status, which we would like to call AAAA.
Joint and several guarantee:
Blue debt is coveredby joint and several guarantee, ie each country,each year, guarantees all the Blue debt of all otherparticipating countries to be issued the followingyear. This guarantee may seem extreme, but it isrestricted to the safest sovereign debt componentof each country, the one deemed to never default
.The joint and several guarantee will ensure thatBlue debt would be considered even safer than thecurrent benchmark bond, namely the GermanBund. Of course, for participating countries tomerit such mutual guarantees, they must allcommit to strict conditions, which will beexplained below.
60 percent GDP limit:
The most important safe-guard to guarantee the quality of the Blue Bond isthe upper limit of 60 percent of GDP to be borrowedin Blue debt by any participating country. What ismore, the allocation of Blue Bonds as determinedby the Blue Bond governance mechanism may bedecreased to well below the 60 percent limit incase of reckless fiscal policies, strengtheningeven more the fiscal sustainability incentives.
The annual allocation of Blue Bonds would be proposed by an independentstability council staffed by members who wouldenjoy a similar degree of professional independ-ence to the board members of the European Cen-tral Bank (ECB). This allocation would then bevoted on by the national parliaments of partici-pating countries, having the ultimate budgetaryauthority required to issue the Blue Bond mutualguarantees. Any country voting against the pro-posed allocation would thereby decide neither toissue any Blue Bonds in the coming year nor toguarantee any Blue Bonds of that particular vin-tage. Since the decision of any major participat-ing country to ease itself out could undermineconfidence in the entire scheme, the independent
2. For instance, the currentGreek debt crisis is due tothe size of the debt (150percent of GDP). Had Greeceentered the crisis with aBlue debt of 60 percent of GDP, it would have been ableto fully service it (3 percentof GDP at most), as its fiscalrevenues were 35 percentof GDP; the debate aboutGreek debt would havefocused only on Red debt.One of the mainrequirements of AAA statusis that debt service bebelow 10 percent of totaltax revenues; every yearsince 1992, Greek Bluedebt would have easily metthis requirement (includingin 2009, 2010 and 2011).It is true that Spanishsovereign debt, despitebeing below 60 percent of GDP, is not AA now andbears spreads of more than200 bps. The reason is notthe sustainability of thecurrent debt level butuncertainties about Spain'sfuture sovereign liabilities(banks recapitalisations,skyrocketingunemployment and futurepension liabilities, givenSpain's low birth rates).
Delpla and von Weizsäcker •
THE BLUE BOND CONCEPT AND ITS IMPLICATIONS
stability council would have a strong incentive toerr on the side of caution, thereby safeguardingthe interests of the European taxpayer.
Full participation in the Blue Bond schemeshould not be regarded as an entitlement but assomething earned through enhanced fiscal credi-bility, by means of low debt levels or credible insti-tutional guarantees (credible national fiscal rulesin particular) that put public finances on a sus-tainable path.
Blue debt agency:
From a bond market perspec-tive, Blue Bonds need to be the operational equiv-alent of plain national sovereign debt. Thisnecessitates the creation of a joint debt agency towhich tax revenues would be transferred directlyto avoid the holding discount customary for mul-tilateral debt.
Red debt, consisting of the remainder of the sovereign debt, would be the junior tranche. Inother words, it could and would be honoured onlyafter the entire Blue debt has been fully serviced.
Red debt can never beguaranteed by another country; it cannot bebailed out by EU mechanisms (European Finan-cial Stability Mechanism (EFSM), European Finan-cial Stability Facility (EFSF), or the futureEuropean Stability Mechanism (ESM)). The ‘nobail-out’ clause would apply only and strictly to theRed debt. Red debt would be issued by nationalTreasuries. As a result, the size of the future ESMwould remain low, as it would have to finance onlyprimary deficits and not the roll-over of Red debt.
Not in banking system:
In order to allow for anorderly default of Red Bonds, we propose that Reddebt should largely be kept out of the bankingsystem. This would be achieved through two
‘The joint and several guarantee will ensure that Blue debt would be considered even safer thanthe current benchmark bond, namely the German Bund. Of course, for participating countries tomerit such mutual guarantees, they must all commit to strict conditions.’