Successfully reported this slideshow.
We use your LinkedIn profile and activity data to personalize ads and to show you more relevant ads. You can change your ad preferences anytime.

How to Solve the Safety Trilemma? The Quest for a Safe Sovereign Asset for the Eurozone

13 views

Published on

Ad van Riet *
Seminar at Eesti Pank, Tallinn, 3 October 2019 *

Published in: Economy & Finance
  • DOWNLOAD THAT BOOKS INTO AVAILABLE FORMAT (2019 Update) ......................................................................................................................... ......................................................................................................................... Download Full PDF EBOOK here { http://bit.ly/2m6jJ5M } ......................................................................................................................... Download Full EPUB Ebook here { http://bit.ly/2m6jJ5M } ......................................................................................................................... Download Full doc Ebook here { http://bit.ly/2m6jJ5M } ......................................................................................................................... Download PDF EBOOK here { http://bit.ly/2m6jJ5M } ......................................................................................................................... Download EPUB Ebook here { http://bit.ly/2m6jJ5M } ......................................................................................................................... Download doc Ebook here { http://bit.ly/2m6jJ5M } ......................................................................................................................... ......................................................................................................................... ................................................................................................................................... eBook is an electronic version of a traditional print book that can be read by using a personal computer or by using an eBook reader. (An eBook reader can be a software application for use on a computer such as Microsoft's free Reader application, or a book-sized computer that is used solely as a reading device such as Nuvomedia's Rocket eBook.) Users can purchase an eBook on diskette or CD, but the most popular method of getting an eBook is to purchase a downloadable file of the eBook (or other reading material) from a Web site (such as Barnes and Noble) to be read from the user's computer or reading device. Generally, an eBook can be downloaded in five minutes or less ......................................................................................................................... .............. Browse by Genre Available eBooks .............................................................................................................................. Art, Biography, Business, Chick Lit, Children's, Christian, Classics, Comics, Contemporary, Cookbooks, Manga, Memoir, Music, Mystery, Non Fiction, Paranormal, Philosophy, Poetry, Psychology, Religion, Romance, Science, Science Fiction, Self Help, Suspense, Spirituality, Sports, Thriller, Travel, Young Adult, Crime, Ebooks, Fantasy, Fiction, Graphic Novels, Historical Fiction, History, Horror, Humor And Comedy, ......................................................................................................................... ......................................................................................................................... .....BEST SELLER FOR EBOOK RECOMMEND............................................................. ......................................................................................................................... Blowout: Corrupted Democracy, Rogue State Russia, and the Richest, Most Destructive Industry on Earth,-- The Ride of a Lifetime: Lessons Learned from 15 Years as CEO of the Walt Disney Company,-- Call Sign Chaos: Learning to Lead,-- StrengthsFinder 2.0,-- Stillness Is the Key,-- She Said: Breaking the Sexual Harassment Story That Helped Ignite a Movement,-- Atomic Habits: An Easy & Proven Way to Build Good Habits & Break Bad Ones,-- Everything Is Figureoutable,-- What It Takes: Lessons in the Pursuit of Excellence,-- Rich Dad Poor Dad: What the Rich Teach Their Kids About Money That the Poor and Middle Class Do Not!,-- The Total Money Makeover: Classic Edition: A Proven Plan for Financial Fitness,-- Shut Up and Listen!: Hard Business Truths that Will Help You Succeed, ......................................................................................................................... .........................................................................................................................
