By Harald Uhlig
Oct. 21 (Bloomberg) — The euro area is burning and policy makers seem increasingly powerless to douse the flames. Meanwhile, we can only stand by and watch this nerve-wracking spectacle.
Yet the situation may not be utterly hopeless. In the last month or so, researchers have floated proposals for the creation of synthetic euro bonds that may offer a way out. The idea rests on three principles: No cross-subsidization between countries; safety; and the replacement of risky sovereign debt by synthetic bonds in European Central Bank repurchases.
I know what you are thinking: Are these people out of their minds? Collateralized debt obligations? Synthetic securities? That is what got us into this mess in the first place.
Let’s take a closer look. The proposals all start with some version of an open-ended mutual fund that would hold euro-area bonds. Ideally, the fund would hold these assets in proportion to the gross domestic product of each member country. It would then issue certificates that would be fully backed by these bonds. If there is a partial or full default on one of the securities (Greek 10-year bonds, say), then the mutual-fund certificates would lose some value.
In the case of a small country or a partial default, the losses would be small. So, the certificates would be reasonably safe.
The most important aspect, however, is that there would no mutual bailout guarantees, no cross-subsidization between countries and no need for high-level political brinkmanship. This is the core of the proposal I put forth with my colleagues Thorsten Beck and Wolf Wagner, of Tilburg University in the Netherlands.
We recognize that many people will say that reasonably safe isn’t safe enough when it comes to synthetic securities. We believe they could be made safer. Markus Brunnermeier and his fellow members of the Euro-nomics group propose to divide the mutual-fund certificates into tranches. The junior tranche would be hit first in case of a default. The senior tranche would be most protected and could be called “European safe bonds” or “ESBies.” Both tranches would be traded on markets.
This would slice a slightly risky investment into several parts, one of which is safe. It would be an important feature if the ECB can’t be persuaded to use the raw mutual-fund certificates directly for repurchasing transactions, or if the original certificates are still considered too risky on bank balance sheets.
The biggest disadvantage of this idea is that it is too reminiscent of the infamous alchemy of 2008. I think it can work if properly implemented.
Another proposal by two Italian economists, Angelo Baglioni and Umberto Cherubini would create the original mutual fund, but it would only buy senior debt from governments, which would be required to post cash collateral. That is less appealing because it would require too much political maneuvering, would too easily allow cross-subsidization, and would entail restructuring of current government debt to create securities of appropriate seniority.
But the main point is this: It would be feasible to fine- tune any proposal to ease particular concerns of participants regarding seniority and safety, as long as the three principles I outlined above are obeyed.
The last of the three principles may be the most critical: These certificates must replace risky sovereign debt in ECB repurchasing transactions. One objection to this is that there is no particular reason now, for, say, a Greek bank to hold Greek debt or for a Spanish bank to hold Spanish debt, when they could all hold much safer German bonds.
‘Hold to Maturity’
The banks that can still afford to mark their sovereign debt to market, rather than “hold to maturity” and pretend all is well, can do this now. They can ensure their safety by selling the debt of Portugal, Ireland, Italy, Greece and Spain, and buying German bonds.
The trouble with that scenario is that if all banks were to act this way, the prices of those bonds might plummet. That would mean far deeper trouble for Portugal, Ireland, Italy, Greece and Spain the next time they try to issue new debt. It would cause problems for the banks, too, as they would get even less than what they currently think the bonds are worth.
The ECB has danced around this issue by repurchasing risky sovereign debt, buying it outright in the open market, supporting these prices through intervention, and trying to unwind again. The ECB is ultimately backed by the euro area’s taxpayers, who either get more inflation or a depreciation of their currency, if things turn south.
In addition, the central bank’s actions have had the unintended effect of encouraging private banks to hold the risky assets, rather than discouraging them from doing so. This makes sense: These bonds get higher returns, are still usable as collateral with the ECB, and are implicitly guaranteed by government bailouts if things go wrong. The real loser is the taxpayer.
The mutual-fund construction removes much of this moral hazard. It can buy a sizeable fraction of the risky debt, taking it off the books of the ECB and the commercial banks. Yes, it may still need to buy German, Dutch and Finnish bonds on the market, but the banks, in turn, would buy these certificates. And, importantly, the ECB uses the mutual-fund certificates or their ESB-safe versions for its repo- and open-market transactions, while gradually phasing out its support of individual risky sovereign debt.
