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The euro crisis is coming to a head with many experts predicting that it is inevitable that Greece will leave the single currency. Leaders from the 27 countries meet in Brussels on Wednesday for emergency talks on how to fix the problem.
Why is everyone suddenly talking about eurobonds?
The idea of joint borrowing has been circulating for at least 12 months, but François Hollande, the newly elected French president, has made it clear that he intends to push for a eurobond at Wednesday's meeting of European leaders, as part of an alternative to pursuing austerity alone as the solution to the debt crisis.
What is a eurobond, exactly?
It is a collective debt: part of the problem facing some eurozone countries is that they are struggling to borrow from financial markets at affordable interest rates. If instead the European commission, for example, could borrow on behalf of all eurozone member states by issuing joint bonds, the cost could be lowered for countries such as Italy and Spain, because investors could be confident that stronger countries stood behind their debts. Analysts calculate that Portugal, for example, would see annual repayments fall by €15bn, or almost 9% of its GDP, as its interest rate fell to the eurozone average.
Over time, the outstanding debts of countries such as Greece could be turned into eurobonds and paid off by the eurozone as a whole. The policy would send a powerful message of solidarity, making it harder for credit-ratings agencies and investors to target individual countries. The Italian prime minister, Mario Monti, and the Paris-based Organisation for Economic Co-operation and Development have recently thrown their weight behind the idea. The European Central Bank (ECB) is also in favour.
How did we get here?
For much of the euro's first decade, financial markets treated many euro countries as though they were issuing common bonds, with countries such as Greece and Italy paying little more to borrow than Germany or France. Investors simply assumed that eurozone countries were yoked together for all time, and if one got into trouble, it would ultimately be bailed out by its partners. These cut-price loans gave governments little incentive to reform; and while in theory the eurozone's stability and growth pact was meant to impose strict deficit limits to prevent countries going astray, the targets were repeatedly missed, including by Germany and France, and no action was taken.
After the credit crunch, when the most severe recession in decades had pushed governments deep into the red, doubts began to emerge about whether, and how, Greece and others could afford to repay their heavy debt burdens. Without any agreed bailout mechanism, markets suddenly began to assess the solvency of each country separately and the cost of borrowing shot up across recession-hit states, driving them towards budgetary crisis. Despite two bailouts for Greece, the question of whether eurozone countries will stand with each other, come what may, has yet to be resolved.
Sounds great. Why don't they just do it?
Eurobonds might sound great to Greece, but they go fundamentally against Germany's approach to resolving the crisis. Collectivising debt removes the incentive for individual countries to put their own public finances in order. It also opens up a so-called "moral hazard" problem: if profligate behaviour goes unpunished, what's to stop any country going on the national equivalent of a giant bender and expecting Germany to pick up the tab? If Germany's borrowing costs rose to the eurozone average, it could cost Berlin an extra €50bn a year in repayments – almost 2% of its GDP.
There are political and constitutional problems with the idea for Germany too: the constitutional court has made clear that it is not willing to sanction open-ended bailouts of other countries, which might well make eurobonds unconstitutional, and German voters – the fabled Swabian housewives summoned up by politicians to represent their frugal citizens – may not be ready to bail out the single currency zone in the way the policy implies.
Even if the Germans signed up, would eurobonds resolve the crisis?
No. They could help to calm the market panic and ease the immediate budgetary crisis of some countries, including Italy and Spain. But a eurobond would do nothing to reduce overall levels of debt, let alone tackle the underlying structural problem that countries such as Greece are simply unable to compete fairly with their eurozone partners.
Don't euro leaders usually come up with a fudge when they can't agree on something?
Yes. There are modest versions of a eurobond, where countries would still be responsible for the majority of their debts, with the commission just picking up the riskiest slice, for example. Such an arrangement might be more palatable than a full-blown collectivisation of the debt. But the less ambitious the plan, the less likely it would be to succeed.
There is also a proposal on the table for €230m of so-called "project bonds", which would see euro countries jointly raise finance for specific infrastructure schemes aimed at creating jobs and boosting growth. This would be a drop in the ocean, and do nothing to resolve the mountain of outstanding debt; but it might be enough of a sop to Hollande for him to be able to claim he's shifted the debate towards growth.