       Reply 
    Are you sure you want to  Yes  No
    Your message goes here
  • DOWNLOAD THAT BOOKS INTO AVAILABLE FORMAT (2019 Update) ......................................................................................................................... ......................................................................................................................... Download Full PDF EBOOK here { http://bit.ly/2m6jJ5M } ......................................................................................................................... Download Full EPUB Ebook here { http://bit.ly/2m6jJ5M } ......................................................................................................................... Download Full doc Ebook here { http://bit.ly/2m6jJ5M } ......................................................................................................................... Download PDF EBOOK here { http://bit.ly/2m6jJ5M } ......................................................................................................................... Download EPUB Ebook here { http://bit.ly/2m6jJ5M } ......................................................................................................................... Download doc Ebook here { http://bit.ly/2m6jJ5M } ......................................................................................................................... ......................................................................................................................... ................................................................................................................................... eBook is an electronic version of a traditional print book that can be read by using a personal computer or by using an eBook reader. (An eBook reader can be a software application for use on a computer such as Microsoft's free Reader application, or a book-sized computer that is used solely as a reading device such as Nuvomedia's Rocket eBook.) Users can purchase an eBook on diskette or CD, but the most popular method of getting an eBook is to purchase a downloadable file of the eBook (or other reading material) from a Web site (such as Barnes and Noble) to be read from the user's computer or reading device. Generally, an eBook can be downloaded in five minutes or less ......................................................................................................................... .............. Browse by Genre Available eBooks .............................................................................................................................. Art, Biography, Business, Chick Lit, Children's, Christian, Classics, Comics, Contemporary, Cookbooks, Manga, Memoir, Music, Mystery, Non Fiction, Paranormal, Philosophy, Poetry, Psychology, Religion, Romance, Science, Science Fiction, Self Help, Suspense, Spirituality, Sports, Thriller, Travel, Young Adult, Crime, Ebooks, Fantasy, Fiction, Graphic Novels, Historical Fiction, History, Horror, Humor And Comedy, ......................................................................................................................... ......................................................................................................................... .....BEST SELLER FOR EBOOK RECOMMEND............................................................. ......................................................................................................................... Blowout: Corrupted Democracy, Rogue State Russia, and the Richest, Most Destructive Industry on Earth,-- The Ride of a Lifetime: Lessons Learned from 15 Years as CEO of the Walt Disney Company,-- Call Sign Chaos: Learning to Lead,-- StrengthsFinder 2.0,-- Stillness Is the Key,-- She Said: Breaking the Sexual Harassment Story That Helped Ignite a Movement,-- Atomic Habits: An Easy & Proven Way to Build Good Habits & Break Bad Ones,-- Everything Is Figureoutable,-- What It Takes: Lessons in the Pursuit of Excellence,-- Rich Dad Poor Dad: What the Rich Teach Their Kids About Money That the Poor and Middle Class Do Not!,-- The Total Money Makeover: Classic Edition: A Proven Plan for Financial Fitness,-- Shut Up and Listen!: Hard Business Truths that Will Help You Succeed, ......................................................................................................................... .........................................................................................................................
       Reply 
    Are you sure you want to  Yes  No
    Your message goes here
  • Be the first to like this

How to Solve the Safety Trilemma? The Quest for a Safe Sovereign Asset for the Eurozone

  1. 1. Rubric How to Solve the Safety Trilemma? The Quest for a Safe Sovereign Asset for the Eurozone Ad van Riet * Seminar at Eesti Pank, Tallinn, 3 October 2019 * Associate Research Fellow at the United Nations University, Institute on Comparative Regional Integration Studies (UNU-CRIS), Bruges, Belgium, and former Senior Adviser at the European Central Bank (ECB), Frankfurt am Main, Germany.
  2. 2. Rubric EMU faces a safety trilemma: a national safe sovereign asset (German bund) as the cornerstone for the open capital market is incompatible with euro area stability, because it does not ensure sustainable asset diversification and durable financial market integration; one of these three features has to be given up. Five objectives of this presentation: 1. discuss theory behind safe sovereign asset 2. explain the safety trilemma of EMU 3. review main proposals for common public debt 4. assess them with regard to public risk reduction 5. discuss potential ECB role as safe asset provider Conclusion: political leaders have various ways to design a safe sovereign asset for the eurozone, to secure its safety for investors, and to limit the exposure to national public risk; no need to put the burden on the ECB. Motivation of the paper 2
