A common bond, through which governments guarantee each others' debt, could help bring some calm in the markets. But it's far too premature for the euro zone to take that step.
Proponents of common bonds can argue that the European Financial Stability Facility, the monetary union's bailout fund, is already beginning to look like a prototype euro bond at least it will be, once reforms agreed by finance ministers on July 21 are approved. Bailout loans were previously short-term and offered at penal rates.
Now they will be longer dated, and borrowers will pay less than some of the guarantors' own cost of funds.
The EFSF will transfer risk from peripheral economies to more creditworthy ones, compressing funding costs across the region like a common bond where countries would jointly guarantee each other's debt.
Even then, the EFSF is a long way from a common bond. It is a temporary mechanism, and its firepower is capped at 440 billion euros, less than five percent of euro zone GDP.
A true common bond would require the euro zone to embrace deeper, more permanent political reforms. Without a cast-iron framework for disciplining wayward states, it would simply fuel moral hazard. Countries would have to not only adopt similar fiscal targets, but also agree to automatic sanctions if they break them.
This is still the matter of heated debates between EU governments, the European Parliament and the European Central Bank.
The euro zone would need a lot of prodding before accepting such changes. With the crisis spreading to Italy and Spain, markets are crying out for a further increase of the EFSF's financial capacity. Guarantor countries would demand greater oversight of fiscal policy as a quid pro quo for financial support. Then a euro bond could gradually take shape.
Still, even that scenario looks moot. France's AAA rating is already being questioned, making it harder for Paris to cough up more guarantees. Increasing the size of the EFSF will be a tough sell in Germany.
The EFSF could provide a template for less ambitious forms of common bonds. It shows how joint issuance programmes can be easily used for a specific purpose. A natural extension would be to use common bonds for other areas, where government policies overlap. It shouldn't be the emergency response to a financial crisis, but a way to fund pan-European spending.
George Papandreou, Greece's prime minister, said on July 27 that the terms of the country's new bailout loans meant that the euro zone had introduced a "European bond".
"The decision of our European partners to lend us at 3.5 percent, an interest rate just above the one at which Germany is borrowing her-self, is essence tantamount to introducing a European bond, regardless of the fact that this system has not been completed yet," Papandreou told Greek party lawmakers.
Euro zone leaders reached terms for Greece second bailout on July 21, including lowering the country's interest rate on rescue loans to 3.5 percent, or not lower the European Financial Stability Facility's cost of funds.
Mario Monti, a former European Commissioner said in a July 20 Financial Times article that "there is a growing consensus that it would be difficult to find a lasting solution to the euro zone crisis without the use of euro-bonds."
Copyright Reuters, 2011