Debunking moral hazard in common Eurobonds

IFR 2001 14 September to 20 September 2013
6 min read
Keith Mullin

Keith Mullin recalls a European bailout of France from 30 years ago.

Keith Mullin

IFR’S 2000TH ISSUE supplement is a wonderful series of reminiscences looking back over the almost-40 years since IFR began publishing. As part of our retrospective, we pulled together a list of 40 stand-out deals over that period. All of the deals were striking in one way or another but I was struck by one in particular from 30 years ago that stood out for a very specific reason that’s very pertinent today.

In 1983, the European Economic Community, the forerunner of the European Union, pulled off the largest capital markets transaction ever launched by any entity away from the US or UK government. The US$1.8bn FRN tranche was the largest-ever Eurobond at the time while the three-tranche fixed-rate piece in European Currency Units (Ecu150m), the pre-euro European composite currency, was at the time the largest Ecu deal. The widely syndicated US$1.3bn seven-year Euroloan was massively over-subscribed, while the package was rounded out by a US$350m four-year Eurobond.

But it wasn’t the deal’s structure or its Ecu4bn-equivalent size – huge for its time – that caught my attention. No, it was the use of proceeds that screamed out at me: all the cash went directly to the coffers of France’s embattled president François Mitterrand, whose crisis-ridden economy was close to running out of money.

IN OTHER WORDS, it was an EEC bailout in the form of a joint and several community Eurobond and Euroloan, the very concept that has been causing so much angst and gnashing of political teeth ever since the eurozone sovereign crisis erupted in the aftermath of the global financial crisis. IFR’s coverage of the deal at the time contained this fabulous line: “within an hour of the EEC Ecu4bn-equivalent global financing being signed, the funds will be on-lent to France via a ceremony which will take place in the room next door”.

I spoke to a banker the other day who worked on the deal 30 years ago and he remembers it very well. “The 1983 EEC deal was a milestone for the development of the international capital markets,” he told me. “The entire transaction was the forerunner of what is being suggested today: to borrow in the name of the EU and channel the money to countries that have borrowing problems in their own right.”

The funds came just in time for France. If you recall, Mitterrand swept to power in 1981 and dogmatically pursued a radical Socialist statist agenda, nationalising swathes of the French economy (including dozens of banks and large industrial conglomerates), increasing taxes on the rich, massively increasing the size of government and government spending as well as upping wages of civil servants and employees of state-owned companies in order to boost demand and drag the country out of recession. He also showered the banks with low-cost money. It was the ultimate stimulus programme.

No surprise: the budget deficit ballooned to three times its size, nationalised companies made huge losses, and inflation grew out of control to twice the levels in the US and Germany. Mitterrand was forced to devalue the French franc three times to keep exports competitive, yet growth still proved elusive and under-shot other members of the EEC.

By 1983, France’s international payments position had become critical. Mitterrand undertook a policy U-turn and switched to painful austerity, imposing currency controls, freezing public sector salaries, putting up trade barriers to stem the flood of imports, and threatening to yank the franc out of the rigid European Monetary System of linked exchange rates – aka “the snake” – and allowing it to float. Long story short, his efforts paid off. By the mid-1980s, the budget was broadly back in balance and inflation had fallen sharply.

“The entire transaction was the forerunner of what is being suggested today: to borrow in the name of the EU and channel the money to countries that have borrowing problems in their own right.”

THE BAILOUT WAS a vital lifeline for France and the EEC got its pound of flesh by imposing some heavy conditionality on the financing and arguably forcing Mitterrand’s political U-turn. So what’s the problem?

Well, common bonds have been vetoed by the Germans despite support from the IMF, OECD, François Hollande and pretty much everyone else, because the Germans reckon they create moral hazard in the form of disincentives for troubled governments to push through structural and budgetary reforms and risk increasing Germany’s cost of borrowing. Doesn’t the EEC financing for France disprove this notion?

German government officials justify their intransigence hiding behind their mantra – hotly disputed – that common bonds are not allowable under EU treaties. As a result, burden-sharing is off the agenda. But it’s worth noting that even though the 1983 EEC-engineered capital markets bailout of France came before the single currency, before the creation of the ECB and at a time when the Banque de France still had the power to effect domestic monetary policy outcomes, it still had the desired impact and didn’t deter French austerity.

With today’s highly centralised European monetary regime, ongoing moves towards banking and fiscal union – the historic approval on September 12 by the European Parliament to grant the ECB supervisory oversight of around 6,000 banks in the eurozone is emblematic of the direction of travel – and the weight of rigorous conditionality, I think the 1983 common Eurobond, if not exactly debunking the myth of moral hazard, certainly shifts the balance of power away from potentially wayward governments in distress tempted to game the system. I say get them back on the table.