By Robin Emmott
BRUSSELS (Reuters) - Calls are growing for euro zone states to consider issuing bonds jointly underwritten by all 17 countries in the bloc -- so-called euro zone bonds.
Some economic analysts, senior European Union officials, members of the European Parliament and financial market participants believe such a step could help resolve the region's debt crisis, but little flesh has so far been put on the bones of the idea.
Germany, which is the euro zone's most powerful economy and enjoys the lowest sovereign borrowing costs, would stand to lose most if such bonds were introduced as it would effectively end up having to underwrite weaker, more risky member states. As a result, German Chancellor Angela Merkel is adamantly opposed.
Despite her opposition, clamor for the bonds has not diminished. The European Commission is now expected to come up with some ideas for the European Parliament to study, an early step in what could lead to more formal legislative proposals.
Below, we look at some ideas already in circulation, and at how realistic the adoption of euro area bonds really is.
WHAT PROPOSALS ARE OUT THERE?
The disparity in financing costs between blue and red bonds -- potentially, a jump of more than 50 percent by some estimates -- would be a big incentive for euro zone countries to bring their debts rapidly down to below 60 percent of GDP, the limit originally targeted by the EU.
Each bond would be split into senior and junior tranches, with the senior section, around 60 percent of the total, insured by the EFSF and its successor, the European Stability Mechanism
The ESM would become a monoline bond insurer that in the event of a default would pay investors quickly and in full on 60 percent of their assets, while the junior debt could be restructured. Such junior debt could trade separately after a default.
The dual structure of the bond would mean sovereigns are charged a higher interest rate than for blue bonds, reflecting the implicit 40 percent first loss carried by the uninsured junior tranche. So the mechanism would still provide an incentive to avoid excessive debt issuance when times are good.
At the same time, the 60 percent risk protection would help moderate spread increases during crises, meaning countries could continue to raise funds at a lower cost than via red bonds.
Dubel envisages member states issuing such bonds separately at first, but a single insured bond for the bloc could emerge if there was fiscal convergence between euro zone economies.
Unlike the EFSF, which is only designed to help rescue euro zone members that are in trouble, the debt agency would regularly issue bonds for individual countries. Strong guarantees -- for as much as 300 percent of the value of the borrowed amount -- would help ensure the bonds were highly rated.
Another alternative is to allow euro zone members to issue bonds individually after being allocated a financing quota from an existing, or newly created, European institution.
Euro zone bonds would not necessarily have to completely replace national debt markets and could complement them.
ARE THESE PROPOSALS PRACTICAL?
Big holes still remain in even the most detailed proposals.
Bruegel concedes its proposal was drawn up when debts were significantly lower across the euro zone.
Spain broke through the 60 percent debt-to-GDP ceiling last November and about half of Italy's debt, currently around 120 percent of GDP, would fall into the red bond category, leaving it vulnerable to soaring financing costs and even default.
Given the critical cut-off point for blue bonds, it is also unclear who would rule whether a country has breached the 60 percent debt-to-GDP level, how authorities would deal with states slow to report their debt levels and who would monitor whether countries were parking debt off the books to keep themselves in the blue zone.
There is also the issue of how the bonds would be rated. Many assume they would secure a top-grade triple-A rating, but Standard & Poor's told Reuters this month that depending on how its guarantees are structured, a common bond could take the rating of the euro zone's weakest member, junk-rated Greece.
Would thousands of bureaucrats involved in national debt issuance suddenly find themselves unemployed? Or would individual countries' debt departments be kept open to deal with outstanding national debt until it matures, and to deal with legacies of the old system?
WHY ARE POLITICIANS IN GERMANY SO WARY?
German politicians and the Bundesbank say a common euro bond initiative creates a "free-rider" situation where bigger economies are saddled with the liabilities of weaker members and face higher borrowing costs. Germany says the idea cannot even be entertained until there is much tighter fiscal coordination and a more level tax field across the euro zone.
Some worry a euro zone bond, with its lower interest rate, would be another invitation for southern Europe to splurge on debt. That could be mitigated in part by charging higher rates for bonds issued by countries with higher debts and deficits.
WHAT ABOUT SOVEREIGNTY ISSUES?
The toughest issue is the loss of sovereignty that national parliaments would confront if euro bonds were introduced.
To make the bonds work and avoid excessive borrowing, Germany would almost certainly insist on creating a central authority responsible for reviewing national budgets and financing needs, with the right to a veto. It would effectively mean the setting up of a pan-euro zone finance ministry or fiscal authority, undermining one of the most fundamental sovereign powers of a state -- taxation.
Parliaments would still have the right to set taxes and decide how their budgets were spent. But handing over so much power may be too much for them to stomach.
That has not been lost on the EU's economic and monetary affairs commissioner, Olli Rehn, who has promised the European Parliament he will present his own ideas for euro zone bonds in the coming weeks. He warned this month of "rather high expectations" for the bonds, given the "unavoidable implications for fiscal sovereignty" they entail.