TAILIEUCHUNG - European Safe Bonds (ESBies)i

There are significant advantages to Trichet bonds over other discussed solutions to the sovereign debt problem. One such proposed solution is the issuance of “Euro Bonds” guaranteed by the Eurozone countries or the EU itself for the purpose of redeeming sovereign bonds by market purchases, or by lending the proceeds to the countries involved for them to acquire their debt. Apart from the considerable political obstacles to such a program, the undertaking actually makes it less likely that existing self-interested debt-holders will sell in the market. The implication of the program is that either through market interventions that push prices up, or by the assumption that the. | European Safe Bonds ESBies The euro-nomics group Markus Brunnermeier Luis Garicano Philip R. Lane Marco Pagano Ricardo Reis Tano Santos Stijn Van Nieuwerburgh and Dimitri Vayanos 26th of September 2011 1. Introduction The European Union today faces one of the greatest challenges in its existence. The euro-zone which just at the start of this century was lauded as Europe s great unifying achievement has given way to states on the verge of default financial systems that seem as solid as a deck of cards and a great deal of disappointment with the European institutions. There are many reasons for this state of affairs most of which fall within the realm of economics. One factor that is crucial but under-appreciated is that Europe s problems are a consequence of a much wider world problem the lack of safe assets. As a long-term trend the impressive growth in the developing world during the last two decades has increased the demand for safe assets as those countries economic development outpaces their financial development yet they already need to build up reserves to smooth future shocks. As a shortterm phenomenon but one that is here to stay the financial crisis of 2007-08 showed that financial markets can go through periods of tremendous volatility that have investors plunging towards an asset that is deemed safe. Modern financial systems rely heavily on safe assets. At the foundation of even the most complex financial securities there is usually a requirement to post as collateral some asset that is deemed safe by the parties involved. Prudent bank regulation following Basel in its many rounds requires banks to manage the risk in their assets in proportion to their capital. As a result a substantial part of any bank s balance sheet must be in safe assets as defined by the financial regulators. Pension funds are another example of a large class of investors that must hold a significant amount of safe Euro-nomics is a group of concerned European economists unaffiliated

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