So what will happen next?
It's impossible to say, but so far there is no evidence that the stern talking-to Merkel received from her G8 partners at the weekend has softened Germany's opposition to eurobonds; so unless politicians' hands are forced by financial markets, we're unlikely to see radical, catch-all solutions like this. Instead, we're likely to be stuck with more muddling-through.
Dinner party one-liner: It's all very well but Angela won't wear it.
So what are the chances for the eurobond solution?
Angela Merkel and her finance minister, Wolfgang Schäuble, have repeatedly expressed their opposition but they will face intense pressure from Hollande and his Germanophone finance minister, Pierre Moscovici. Monti also backs the idea, and has previously had Merkel's ear – but Italy would be a major beneficiary so he's likely to be seen as talking his own book. Another powerful Italian, ECB president Mario Draghi, favours eurobonds, but so far Germany has paid little heed to his demands for more rescue measures.
David Cameron has also been urging a more collective approach on the UK's euro-neighbours, but his view counts for little in Germany after he infuriated Merkel by vetoing a new European treaty last year
Germany refused to share the debt burden of stressed eurozone peers on Tuesday, ignoring two of the most influential international economic bodies which offered support for proposals championed by Paris, Rome and Brussels ahead of a summit.
Angela Merkel, Germany’s chancellor, has argued that any co-mingling of eurozone debt would remove incentives for southern economies to adopt structural reforms. The calls from the International Monetary Fund and the Organisation for Economic Co-operation and Development came on the eve of Wednesday’s EU summit.
François Hollande, France’s new president, has strongly backed common eurozone bonds – which would ease funding constraints for the eurozone’s stressed periphery but potentially raise German borrowing costs by diluting its creditworthiness across the currency union.
German officials made clear the idea was a non-starter in Berlin.
“There is no way of introducing them under the current [EU] treaties. Indeed, there is an explicit ban on them,” one senior German official said, adding Berlin would not drop its opposition in the foreseeable future. “That’s a firm conviction which will not change in June.”
Increased jitters over how Europe’s banking system would be affected by an exit of Greece from the eurozone have lent urgency to the latest discussions over measures to tackle the sovereign debt crisis.
Mr Hollande has vowed to raise eurozone bonds at the informal summit. He won backing from the OECD, which in its twice-yearly economic outlook specifically called for such bonds, saying they were needed to break a vicious circle “involving high and rising sovereign indebtedness, weak banking systems, excessive fiscal consolidation and lower growth.”
“We need to get on the path towards the issuance of euro bonds sooner rather than later,” Pier Carlo Padoan, the OECD chief economist, told the Financial Times.
Christine Lagarde, the IMF chief, also called for more burden-sharing. Though she stopped short of explicitly backing euro bonds, she said “more needs to be done, particularly by way of fiscal liability sharing” – a thinly veiled reference to such debt instruments.
Diplomats said the summit, which just last week looked like it would be a highly scripted affair on European growth, had become increasingly unpredictable, with leaders struggling with how to respond to the havoc wreaked by political instability in Greece. Officials emphasised that no formal decisions would be taken.
The euro bonds debate could produce fireworks between Mr Hollande and Ms Merkel – a possibility that has captivated officials involved, given the comparatively harmonious Franco-German relationship in the latter years of Nicolas Sarkozy’s tenure. But most diplomats believe Ms Merkel would succeed in blocking any proposal, producing more smoke than fire.
“They say that when Germany and France don’t co-operate, we have a problem,” one senior diplomat from a smaller EU country said. “And when they do, we have a problem, too.”
Of more urgent concern are ongoing discussions over eurozone banks, with officials saying the fear of a Greek eurozone exit has forced leaders to contemplate massive rescues, particularly in Spain. Rising estimates of bad loans have forced Madrid to part-nationalise one bank and face the increasing likelihood it will need to inject more government money into others.
Senior EU officials question whether Madrid, which has faced rising bond market borrowing costs, has the financial wherewithal on its own, spurring a furious series of negotiations over whether the eurozone needs to move quickly towards a common bailout and deposit guarantee scheme.
Although officials said such reforms have pushed themselves onto tonight’s agenda, it remains unlikely any can be agreed quickly, making the European Central Bank the last line of defence if Greece forces more immediate action.