  3. 3. Rubric A safe sovereign asset is a marketable financial claim to which investors attach an extra convenience yield, because of its positive attributes in terms of moneyness, liquidity, security and stability. => Safe store of value like money => High-quality liquid asset => Secure form of collateral => Stable pricing benchmark No sovereign asset is absolutely safe, but interest rate on safe debt is lower than on less safe debt. Convenience yield for investors is an economic rent for the issuer. Safety of advanced economies reflects proven reputation that they do not default. What is a safe sovereign asset? 3
  4. 4. Rubric Safety of public vs. private debt is based on the powers of the nation state to secure debt service and repayment in nominal terms: 1. Power of taxation: ensure debt service by extracting tax revenues from citizens 2. Power of regulation: create financial incentives to buy and hold government debt 3. Power of repression: secure capital market access at affordable non-market interest rates 4. Power of seigniorage: rely on inflation to eat away the real value of debt 5. Power of partnerships: official support from partner countries when in distress  Monetary sovereignty enables the government to issue debt in its own currency, but not unlimited, since high public debt would undermine public confidence.  Advanced economies no longer have privileged access to money and finance (other than for prudential reasons).  They rely on powers 1 and 2 in normal times, but may still apply 3, 4 or 5 in a crisis; market actors take these fall-back options into account  Assumes not only ability, but also willingness to repay debt instead of default What makes sovereign assets safe? 4
  5. 5. Rubric By adopting the euro and giving up monetary sovereignty, Member States became subsidiary governments (like American States) unable to issue debt in a currency under their own monetary control. Their public debt carries a higher risk of default; it is only a semi-safe asset and requires stronger safeguards to attract investors. EU tried to secure the fragile status of euro area sovereigns as safe asset providers: o Maastricht Treaty: no bail-out, no credit guarantees, no monetary financing, in order to support market-based fiscal discipline o Stability and Growth Pact: imposed fiscal policy rules with EU surveillance, peer pressure and sanctions to ensure sound and sustainable public finances o EU prudential legislation: financial institutions (notably banks) could treat their claims on all Member States as ‘zero risk’ by definition without exposure limit o EU collateral legislation: euro area repo market could consider national government bonds as interchangeable Safety by law: All euro area countries are (to be made or treated as) issuers of safe public debt. This public risk reduction could lead to public risk sharing in a fiscal union. EMU before the crisis: semi-safe sovereigns 5
  6. 6. Rubric EU laws for producing safe assets out of semi-safe debt of subsidiary governments were misaligned with fiscal practice, regulatory fiction, and market perceptions: o EU fiscal rules were not rigorously implemented: budget deficits, public debt and contingent fiscal liabilities remained high o Regulatory fiction that EU sovereign bonds entail ‘zero risk’ and are interchangeable stimulated banks and non-banks to search for yield and build up exposure in more risky public sector (and private sector) assets across the eurozone o Markets treated all euro area government bonds as safe assets: to preserve the euro in a crisis, a country (and its banks) would just have to be bailed out Sovereign debt crisis: gap between euro area countries considered to be safe (core group around Germany) and those perceived as risky (periphery group). National authorities and EU institutions, including ECB, took measures to counter financial instability, repair financial fragmentation, and tighten economic governance. EMU after the crisis: risky sovereigns 6
  7. 7. Rubric Lesson: A national safe sovereign asset cannot perform the functions of safe haven, liquid asset, reliable collateral, stable pricing benchmark for cross-border transactions on equal terms for all member countries of the eurozone. A common safe sovereign asset is a necessary common public good, without this cornerstone of EMU, financial integration is fragile: rising country risk could lead to contagious financial instability, capital flight to national safe havens, home bias among investors, and market fragmentation between safe and risky countries. The safety trilemma of the eurozone 7
  8. 8. Rubric Current approach: all euro area countries must strive to have rock-solid economic fundamentals. But occasional political risks and euro break-up fears may upset this multi-polar system of semi-safe sovereign assets, as seen in the euro crisis. Additional supply of top-rated EU/EMU supranational debt securities of € 800 bn. is <10% of 19 euro area governments’ debt securities and is meant to finance temporary and specific tasks rather than to serve as permanent safe assets. How to solve the safety trilemma? 8 Table – European supranational debt securities EU/EMU institution Stock of end-2018 Maximum capacity Credit rating (EUR billion) (EUR billion) (Fitch) EFSF 192 440 2) AA ESM 98 500 AAA EU 53 1) 110 3) AAA EIB 455 690 AAA Total 798 1300 (excl. EFSF) 1) EU includes the EFSM (EUR 46.8 bn.), the Balance of Payments Facility (EUR 1.7 bn.) and the Macro-Financial Assistance Programme (EUR 4.5 bn.). 2) The maximum capacity of the EFSF has expired. 3) Consists of EUR 60 bn. for the EFSM and EUR 50 bn. for the BoP facility. No ceiling for the MFA. Sources: Public information from European Commission, EFSF, ESM, EIB.
