In These New Times

Curbing speculatives attack is the first line of defence against the war being conducted against the Euro by Anglo-American finance. With regard to budget deficits it is notable that the emphasis always falls on cuts as if there weren’t two aspects: expenditure and revenue. Through wealth creation, the reconstruction of the real economy, revenue increases. This has to be the long-term focus of European policy.

Walter Otremba

Spiegel

11th October, 2011

Walther Otremba, 60, served successively as a senior official in the German economy, finance and defense ministries. He retired in March. He has written a guest commentary in SPIEGEL explaining his idea for a state credit insurance system that could help to tackle the euro crisis.

The current euro debt crisis was triggered by an increase in the yields on Greek, Spanish and Italian government bonds caused by the sudden realization that sovereign bonds issued by euro-zone member states weren’t risk-free investments.

Jointly issued euro bonds could perhaps stabilize the situation, but they would destroy important incentives for governments to limit their borrowing. The current strategy for containing the crisis, modelled on the practices of the International Monetary Fund, consists of providing fresh credit and guarantees in return for pledges of strict austerity programs. But that system places nations in fiscal straitjackets and is out of keeping with the principle of national sovereignty.

Another possibility to contain the crisis would be the establishment of a state-run European credit insurance system. It would preserve the incentives provided by risk premiums on national governments bonds, would provide security for creditors and wouldn’t burden stable countries more than absolutely necessary. The basic idea is that risk premiums for government bonds would be channelled into a guaranteed bond insurance system. For example, the purchaser of a bond issued by Italy would pay an annual insurance premium of 3.6 percent from his yield of 5.6 percent. In return, he would receive a secure bond with a slightly higher yield than that paid on a German bond.

Such a model could be introduced quickly, unlike the common economic government that many are now demanding for the euro zone. It would skim off the profits of the bond buyers and ensure that the rescue strategy is financed by those that caused the crisis through unstable fiscal policies and imprudent lending. That could increase the political acceptance of euro rescue measures in the countries that are providing assistance to high-debt nations.

The idea at first glance looks like a complicated version of the much-cited euro bond. In fact, there are two decisive differences. True, in the end, the community of all euro countries guarantees all insured government debt. But the countries wouldn’t all pay the same interest rates — instead, nations would pay according to their standing in the financial markets and according to the stability of their government finances.

The second difference is equally significant. Debtors and creditors would themselves pay for the (potential) insolvency themselves in advance.

Lasting Stability

Compared with today’s situation, that could create lasting stability for the financial markets. As long as Europe still has the confidence of investors in its ability to repay all the bonds issued by euro-zone nations — and that remains a fair assumption so far — it would make no sense to speculate against individual nations whose bonds are insured. Constant discussion about whether a bailout fund is big enough, about the stability of banks with major bond holdings or about their amount of equity capital would become redundant.

Of course, the effectiveness of the model depends on the credibility of the guarantee pledge — but this precondition must be met with all rescue operations. As a result, governments would continue to have to consolidate their finances, but they would be led and driven on by the pressure of their financing costs.

The sale of such bonds could generate major revenues. In the last three years investors in the euro zone have earned more than €100 billion ($136 billion) in risk premiums — enough, for example to finance a Greek debt restructuring with a 30-percent haircut. Italy next year will borrow over €300 billion. The difference in yield between Italian and German bonds currently amounts to more than 3.5 percentage points. The insurance for Italy alone would generate revenue of some €10 billion in the first year.

If the entire outstanding credit of the euro zone were insured in the end, 1 percent credit insurance would generate some €80 billion in revenue per year. These funds could be used to compensate low-risk countries, to set up reserves and to pay dividends to countries that have made proven, fast progress in restoring their public finances to health.

The financial investors could of course continue to reject state insurance for their bonds. But that would only be an option for those that deliberately pursue risk strategies. Against the background of state insurance, it would be clear that unprotected securities would be the first affected if a government ran into trouble with its payments.

The model would be relatively easy to run. One would need an institution to set the premiums for insurance policies and to issue guarantees. Unlike with euro bonds, there would be no need for a pan-European borrowing strategy that would infringe the sovereignty of national parliaments. As a result, the system would be less at risk of running into constitutional objections in the individual member states.

The decisive advantage of the proposal lies in the transfer of the unspoken guarantee for state bonds into a cost-linked, explicit insurance. The insurance would remove the uncertainty by explicitly promising what would in any case be necessary for the future of the euro and for financial market stability: to guarantee that members of the euro zone will not go bankrupt.