Who can create these certificates? A savvy market participant could probably pull this off in a few days. But it would be better to have a public institution do it instead. Competition among several such funds may even be better, with the ECB deciding which ones to accept and which ones to phase out. In any case, this can be done quickly, if decision makers in government and the financial-market institutions can be persuaded to act.
This isn’t a glamorous, magic solution. Nor is it a sexy proposal for politicians to sell in speeches. This is a simple step forward that wouldn’t cost much, but is easy and effective. Most of all, it is what the euro area needs right now.
(Harald Uhlig is chairman of the economics department at the University of Chicago and a contributor to Business Class. The opinions expressed are his own.)
- The Eurozone Crisis For Dummies (businessinsider.com)
- Franco-German deadlock over ECB’s role in rescue fund (jhaines6.wordpress.com)
- Italy Picks Surprise Central Bank Chief (online.wsj.com)
- EU Said to Consider Wielding $1.3 Trillion to Break Impasse (businessweek.com)
Italian energy company ENI said it encountered nearly 700 feet of continuous gas pay at the Mamba South discovery about 25 miles north of Mozambique. The company said the discovery could contain as much as 15 trillion cubic feet of natural gas.
ENI said the “impressive discovery” will lead to major developments in the natural gas sector in Mozambique. This includes access to regional and international markets through liquefied natural gas capacities.
The discovery was made in 5,200 feet of water.
ENI said the Mamba South discovery marks the largest operated discovery in the company’s exploration history.
The company added that its results at Mamba South exceeded initial expectations. ENI serves as the operator with a controlling interest in the area.
- Mozambique gas field discovered (bbc.co.uk)
- Venezuela: Repsol, Eni Await Approval for Gas Extraction from Cardon IV (mb50.wordpress.com)
- Unconventional No More: Huge Gas And Oil Plays Emerge (mb50.wordpress.com)
In Iraq, Saipem has been awarded by South Oil Company the EPIC contract for the Iraq Crude Oil Export Expansion Project – Phase 2, within the framework of the expansion of the Basra Oil Terminal, off the Al Faw Peninsula in the Arabian Gulf, approximately 550 kilometres south-east of Baghdad.
The contract encompasses the engineering, procurement, fabrication and installation of a Central Metering and Manifold Platform (CMMP), to be installed in a water depth of 28 metres, along with associated facilities.
Fabrication of the CMMP topsides will be carried out at Saipem’s yard in Karimun (Indonesia), while the jacket and piles will be fabricated at the Saipem Taqa Al-Rushid (STAR) yard in Dammam (Saudi Arabia). Offshore activities will be performed in the third and fourth quarter of 2013.
In Nigeria, Saipem has been awarded the OFON2 – D030 contract by Total E&P Nigeria Limited, for new offshore facilities in the Ofon field, about 50 kilometres off the southern coast of Nigeria.
Saipem will carry out the engineering, procurement, fabrication and installation of the OFP2 Jacket (comprising the 1,970 ton jacket structures and the 4,500 ton piles), as well as the transportation and installation of the complete new OFQ living quarter offshore platform.
The fabrication of the jacket will take place in the Saipem Rumuolumeni Yard in Port Harcourt, Nigeria.
Offshore activities will be performed mainly by Saipem 3000 vessel, in different phases during 2013.
Furthermore, Saipem has been awarded contracts in the Norwegian and British sectors of the North Sea and in the Gulf of Mexico, mainly based on deployment of the Saipem 7000 vessel, for the transportation and installation of platforms and marine facilities, along with the decommissioning of existing offshore structures.
Offshore activities will be performed in several phases commencing in the fourth quarter of 2011 through to late 2014.
Finally, Saipem has agreed to increase the scopes of its work on a number of existing E&C Offshore contracts.
Saipem is organised into two Business Units: Engineering & Construction and Drilling, with a strong bias towards oil & gas related activities in remote areas and deepwater. Saipem is a leader in the provision of engineering, procurement, project management and construction services with distinctive capabilities in the design and execution of large-scale offshore and onshore projects, and technological competences such as gas monetisation and heavy oil exploitation.