  9. 9. Rubric Future perspective: euro area treasury issues genuine eurobonds with joint and several liability, backed by own tax capacity. A fiscal union is not feasible right now. Transition period: European Public Debt Agency (EPDA) gets a mandate to issue common public debt and to invest in a diversified pool of national sovereign bonds.  Add safety-enhancements on the asset and/or liability side to secure high credit quality of common public debt for investors, and to reduce exposure to national public risk and moral hazard concerns from pooling national sovereign bonds. How to solve the safety trilemma? 9 EPDA assets: EPDA liabilities: National sovereign bonds purchased at face value or at market price (countries weighted by GDP or ECB capital key) Common public debt securities
  10. 10. Rubric 1. Add a collective credit protection for common public debt o Common conditional bonds enjoy a mutual credit guarantee from euro area countries o Common issuance of E-bonds secured by capital paid in pro rata by each euro area country, or by senior creditor status of the issuer, like European Stability Mechanism (ESM) 2. Pool only the safe component of national public debt o Common blue bonds for financing national public debt up to 60% of GDP; public debt above 60% of GDP remains national responsibility (purple/red bonds) o Common stability bonds for national public debt up to 25% of GDP with debt service secured by national tax funds o Common auction of eurobills up to 10% of eurozone GDP replacing national treasury bills up to 10% of GDP (= low-risk short-term asset, but offers no capital market integration) o Governments issue their bonds in a safe senior tranche and a risky junior tranche and EPDA only pools the senior tranches 3. Extract safe component from common public debt o Common synthetic eurobonds issued in safe senior tranche and risky junior tranche These design features aim to reduce public risk at the supranational level. Enhance safety on liability side of EPDA balance sheet 10
  11. 11. Rubric 1. Strengthen fiscal discipline against sovereign credit risk: o Condition of strict compliance with EU economic governance rules (SGP and MIP) o Apply country-specific risk premia in interest rates for common financing of national debt o Governments must fund structural deficits (above 0.5% of GDP) with accountability bonds (i.e. debt service payments are suspended when government debt exceeds 120% of GDP or when a country requests ESM assistance or defaults on its regular bonds) o Governments can fund normal cyclical deficits with safe senior bonds (with a cap on total issuance) but must fund structural or extraordinary deficits with risky junior bonds o Phase out preferential treatment of national public debt in EU financial laws o Make national public debt subject to private sector bail in before any ESM assistance 2. Strengthen fiscal insurance against private market risk o Governments to raise share of long-term debt to reduce interest-rate risk o Governments to raise share of patient investors to reduce roll-over risk o Governments to issue state-contingent / GDP-linked bonds to share economic risk These design features aim to reduce public risk at the national level. Enhance safety on asset side of EPDA balance sheet 11
  12. 12. Rubric Proposals for common public debt differ in how to achieve supranational safety and in adding additional national safety guarantees. Combining supranational and national safety features 12
  13. 13. Rubric European Stability Mechanism (ESM) or future European Monetary Fund (EMF) gets a mandate to act as EPDA and to create a diversified pool of national sovereign bonds (or loans) and to issue common E-bonds. – Safety is ensured ex ante by ESM’s paid-in capital or its reserves built up by relatively low own interest payments thanks to its senior creditor status (= similar to financing structure of crisis assistance). – Participating countries only guarantee their own share of capital or reserves, not covering for others. – Given seniority of EPDA, national sovereign bonds issued to private market participants are subordinated and carry a slightly higher risk premium – Contribution to overall financial stability relies on safety of debt service payments on the underlying diversified portfolio of national sovereign bonds. Option of sovereign-bond backed E-bonds 13 EPDA assets: pooling for diversified portfolio EPDA liabilities: collective credit protection National sovereign bonds or loans purchased at face value or at market price (countries weighted by GDP or ECB capital key) Common public debt security guaranteed by capital base or seniority of the issuer
