Europe’s Government Bond Market May Thrive Post-Crisis

Terry Flanagan

With greater fiscal union among eurozone nations now seen as the answer to curing the escalating European sovereign debt problem, some market participants believe that the region’s government bond markets will stabilize and also thrive post-crisis.

Earlier this week, the European Commission issued proposals, likely to come into effect in 2014, to create a banking union among the 17 nations of the eurozone that would create closer co-ordination between countries to force future losses of failing banks on to bondholders and shareholders, rather than the taxpayer—bringing to an end the ‘too big to fail’ culture in Europe as larger banks posing a systemic risk would be propped up in part by having unsecured creditors of the bank taking a much larger hit—and moving the supervision and support of banks away from national to European regulators in a bid to bring an end to the eurozone crisis.

“A stronger federal government of Europe is needed to absorb the debts of the member states, and to enable the combined states of the euro area to be able to raise revenues and authorize expenditures in future, and to issue bonds in the name of the eurozone as a whole in future,” said John Greenwood, chief economist at Invesco, an investment management firm based in London.

Establishing in principle the issuance of eurobonds is currently proving a tricky one for stronger eurozone nations, such as Germany, to swallow as collective eurozone debts would enable other more indebted countries to benefit from lower borrowing costs, as bond yields would no longer vary across the eurozone, and reassure the markets of Europe’s willingness to stand behind the euro. Germany has been against eurobonds as it believes that it would be forced to take on some of the debts of the more indebted countries in the region and be forced to pay higher borrowing costs itself, but easier borrowing costs for other nations could help finance such things as public infrastructure projects more easily, thus allowing a boost to their economies.

“If Brussels were to take over the debts of Greece and other struggling peripherals the immediate credit crisis would recede, and euro-area credit would establish itself alongside US Treasury debt as one of the foremost debt markets in the world,” said Greenwood.

As of early afternoon trading on June 7, yields on 10-year government bonds in the European Union varied markedly, with Germany, at 1.35%, and the UK, at 1.67%, experiencing near record lows while, in contrast, the southern European nations of Spain (6.17%), Italy (5.72%) and Greece (28.37%) all continued to struggle with punitive borrowing costs.

The Commission’s resolution regime is to be based on four pillars, including a single European Union deposit guarantee scheme covering all EU banks; a common resolution authority and a common resolution fund for the resolution of, at least, systemic and cross-border banks; a single EU supervisor with ultimate decision-making powers, in relation to systemic and cross border banks; and a uniform single rule book for the prudential supervision of all banks. It also says that banks that pose no systemic risk will be allowed to fail and that banks will have to keep higher levels of capital and have more transparent market structures. Between 2008 and 2011, the Commission said that European governments issued €4.5 trillion, equivalent to 37% of EU gross domestic product, of state aid measures to financial institutions.

“The proposal is an essential step towards banking union in the EU and will make the banking sector more responsible,” said José Manuel Barroso, president of the European Commission. “This will contribute to stability and confidence in the EU in the future, as we work to strengthen and further integrate our interdependent economies.”

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