- Iraq Awards Oil Export Project to Italy’s Saipem $469 million contract (ataleoftwocitiesdotnet.wordpress.com)
- Chinese-built oil rig setting sail for Cuban waters (mb50.wordpress.com)
- Iraq inks final gas deal with SKorea’s KOGAS (seattlepi.com)
- High-Spec Jackup Market: Hercules Offshore increases stake in Discovery Offshore (mb50.wordpress.com)
The war on the young is led “by cadres of elderly men, content to manage decline” and exacerbated by younger generations, who don’t seem to know what’s going on or understand the gravity of the financial situation that will hit them in the future. Luke Johnson, writing in the FT, describes the Italian and Japanese version of this trend.
Neither country has renewed itself because vested interests have failed to take the tough decisions. Their traditional cultures have not caught up with modern lifestyles. The male bureaucrats, policymakers and bankers who run all the important institutions must be forced to take radical steps to unleash the energy and imagination of their young, because in both countries they are very pessimistic. Many cannot obtain the job security and standards of living their parents took for granted. Traditional employees enjoy cast-iron protections, so companies are reluctant to create such positions. So, only temporary or part-time work is available for most newcomers to the workplace. Consequently, young Japanese and Italians pursue increasingly cautious lifestyles. Nearly 80 per cent of unmarried Japanese between the ages of 18 and 35 live with their parents. The ratio is nearly as high in Italy.
Such unadventurous living means people do not grow up, and do not take risks – such as having children or starting a business. Meanwhile, their parents bask in comfortable retirement, busy consuming their considerable savings.
Both nations are burdened by weak leadership, over-regulation, feeble productivity growth and a lack of economic dynamism – despite plenty of natural ingenuity and ambition. It appears that the vitality of Italy and Japan is being sucked out of their cultures by deteriorating demographics, high taxes, the burden of caring for elderly relatives and a youthful cohort with a diminished sense of self-confidence or optimism.
The war on the young is most intense in countries (and, in the US, industries and states) which have the blue social model deeply embedded in their social institutions. It is an interesting struggle: these days, the young face serious trouble finding employment and will be saddled with debts run up by their elders as they grow up.
The older generations benefited from a kind of escalator system in life. You step on the escalator after finishing your education and it almost automatically carries you upward in life, with higher pay and higher status until, at retirement, you step off and enjoy a good, level standard of living for the rest of your days.
One of the younger generations’ biggest problems is that many of those escalators don’t work anymore. In Italy and Japan, companies are reluctant to hire young people on what American universities call “tenure track”; unsure about their future needs and resources they don’t want high cost employees that can’t be fired. The older workers are too powerful to dislodge — just as in American universities the tenured professors are too powerful to give up tenure. So younger workers increasingly are hired if at all on temporary contracts, with lower benefits and fewer prospects for promotion.
To succeed today, many young people need to recognize that no job will be waiting for them when they finish studying. They are going to have to create their own opportunities. It is a good time for creative entrepreneurs.
The young will not find it easy to strike off on their own, especially as fewer opportunities makes them more risk-averse. But the examples of Italy and Japan suggest that many young people today face a choice: collective depression about their sorry state of affairs or somehow spurring elder generations to seize and nurture the potential embodied by passionate and hard-working youths everywhere.
Italy and Japan have particularly bad cases of the blues; with relatively small numbers of young people and large ones of older people, the old are not only cunning and entrenched in positions of power: they can still beat the kids in elections. Politicians reinforce generational privilege rather than acting on the knowledge that, in the end, an economy that doesn’t work for the young is an economy doomed to decline.
What many countries need, and I include the United States, is a real youth movement composed both of younger people and of future oriented oldsters that looks at every political and social question from the standpoint of how does it affect the interests of youth. This isn’t about convening death panels and cat food commissions for grandma, but it’s about making sure that our institutions and our policies are opening opportunities to the young rather than closing them off.
- Italy Seeks to Tackle Youth Joblessness (online.wsj.com)
- WALTER RUSSELL MEAD: The War On The Young: A Warning From Italy And France. The war on the youn… (pajamasmedia.com)