  14. 14. Rubric Governments issue two tranches of their national bonds. The low-risk senior tranche is protected by the subordinated junior tranche that by contract carries any losses due to sovereign credit events. The EPDA only pools the senior tranches. – Creates a safe debt instrument in all member countries without any common liability that contributes to a diversified EPDA portfolio with a safe flow of debt service payments – The senior tranches enjoy a high credit rating, enhances domestic financial stability – But the national senior/junior ratio depends on a country’s creditworthiness; both need to be issued whereas in volatile markets the demand for subordinated debt dries up. – GDP-linked national bonds share economic risk between public sector and private sector and help to mitigate uncontrollable national debt dynamics. Option of senior sovereign-bond backed E-bonds 14 EPDA assets: pooling for diversified portfolio EPDA liabilities: protected by national senior tranches Senior tranche of national sovereign bonds purchased at face value or at market price (countries weighted by ECB capital key) Common public debt security guaranteed by taking senior tranches in the portfolio
  15. 15. Rubric The EPDA issues common public debt securities to finance national sovereign debt up to 60% of a country’s GDP (Maastricht Treaty ceiling), or less; this is called blue debt, which is protected by a mutual credit guarantee. Any debt in excess of 60% of GDP is funded nationally and called red debt. When high debt ratio above 60% is falling by 1/20 of the gap per year, in line with SGP requirement, this debt is protected from debt restructuring; it is called purple debt. – National sovereign debt up to a relatively safe level is pooled and mutualised – A country with relatively low sovereign debt has an incentive to raise it to 60% of GDP. – Countries with a legacy of high debt above 60% of GDP have an incentive to reduce it – Offers a substantial supply of safe blue bonds for the financial sector Option of blue-purple-red bonds 15 EPDA assets: pooling for diversified portfolio EPDA liabilities: protected by safe part of national debt National sovereign bonds purchased at face value or at market price up to 60% of a country’s GDP (countries weighted by GDP or ECB capital key) Common public debt security (blue bond) with mutual credit guarantee
  16. 16. Rubric Public or private sector Special Purpose Vehicle (SPV) creates a diversified pool of national sovereign bonds, and issues both senior and junior tranches of a synthetic eurobond without common liability – The low-risk senior tranche (ESBies), is protected by the subordinated junior tranche (EJBies) that by contract carries any losses due to national sovereign credit events. – Senior tranche of 70% is expected to get a high credit rating; junior tranche of 30% is below investment-grade (extra mezzanine tranche may be just above investment grade). – Senior tranche attracts safe-haven capital flows in a crisis; junior tranche will absorb market volatility in a crisis. – Asking banks to hold the senior tranche breaks vicious nexus between fragile banks and weak sovereign, reduces overall systemic risk, enhances euro area financial stability, also making junior tranche less risky. Option of sovereign-bond backed security or synthetic eurobonds 16 SPV assets: pooling for diversified portfolio SPV liabilities: tranching of common debt security National sovereign bonds purchased at market price (weighted by GDP or ECB capital key) Senior tranche (70%) Junior tranche (30%)
  17. 17. Rubric ESRB Task Force on Safe Assets (2018) believes that a demand-led introduction of a SBBS with senior and junior tranches is feasible, but there are several challenges: – Careful design needed to make senior tranche as safe as German bund (AAA-rating not ensured); junior tranche may require credit protection, e.g. a common fiscal backstop – Preferential regulatory treatment of national sovereign bonds constrains demand for the senior security, while default risk on the junior security must be recognised. – Need to remove EU regulatory bias against holding securitised sovereign products and amend ECB collateral rules for sovereign asset-backed securities. – Commission proposal for EU enabling product regulation as amended and adopted by European Parliament addresses prudential issues. – SBBS as a demand-led product requires a sufficient supply of senior/junior tranches and sufficient demand for junior tranche, which will be pro-cyclical – Governments still issue and service their own bonds subject to market discipline, but the more pooling is scaled up, the more it reduces credit risk and creates moral hazard. – National public debt offices fear reduced market liquidity when their issues are absorbed in the pool (unless mitigated by securities lending); but there are also positive liquidity spillovers from hedging opportunities in a mature market for safe common debt securities. Challenges of sovereign-bond backed security or synthetic eurobonds 17
