November 23, 2017 / 2:35 PM / a year ago

German officials unimpressed by "European safety bond" suggestion

BERLIN, Nov 23 (Reuters) - Joint euro zone bonds would increase financial risk in the single currency bloc instead of acting as a shield to crisis, two German finance ministry officials said on Thursday.

They rejected the idea, expected in a European Commission proposal in two weeks, to consider creating “European Safe Bonds” as part of enhanced economic and monetary union.

The German finance ministry officials wrote in an article published in the Frankfurter Allgemeine Zeitung newspaper that while the stated goals of such safety bonds were right, they would only “add fuel to the fire” when a crisis hits.

Under the scheme, a special purpose vehicle would buy national government bonds and issue two types of securities: a junior one bearing the risk of a sovereign debt default; and a senior tranche, called ESB, would be risk-free.

“The country with the weakest fiscal performance will likely determine the rating of the whole pool,” Ludger Schuknecht and Levin Holle wrote. “When market uncertainty grows, a flight into safety sets in and the demand for the risk-bearing junior tranche will dry up. Without demand for the junior tranche, the senior ‘safe’ bonds can no longer be generated.”

This will inevitably lead to “euro bonds through the back door!” they said, referring to the idea of pan-euro zone sovereign bonds.

Political pressure would rise on euro zone countries to rescue the ESB concept with joint guarantees, they said.

The two officials said responsible public finances aimed at reducing debt and risk-adjusted capital requirements for banks are the only two tools that will bring stability to the bloc.

“These two elements sound almost trivial. At least they look much less exciting and innovative than new ideas for financial engineering,” they said. “But they are the only effective way to achieve true stability and safety in European financial and debt markets.” (Reporting by Joseph Nasr in Berlin and Jan Strupczewski in Brussels)

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