ESBies: Safety in the Tranches
by Markus K. Brunnermeier, Sam Langfield, Marco Pagano, Ricardo Reis, Stijn Van Nieuwerburgh, and Dimitri Vayanos, VOX, CEPR’s Policy Portal
The Eurozone does not provide a union-wide safe asset. In its absence, financial stress triggers cross-border capital flights to safety, which create distortions (Lane 2013). During sovereign debt crises, a diabolic loop sets in whereby banks holding risky sovereign debt suffer losses to their net worth, causing them to cut back on their lending to the real economy and increasing governments’ contingent liabilities (Farhi and Tirole 2016, Brunnermeier et al. 2016a).
The policy challenge is to create a union-wide safe asset without joint liability among sovereigns. Brunnermeier et al. (2011) propose a design for such an asset, named ‘European safe bonds’, or ESBies. ESBies are the senior tranche of a diversified portfolio of Eurozone sovereign bonds (see Figure 1). Sovereigns remain responsible for their own bonds, which would still be traded at a market price, exerting discipline on borrowing decisions. A sovereign could default on its own obligations without others bearing any bail-out responsibility and without holders of ESBies bearing any losses.