If Spain/Italy yields are "unsustainable" because they are 3% too high, then just pay the 3% from EFSF/ESM/EU as a subsidy and let them finance in the market.
To avoid risk of having to pay very high subsidies, the EFSF/ESM/EU can backstop bond auctions at, for example, 9%.
Benefits:
- Vastly reduces risk: Instead of holding large credit positions, the cost of this subsidy for €300bn of debt would be €9bn/year, but only for as long as the market misunderstands that Spain/Italy are better credits. The cost of subsidizing €2 trillion of debt is the same as the cost of EU agriculture subsidies.
- Reduces pressure on Target2 creditors since they don't have to assume this additional risk.
- Conditionality works much better since Europe dispenses the benefit over time instead of up front.
- Highlights how small are amounts that are claimed to cause unsustainability.
- Eliminates subordination risk.
- Retains market information, which is the first step to appreciating that information.
---- Perspectives would have changed had it been shown that Spain could have financed the €100bn for bank capital in the market. The suggested approach allows this to be attempted without risk of disaster.
---- The market is often wrong, but should not be dismissed. When the market appears wrong, it's a good exercise to try to figure out why it might not be. Analysis of Greece would have benefited from this; same for Spain. Destroying this information makes it impossible to consider it.
Variations:
- Subsidy could be repaid as subordinated debt or ordinary debt.
- Subsidy could be repaid as GDP-linked debt
- If the auction is bought at 9% pursuant to the backstop, the subsidy is zero.
Hi Will,
ReplyDeleteInteresting idea. I'm more of a central bank watcher, government finance isn't my thing. But it seems to me that this plan would surely be more politically feasible than outright bond purchases, simply because 9 billion euros/year sounds like a lot less than 600 billion. A political free lunch to say.