: strong covariance of economic indicators
-No safe assets
-Mutual gain through the liquidity premium
National bonds country A
Eurobonds
intrrest ratek
Interest rate: high
National bonds country B
interest rate: middle
Interest rate: low

37. Why pro rata bonds might be toxic and might lead to a race to the bottom
Interest rate of pro rata bond=average of national bond rates
If pro rata bonds co-exist with national bonds a state can
-increase national debtsincrease riskincrease national interest rateincrease interest rate of pro rata bondsshift some of the costs to other states.
This might lead other states to do the same to avoid this burden.

38. Transfers from the stronger to the weaker countries
Economic Consequences:
Transfers from the stronger to the weaker countries
Increases moral hazard
No safe assets
Mutual gains through reduced liquidity premium possible
Probably no stabilizing effect against diabolic loop

39. Legal Requirements
It is debated whether they violate The TFEU, Art. 125
They might violate national constitutional law in those countries, from where there is a transfer payment. As this transfer payment is only implicitly part of the budget.

40. Pro rata bonds exist already
European development bank
European Stability Mechanism (ESM)
Credits to Greece before the establishment of the ESM

41. VI. Pro rata bonds Eurobonds “light”
pro rata bonds with internally differentiated interest rates
A European debt agency issues Eurobonds at an average interest rate.
Each country is liable for its share of the debts.
Each country pays its national interest rate.
The decreased liquidity premium leads to a profit of the debt agency.
Member states can distribute this profit as they like.
Pure Pareto improvement (win-win)
No spillover effects
No additional moral hazard
No stabilization effect
No safe assets
Few legal hurdles

42. VI. Mutualization of all public debts or Eurobonds as red bonds (EU-Commission), The proposal of the German Council of economic experts, The 5 Presidents’ Report
-Lowers interest rates for distressed countries considerably.
-increases interest rates of other countries.
-Carries huge moral hazard problems.

43. Proposals to avoid moral hazard:
Transfer of debt management of all member countries to a Eurozone body. (Council of ministers, Parliament, Minister of Finance)
This would imply a degree of centralization unknown even in federalist countries

44. VIII.
The red bond blue bond proposal with all debts over 60% of GNP as blue and mutualized bonds. (Weder di Mauro)

45. Introduce blue bond/red bond concept Change the treaty (TFEU)
IX. Preferred Proposal
Introduce blue bond/red bond concept
Change the treaty (TFEU)
Change national constitutions
Make member state insolvency easy
Reduce bailout necessities by requiring more equity capital for financial institutions

46. X. The most likely outcome
The 5 presidents report (2015)
Commission
Central bank
European Council
European Parliament
Euro Group
Speech of President Macron in September 2017

47. A separate parliament for the Eurozone.
A budget for the parliament to finance projects in the Eurozone.
Own taxes and/or Eurobonds to finance it.
A “European Finance Minister”