LONDON (Reuters) - Germany keeps reaffirming its long-standing opposition to shared euro zone bonds but analysts say the region is already headed towards implicit mutual responsibility for national debts and Berlin will come under increasing pressure to succumb.
The region’s complex TARGET2 payments system, which hosts payment flows between euro zone member states, suggests there is already a good deal of risk-sharing implicit in regional structures, not to mention the exposure the European Central Bank has to peripheral debt.
That shared liability may fall short of the kind of joint risk-taking foreseen for a common bond, where one country is responsible for the non-payment of debt by another.
But analysts say the build up of imbalances in the system - as the ECB replaced private sector lending which dried up for peripheral countries - reflects the latest in a number of crisis-fighting steps that have increased regional integration.
The tab Greece and other indebted euro zone members are accumulating at the Bundesbank via the ECB illustrates how intertwined Germany’s fate has become with those of peripheral states.
“As these assets or claims and liabilities vis-a-vis other member states grow, it means you get more and more involved in each other’s business and that’s basically the same as saying that you are gradually moving towards a fiscal union,” Elwin de Groot, senior market economist at Rabobank, said.
During the crisis Greece, Ireland, Italy, Portugal and Spain built up the bulk of the 644 billion euros worth of Bundesbank IOUs in the region’s cross-border TARGET2 system.
Economists say the imbalances carry only become a problem when one or more countries leave the euro.
But if a member state does exit and its central bank is not able to honor its liabilities with the ECB, the cost could end up with the rest of national central banks.
The prospect of an euro exit is no longer so far fetched. The once unmentionable is now openly discussed by officials.
“If there are losses on these claims that the ECB has, these losses get distributed in the euro area as a whole, according to (national central banks’) capital shares at the ECB,” said Guntram Wolff, deputy director of Brussels-based Bruegel think-tank, which published the Blue Bond proposal outlining a possible structure for common debt issuance.
“So in that sense it’s a euro bond but a special euro bond which ... takes on a risk and distributes this risk in the entire euro system.”
By September 2011, the volume of liabilities that Greece, Ireland, Italy, Portugal and Spain had against the Bundesbank through the ECB system far exceeded the official loans given to them by the euro zone countries combined, according to an academic paper co-authored by Hans-Werner Sinn and Timo Wollmershaeuser at Germany’s Ifo economic institute last year.
Sinn, who heads the institute, told Reuters that common bonds were the “logical consequence” of the TARGET2 system.
In a testament of sentiment in Germany towards the idea, he also said it was “an inevitable force that pulls Europe into what I would call a disaster”.
Berlin opposes the concept for fear it will end up paying for overspending in peripheries. Only when it sees the risks to the euro zone of not acting as greater than the domestic political cost of putting Germany ever more on the hook, is it likely to budge.
Chancellor Angela Merkel, who faces elections next year, showed no sign of dropping her objections at a summit of European Union leaders last week, but new French President Francois Hollande is an advocate.
Merkel insists euro zone bonds can only be discussed at the end of a long process towards fiscal integration. Even if she agreed, it would require the European Union treaty to be changed, a process that typically takes months or years, not weeks.
“It is unlikely, notably for legal reasons, that the ‘silver bullet solutions’ which investors would like to see, such as Eurobonds ... can be easily envisaged in the timeframe relevant for the current financial turmoil,” said Deutsche Bank economist Gilles Moec. “Indeed, vocal opposition to Eurobonds is not weakening in Germany.”
But if a Greek euro exit materializes, which elections next month could hasten, contagion will spread and emergency crisis action of some sort will be needed. Many analysts see common bonds as the best way of solving the crisis.
“(The TARGET2 system) is certainly something that they will have to bear in mind when looking at the consequences of any breakdown in the system,” de Groot said.
“The bigger the claims versus liabilities grow, the bigger the chances that they will try to stop such a scenario of a break-down,” he said. “This puts pressure on the Germans at some point to accept euro bonds.”
A Bank of Greece’s financial statement showed that as of January it was carrying TARGET2 liabilities of 107 billion euros, a sum that has likely remained around that level since and which represents a big potential problem for the other euro zone central banks and the governments that back them.
There are still no official plans for a common euro bond, or detail of how it might be structured.
The Bruegel institute in May 2010 published the Blue Bond proposal which foresees a pooling of a chunk of national debt into a senior blue bond with joint liability and anything beyond that issued as national, junior paper.
The idea is to secure a liquid pool of debt with low borrowing costs on the one hand, and keep incentives for fiscal discipline on the other.
“That’s the route that we may go down. And it may well be that the European Stability Mechanism (ESM) represents the first stage of that,” James Nixon, chief European economist at Societe Generale said.
The ESM is the euro zone’s permanent rescue fund which will take over responsibility for future bailouts in July.
Graphics by Scott Barber, editing by Mike Peacock