Monday 21 November 2011

Eurobonds. Democratic Deficit

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Αρθρο στο News247

The idea of the Eurobond as a Deus ex Machine saviour of Europe is not new. Various European leaders in distress like Mr Papandreou and others coined the idea of a single Eurobond that is going to solve all present and future problems. The problem is that everyone has a different idea of what a Eurobond is and how it would achieve saving Europe.
So let me describe what a bond is in my simple mind. It is a senior unsecured (most often) obligation (legal contract) of a legal entity that has the financial means to service the interest rate payment and repay the principle according to the schedule and covenants of the bond. Furthermore, the prospectus of the bond describes the way this legal entity is going to generate the cash that is going to repay interest plus principle. Sometimes, this description is very vague but nevertheless it should be there, otherwise how a prospective buyer would gauge the risk and assess the ability of the entity to repay him. In addition, as Bonds or debt is senior to the equity owners of the entity, the stockholders, have to vote or (democratically) approve the taking on of debt.
In the case of an independent sovereign like most European countries would like to think of themselves this means:
1.     Legal entity is the Sovereign
2.     Sovereign has taxing powers over its subjects and companies in order raise cash to repay the debt.
3.     The equity holders in this case are the voters who democratically elect the government (Board of directors) to tax them and raise the cash to repay the debt. This is one of the most fundamental principles of our western liberal democratic system. NO TAXATION WITHOUT REPRESENTATION.

Thus, for something to be called a proper Eurobond the three aforementioned principles must be satisfied. If not then we do not have a Eurobond but a Eurobond look-alike.

For example, lets have a look at the bonds the EFSF has issued:

The EFSF was incorporated in the Duchy of Luxembourg and has registered capital of €28,440,453.35. The shareholders are the states of Eurozone and has the right to take on debt of €440bil because the states have issued credit guarantees totalling this amount. Interestingly the Luxemburg central government seems to be exposed to the EFSF risk[1].

EFSF, thus fulfills (1) and partially (3) but not (2). In other words EFSF is a legal entity and has been classified as a “public sector entity” but has limited means to earn cash or any business activity that can generate the required money to repay the issues. The trading activity that is basically allowed to enter in is not a main business activity. In fact, as far as I can see, the EFSF has no business activity. It is just a shell company that can issue debt. Principle (3) is partially satisfied as the EFSF takes its orders for issuance from the commission (unelected body) and the IMF (not an EU institution) once the country in need has signed an MOU. EFSF has no specific statutory requirement for accountability to the European Parliament.

In other words, the EFSF bonds are not Eurobonds in my definition. It is for this reason too, that the EFSF bonds even though are AAA rated; they are trading at almost 200bp above the respective German bonds.

Real Eurobonds can exist

A real Eurobond would not just have the credit guarantees of the EZ countries but would have income from tax revenues and a democratically accountable way to spend this cash. Europeans should not allow the raising of cash and subsequent spending of it by unelected bodies or officials. Even if these officials are indirectly elected. This seems to be what is on offer currently by the Franco/German politicians. Of course this means, passing some sovereignty from the national parliaments to the European one. This is anathema to most local politicians who would see their power diminished. But it can start by having some pan-European indirect tax.
For example, a levy on tobacco, alcohol, gambling and possibly on speculative financial transactions could raise enough cash per year to support coupon payments on bonds with notional up to €1trillion or more.
Indeed, this means some form of fiscal union, but right now this is the only way forward if the EU experiment is to survive the crisis. An EU with just a monetary union and no elected treasury is no longer an option. All other solutions will be temporary and would not address the core of the problem, which is how we can build a democratic and stable union.

Democratic Deficit
Europe along with the financial deficits suffers from an even bigger democratic deficit. The European Parliament, which after all is the only directly elected European institution, has limited powers. Any bond issuance and any restrictions that do not pass through a democratic process take Europe back few centuries.
To have the commission or the European Council or Ecofin impose strict fiscal or other financial straitjackets in return for funding should be unacceptable unless it is done with the consent of the people of Europe. If Europe is to have a Eurobond then the only way to do it is for the European parliament to vote for a minister of finance and to be given certain tax raising powers. The European parliament would then decide how to spend this money and on which country. It can further impose fiscal stability rules to the country that has strayed from the financial prudency path. JC Trichet said so in his last speeches before retiring. He should have been more vocal.
A great country across the big pond (USA) was created on the premise of NO TAXATION WITHOUT REPRESENTATION. European politicians should not forget this history lesson.