REMEMBER ALL THAT over-excited speculation two to three years ago and the political to-ing and fro-ing about the possibility of the eurozone countries issuing joint bonds?
It was a neat solution but the idea never got off the ground because Germany was dead set against it – because of the moral hazard embedded in the idea of burden-sharing, the clear disincentives common bonds might create for distressed governments to execute structural reforms, and the increase in Germany’s borrowing costs that would be a natural outcome of a broad eurozone financial backstop.
Now, a single security fronting multi-country government debt is back on the agenda – albeit not one that facilitates burden sharing. This time around, securitisation is providing the wrapper, with the European Central Bank’s Asset-Backed Securities Purchase Programme the originating mechanism and destination. All of this is being spurred by potential regulatory limits on banks’ holdings of sovereign debt.
A blueprint for repackaging existing sovereign debt into ABS that can then be bought by the ECB has been doing the rounds and I love it – it ticks so many boxes. What you end up with in essence is a potentially massive pool of eurozone sovereign collateralised loan obligations that can be structured with all the hallmarks of a common eurobond that draw together a lot of different strands of the current policy debate.
Sovereign ABS offer an efficient swerve around the politically charged debate
SOVEREIGN ABS WOULD enable the ECB to expand its balance sheet by €1trn. They also solve the fundamental problem that the pool of existing ABS that meet the ECB’s high-quality criteria is way too small to get the ECB anywhere near its asset-purchase targets. Not only that, but they solve the sovereign risk concentration issue that is freaking out eurozone banking regulators to such an extent. And they could mop up much of the potential forced recycling of €1.1trn of sovereign debt held on the books of ECB-supervised banks if regulators cap sovereign holdings at 25% of bank capital.
Sovereign ABS offer an efficient swerve around the politically charged debate about the ECB widening its net to include outright government bond purchases. It’s QE through the back door.
Officials have been trying their damnedest to stay cool and game everyone away from the absolute certainty and/or imminence of sovereign bond purchases but the market ain’t buying. Rampant speculation that ECB sovereign asset purchases are just around the corner has led to massively distorted eurozone government bond curves.
Many government bond yields in the region are at or close to record-lows – Spanish 10-years at 1.9% this week, Ireland at 1.45%, the Austria-German spread ratcheting in to just 16bp, and forecasts that 10-year Bunds could fall as low as 65bp. That tells a misleading story about the underlying economics within the currency bloc. It’s not healthy.
THE CREATION OF a sovereign ABS market is backed by Catherine Mann, chief economist at the OECD, but the idea came in a recent paper by Carlo Bastasin, a visiting fellow at the Brookings Institution, entitled “A Silver Bullet for the European Crisis” which envisages the creation of EQUIP – the European Quantitative-easing Intermediated Program.
The paper says “there is a high probability that the purchases of private securities, ABS and covered bonds fall remarkably short of the desired target of €1trn”. I think we all agree with that. “The new EQUIP security would represent a new European safe asset which is coveted by global investors lamenting the absence of just such a European asset. It would create a market similar in size to the US Treasury bond,” it continues. Pretty cool eh?
The eurozone doesn’t have a single liquid and public security representing the entire community so Bastasin says the structure of EQUIP would mirror the way the ECB is likely to purchase government bonds: in distinct quantities replicating a pre-fixed key as close as possible to the ECB capital key representing each State’s contribution to ECB capital.
“ECB intervention would be less distortive and more effective if it could leverage on the existence of a liquid market for a public security representing the eurozone as a whole, based on the securitisation of the different underlying national public securities. It would consist of an ABS of the existing eurozone public securities composed according to the pre-defined key.”
“The new ABS would not be an attractive innovation for the ECB only, but would greatly benefit private investors, both European and non-Europeans, who are longing for a European liquid and safe asset. Market-makers engaged in the EQUIP would provide liquidity for an important segment of financial markets, reducing the transaction costs for the basket of national public securities.”
“If the total amount of QE is estimated at €1trn, the market behind the new security would amount to one of the largest in global finance,” the paper says. “A group of financial intermediaries, mainly the largest government bond market-makers, would be called upon to set up the market for the new security. Private actors might find [it] attractive to create and trade a security which finds an ultimate purchaser in the ECB in the context of the QE program. In other words, liquidity of the new asset would be assured.”
What’s not to like? Sounds like a winner to me.
