A Safer Way to Save the Eurozone

Cross published from my Uni paper, not sure if I’m allowed. But hey, I’ve nothing else written.

For the fourth or fifth time in as many years Europe needs a rescue plan. A group of academics from all around Europe, including LSEs Professor Luis Garicano and Professor Dimitri Vayanose now have a proposal which may be part of the last rescue plan necessary.

The problem is simple. Many countries, from Greece to Portugal, Italy, Spain and Ireland, carry debts they may not be able to pay back in full. Failure to pay back these debts would return Europe to recession because much of this debt is held by European banks who once considered it safe.

There is enough money in Europe to pay these countries debts, it is just that it is earned and spent in Germany by Germans, and the Germans are understandably keen to keep it this way. Previous plans have fallen short because the citizens of northern Europe are unwilling to commit to a bailout of southern Europe.

A rescue plan is not elusive because the economics are hard, politics is the fundamental problem. A successful plan to save Europe from renewed crisis will need to leverage Europes economic clout to shore up confidence in its riskier members in a way which does not put German taxpayers money in harm’s way. Eurobonds, once mooted as a potential solution to Europes woes were rejected for just this reason. They would have left Germany and other safe European countries on the line for the risky borrowing of other European countries.

Their rescue plan, published at the Euro-nomics website, is gaining traction with many of institutions at the heart of Europe. They propose to bundle up a portion of the debts of all Eurozone members and split it into a safe senior tranche and a risky junior tranche. Complex financial products got us into this mess and it is hoped that they may well get us out.

The senior tranche of debt would be known as European Safe Bonds (or ESBies, if you like your financial derivatives to have cute names) and would be amongst the safest financial assets in the world. They would be backed by the first 70% of debt payments from all European countries. Were things to go badly wrong through the Eurozone and many countries were to default ESBies would remain safe.

By their calculations, this means ESBies would only suffer losses every 600 years or so. They would be dull and their rewards would be meagre, just what Europe needs in these troubled times. Those who wanted higher returns, hedge fund and private equity investors, could gamble on the junior tranche without the problems caused by risky bonds being held by large banks.

This is important, rescue Europe and you rescue the employment opportunities of everyone who graduates from LSE next year. It would take a few months to get up and running but even moving towards this solution would calm markets and help return Europe and the world to stability.