Here Comes Europe's Hail Mary - Presenting The "Redemption Fund"
A week ago, Zero Hedge brought up the last Hail Mary available in Europe's fiscal arsenal: the Redemption Fund. Specifically we said, " There are currently three options being discussed for the Stabilittee bonds - all of which have more than short-term time horizons for any potential implementation and so we suspect, as CS mentions, that the talk of the Redemption Fund from the German Council of Economic Experts will grow louder as an interim step" and quoting Credit Suisse, " One proposal that might be able to co-exist with the Treaties as they are is the recommendation of the German Council of Economic Experts, pooling sovereign debt in a Redemption Fund as we discussed briefly last week. We are quite surprised that the idea does not seem to have generated more traction in the press since it is one of few proposals that actually provides a means for reducing debt (rather than moving it around the euro area) and is aimed not to fall foul of the German Constitution. Something based around this idea might be a contender for a precursor to permanent Eurobonds, buying time while the Treaties are changed." Sure enough here is Reuters showing that it only took Germany one week to catch up to what our readers already knew, from Reuters: "Germany will propose setting up special national funds for euro zone sovereign debt that is over 60 percent of gross domestic product to help build market confidence, the country's finance minister said on Thursday. Wolfgang Schaeuble told reporters that Germany would make the proposal at a European Union summit next week. The funds should be supported by public revenues and dismantled within 20 years, he said." In other words even Europe now admits that the EFSF as even as stop gap measure to fill the void before the ECB acquiesces to print, is dead, and is looking at the last measure available to fix the fundamental problem at the heart of the Eurozone (yesterday's liquidity band aid is just that) which is the rolling of untenable amounts of leverage. Unfortunately, the core provision of Schauble's redemption fund variation which is that the fund is national, "which would get around German concerns about the "communitarization" of debt between European states" means that the idea is hardly unlikely to pick up as it relies on already insolvent countries to fund it. If this is indeed the final backstop to be presented at the European Summit, it may be time to turn bearish on Europe all over again, today's surging sovereign bond prices notwithstanding.
And here is Morgan Stanley with some more perspectives:
Debt redemption pact and safe bonds
As a specific example of the partial issuance approach, the German Council of Economic Experts (GCEE) presented in their Annual Report 2011/1224 a proposal for safe bonds that is a part of a euro-area wide debt reduction strategy aimed at bringing the level of government indebtedness back below the 60% ceiling as put in the Maastricht Treaty.
One of the pillars of the strategy is a so-called debt redemption fund. The redemption fund would pool government debt exceeding 60% of individual countries' GDP of euro area Member States. It would be based on joint liability. Each participating country would, under a defined a consolidation path, be obliged to autonomously redeem the transferred debt over a period of 20 to 25 years. The joint liability during the repayment phase means that safe bonds would thereby be created. In practice, the redemption fund would issue safe bonds and the proceeds would be used by participating countries to cover their pre-agreed current financing needs for the redemption of outstanding bonds and new borrowing. Therefore, the debt transfer would occur gradually over around five years. Member States with debt above 60% of GDP would therefore not have to seek financing on the market during the roll-in phase as long as the pre-agreed debt reduction path was adhered to. After the roll-in phase, the outstanding debt levels in the euro area would comprise: (i) national debt up to 60% of a country's GDP, and (ii) debt transferred to the redemption fund amounting to the remainder of the debt at the time of transfer. Open questions remain, for example on the fund's risk, and the impact on the de facto seniority from collateralisation of the fund's bonds.
The GCEE debt redemption pact combines (temporary) common issuance and strict rules on fiscal adjustment. They do not constitute a proposal for Stability Bonds in the meaning of this Green Paper, in the sense that common issuance would be temporary and used only for Member States with public debt ratios above 60% of GDP. Instead, the GCEE proposes to introduce a temporary financing tool that would give all euro-area Member States time, and financial breathing space, to bring their debt below 60% of GDP. Once this goal is reached the fund and safe bonds will be automatically liquidated. Therefore, safe bonds are a crisis tool rather than a way of permanent integration of the euro-area government bond markets. Even though temporary, the debt redemption pact could contribute to the resolution of the current debt overhang problem.