An influential European body has asked Central Bank governor Philip Lane to develop a plan to keep euro area states' borrowing costs low following the financial crisis – without triggering a fiscal union.
The European Systemic Risk Board, set up in 2010 to promote financial stability in the EU and chaired by European Central Bank governor Mario Draghi, has requested that Prof Lane "investigate the potential creation of sovereign bond-backed securities", according to minutes of a board meeting on September 22nd, published on Thursday.
Prof Lane will do so as chair of the newly created ESB High-Level Task Force on Safe Assets, consulting with public and private sector parties in developing a plan, according to the minutes.
Trinity work
The task draws on work Prof Lane has been involved in since the height of the financial crisis. In 2011, while head of Trinity College Dublin's economics department, he was among a group of economics and finance professors to write an open letter published by the Wall Street Journal on how to save the euro zone while avoiding a full-blown political or fiscal union.
The group proposed creating a new European debt agency that would buy sovereign bonds of member nations. The agency would then use these bonds as collateral to issue two types of securities to investors, including banks.
Firstly, it would sell European Safe Bonds, which would have a senior claim on payments from the bonds in the portfolio.
“This way, payment on the safe bonds would not be jeopardised even in a worst-case scenario, such as a default by Greece, Portugal and Ireland,” the group wrote, at a time when all three countries were in a bailout programme and only months after Ireland’s 10-year Government bond yields hit an euro-era high above 14 per cent.
Private investors
The debt agency would also issue junior bonds, which would be first in line to be hit in the event of losses triggered by a default. These securities would carry a higher interest rate and most likely appeal to private investors such as hedge funds.
“Europe’s financial system would be safer if new banking regulation induced banks to move their portfolios toward European Safe Bonds, since this would cut the contagion link,” the group wrote at the time.
“Because the agency that issues ESBies would buy only a fraction of each country’s total debt, national governments would still have to find private buyers and pay market interest rates that reflect their risk. This would provide the incentive to manage their public finances prudently.”
At the moment, euro-area government bond yields are hovering near record lows, largely as a result of the ECB’s unprecedented €1.7 trillion bond-buying programme. However, the work that Prof Lane is involved in investigating would help sovereigns in a post-crisis world, after the stimulus programme has come to an end.
Prof Lane became governor of the Central Bank of Ireland last November.