  18. 18. RubricECB as safe asset provider for the eurozone? 18 Eurosystem has bought €1,941 bn. of investment-grade national public sector bonds (nearly 20% of total debt of the 19 euro area governments at end-2018) in exchange for overnight reserves. PSPP has increased net supply of safety and liquidity. 1. ECB to swap its national public sector bonds for common public debt?  How would safety of common public debt kept by ECB be ensured? 2. ECB to give all financial institutions access to its credit and deposit facilities?  Current excess reserves of banks show unequal distribution across eurozone 3. ECB to issue fixed-term time deposits, tradable debt certificates, bills or bonds?  ECB debt certificates (maturity up to 1 year) are to mop up excess liquidity, other types of (short-term or long-term) debt require legal debate.  Confounds temporary monetary policy with permanent public debt management. Eurosystem assets: Eurosystem liabilities: Swap national public sector bonds (from QE) for common public debt Reserves held by banking system, plus ? And/or: ECB issues debt
  19. 19. Rubric  Many ways to design a common safe sovereign asset with flanking measures that secure its credit quality and reduce exposure to national public risk.  This cornerstone of the financial system could go a long way in solving the safety trilemma and deliver various other stability benefits for the euro area as a whole.  Why do euro area countries continue to resist it?  National public debt managers fear the competition from common public debt, but they focus on their own narrow mandate rather than on safeguarding EMU.  Redistributive effects raise fear for moral hazard and transfer union, but can be reduced with incentives for fiscal discipline and improved fiscal insurance to reduce public risk  GDP-linked national bonds support public-private risk sharing ex post.  Yet, a safe sovereign asset is a common public good and may become too vital to fail  A modest public risk sharing remains necessary as an ex ante commitment of the participating countries to ensure the ultimate safety of common public debt.  ECB as safe asset provider for the eurozone is public risk sharing through its balance sheet and removes political incentives to strengthen EMU architecture. Thanks for your kind attention! Conclusions 19
  20. 20. RubricSelected literature Benford, J., J.D. Ostry and R. Shiller (eds.) (2018), Sovereign GDP-Linked Bonds: Rationale and Design, VoxEU.org eBook, CEPR Press, London. Bini Smaghi, L. and M. Marcussen (2018), Strengthening the euro area architecture: A proposal for purple bonds, SUERF Policy Note, No. 35, The European Money and Finance Forum, May. Brunnermeier, M.K., S. Langfield, M. Pagano, R. Reis, S. van Nieuwerburgh and D. Vayanos (2016), ESBies: safety in the tranches, ESRB Working Paper, No. 21, September, European Systemic Risk Board, Frankfurt am Main. Further published in Economic Policy, Vol. 32, Issue 90, April 2017, pp. 175-219. Cœuré, B. (2016), Sovereign debt in the euro area: too safe or too risky?, Keynote address at Harvard University’s Minda de Gunzburg Center for European Studies, Cambridge MA, 3 November. De Grauwe, P. and Y. Li (2018), How safe is a safe asset?, CEPS Policy Insights, No. 8, February. ESRB Task Force on Safe Assets (2018), Sovereign bond-backed securities: a feasibility study - Volume I: main findings, Volume II: technical analysis, European Systemic Risk Board, Frankfurt am Main, January. European Commission (2018), Proposal for a Regulation of the European Parliament and the Council on sovereign bond-backed securities, COM(2018) 339, Brussels, 24 May. Gabor, D. and J. Vestergaard (2018), Chasing unicorns: The European single safe asset project, Competition & Change, Vol 22, Issue 2, April, pp. 139-164. Hild, A.M.D., B. Hertz and C. Bauer (2014), Structured Eurobonds: Limiting Liability and Distributing Profits, Journal of Common Market Studies, Vol. 52, Issue 2, March, pp. 250-267. Juncker, J.-C. and G. Tremonti (2010), E-bonds would end the crisis, Financial Times, 5 December. Leandro, Á. and J. Zettelmeyer (2019), Creating a Euro Area Safe Asset without Mutualizing Risk (Much), Peterson Institute for International Economics, Working Paper No 19-14, August. Tonveronachi, M. (2018), European Sovereign Bond-Backed Securities: An Assessment and an Alternative Proposal, Levy Economics Institute of Bard College, Public Policy Brief, No. 145. van Riet, A. (2017), Addressing the safety trilemma: a safe sovereign asset for the eurozone, ESRB Working Paper, No. 35, February, European Systemic Risk Board, Frankfurt am Main. van Riet, A. (2019), How to Solve the Safety Trilemma? The Quest for a Safe Sovereign Asset for the Eurozone, manuscript, 21 March. 20

×