We hadn’t planned to devote two articles to the eurobond, but it is of such central importance to the future of the eurozone that we feel it is worth digging deeper into important technical details. What interests us specifically is whether the cash flows and the fiscal relief from a vanilla eurobond bond could be replicated by a structured finance product. The short answer is: up to a point. The problem is that these alternatives are no panacea. They are politically just as controversial, and it is not clear that they can get the job done as efficiently.

Our estimate of the total crisis effect, not just this year, on debt-to-GDP is about 20-50pp. The financial/euro crises added some 20pp to the debt ratio. This time, we think the impact will be larger. Could Italy live with a debt-to-GDP ratio of 180-200%? In theory yes, but that would require permanent support by the ECB. There is also a risk that the EU commits the same error as last time, and forces Italy onto a premature deficit-reduction path. Investors will question Italy’s sustainability in the eurozone, and will demand a premium despite ECB interventions. That situation is, in our view, unlikely to be sustainable politically.

Mario Draghi focused in his much-reported FT comment on the need for funding to deleverage the private sector. We believe this will be at least as costly as the bank rescues ten years ago. Draghi stopped short of calling for a eurobond because there are other technical ways to deliver this. 

One construction which we know is currently being discussed is a special-purpose vehicle with a banking licence. We understand that Giuseppe Conte has definitely shifted his views against the ESM, which carries stigma in Italy after the last crisis. We also believe that a traditional ESM programme would not be the right instrument to deliver deleveraging. Any effective scheme would have to involve the ECB in a critical capacity.

We are hearing that one such option currently under discussion in Italy is an instrument with the following characteristics: Italy transfers its guarantees to the EIB or a special-purpose vehicle with a bank licence. The SPV would then buy privately-placed bonds. In Italy’s case, these would be from the Cassa Depositi e Prestiti, Italy’s development bank. The guarantees would then be repoed at the ECB. Resources are then channelled to the private sector. There is one precedent, in kind but not on the same scale: the Marguerite fund, which invests in energy infrastructure projects. We think such constructions are worthy of consideration. The question is whether they can be made big enough to get the necessary private sector debt restructuring under way. And, while it takes one big chunk out of the fiscal load going forward, such a vehicle will not make Italy’s fiscal position sustainable on its own. That would require continued forbearance in the application of EU fiscal rules, and unlimited ECB support practically forever. The reason we favour a eurobond is because it is so much simpler. 

An instrument that will absolutely not get the job done are the much-discussed European safe bonds. They include no element of mutualisation. The scheme was intended primarily to address the doom loop between banks and governments, but that is not the issue presently.

In his FT column, Wolfgang Munchau proposes that the countries in favour of a coronabond go ahead among themselves, set up a vehicle that issues coronabonds, and then challenge the ECB to buy them. We noted quite a number of angry responses to this column yesterday, often making the point that such a construction would break the eurozone. We think such criticism has cause and effect mixed up. It is the lack of insurance and burden-sharing, not an attempt to address it, that is responsible for tensions in the eurozone.

We are also not sure that Emmanuel Macron is on board for this. He co-signed the letter calling for coronabonds, but we do not know how much political capital he is ready to invest. For all his pro-European enthusiasm, he never struck us as being strategic in his policy choices. He ended up surrounding himself with advisers who, like him, critically misjudged German politics. We don’t think that he is ready to break with Germany. But we think that Italy and Spain would together have enough weight to do this, even without France. Such an alliance never came about during the previous crisis.

We agree that the best way forward is to be flexible. This is not about the eurobond as a permanent fixture in the EU’s policy armature. That battle has yet to be fought. This is about a financial instrument to help the eurozone get through the present crisis.