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110322 Pc Blue Bonds

110322 Pc Blue Bonds

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Published by: bruegel_3ev on May 19, 2011
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ISSUE 2011/02MARCH 2011
EUROBONDS: THEBLUE BOND CONCEPTAND ITS IMPLICATIONS
JACQUES DELPLA AND JAKOB VON WEIZSÄCKER
Highlights
The Blue Bond proposal, published in May 2010 (Bruegel
Policy Brief 
2010/03) suggests that sovereign debt in euro-area countries be split intotwo parts. The first part, the senior ‘Blue’ tranche of up to 60 percent of GDP,would be pooled among participating countries and jointly and severallyguaranteed. The second part, the junior ‘Red’ tranche, would keep debt inexcess of 60 percent of GDP as a purely national responsibility. This paperrevisits the proposal, discusses its implications and addresses some of thecomments and criticisms received in response to the proposal.This paper was prepared for the European Parliament’s Economic and MonetaryAffairs Committee, session of 21 March 2011 on the interaction between bankand sovereign debt resolution. Copyright remains with the European Parliamentat all times.Jacques Delpla is an economist at the French
Conseil d’Analyse Économique
.Jakob von Weizsäcker is a Non-resident Fellow at Bruegel and an economist atthe
Thüringer Ministerium für Wirtschaft, Arbeit und Technologie
.
Telephone
+32 2 227 4210info@bruegel.org
www.bruegel.org
BRUEGEL
POLICY
CONTRIBUTION
 
EUROBONDS: THE BLUE BOND CONCEPTAND ITS IMPLICATIONS
JACQUES DELPLA AND JAKOB VON WEIZSÄCKER,MARCH
In the next section we outline the main feature of the Blue Bond proposal and the key properties of this mechanism. The third section concludes bylooking at 'frequently asked questions' we havereceived to date, thereby highlighting some of thepolicy issues at stake.
BLUE AND RED BONDS: BASIC CONSTRUCTIONAND KEY FEATURES
As indicated above, the basic idea is to create twodifferent sovereign assets for two different objec-tives. First, the Blue Bond would make the lion'sshare of sovereign borrowing in the euro areamore affordable (up to the Maastricht debt limit of 60 percent of GDP) by creating an asset that sat-isfies the demand for super safe and ultra liquidinvestment opportunities, including from Asiancentral banks and other large investors looking forsuper safe assets. Second, the Red Bond wouldmake borrowing more expensive at the margin,especially for countries pursuing unsustainablefiscal policies or lacking fiscal credibility, therebyreinforcing the rules-based Stability and GrowthPact through market signals.
Blue debt
Super safe:
The Blue debt is the senior tranche(repaid before any other public debt – exceptingonly the IMF which enjoys super seniority) of thesovereign debt of the euro area participatingcountries. It is the part of any euro area sovereigndebt that will be repaid under virtually all circum-stances since it is issued only up to 60 percent of GDP, which is the Maastricht limit. As the debt-car-rying capacity of any developed EU member state,even under extreme stress, stands well above thatlevel and on top of this the Blue debt is jointly andseverally guaranteed, it will enjoy super-safe AAA
02
BRUEGEL
POLICY
CONTRIBUTION
THE BLUE BOND CONCEPT AND ITS IMPLICATIONS
• Delpla and von Weizsäcker
1. Jacques Delpla andJakob von Weizsäcker(2010) 'The Blue BondProposal', Bruegel
PolicyBrief 
2010/03.
IN MAY 2010, WE PUT FORWARD THE IDEA
thateuro-area countries should divide their sovereigndebt into two parts. The first part, up to 60 percentof GDP, should be pooled as 'Blue' bonds withsenior status, to be jointly and severally guaran-teed by participating countries. All debt beyondthat should be issued as purely national 'Red'bonds with junior status
1
. While not a panacea forthe current euro crisis, our proposal has twoappealing features:First, the Blue Bonds would constitute anextremely liquid and safe asset on par with theUS Treasury bond. This should help the rise of theeuro as a major reserve currency, enabling theentire euro area to borrow part of the sovereigndebt at interest rates comparable to, or hopefullyeven below, the benchmark German bond.Second, the Red Bonds would help to enforcefiscal discipline. They would make borrowingmore expensive at the margin and strengthenmarket signals in the absence of a crediblefiscal stance, thereby complementing the Sta-bility and Growth Pact rules. Furthermore,according to our proposal, Red Bonds should belargely kept out of the banking system andcould plausibly form the basis for the plannedorderly default mechanism in the euro area.On the basis of these two main features, webelieve an attractive policy package could be con-structed for fiscally stronger and weaker countriesalike. Thereby, the Blue and Red Bond mechanismcould become a permanent feature of sovereigndebts in the euro area. Blue debt would be a supersafe ‘eurobond’ that should never default. Red debtwould be the part of the sovereign debt that wouldbear the lion's share of sovereign risk and whichwould be subjected to investor participation incase of crises.
 
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
2
.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.
Governance mechanism:
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).
03
BRUEGEL
POLICY
CONTRIBUTION
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.
Entry:
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
 Juniority:
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.
National responsibility:
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.’ 

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