Beware of Eurobonds

The proposal to issue Eurobonds to combat the European Debt crisis has been repeatedly proposed by debt-ridden states and rejected by the richer states like Germany. Eurobonds would replace individual country bonds like Spain’s with pan-European obligations. Spain’s debts would effectively become all of Europe’s, thus reassuring investors of repayment and reducing borrowing costs.

The danger of the Eurobond idea is that it could effectively be used to force investors to take a haircut on their bond holdings, much like we experienced with Greece. Since individual country bonds trade at varying relativities, European governments would be tempted to swap their bonds for fewer Eurobonds. For instance EUR 100 of German debt might swap for EUR 100 of Eurobond while EUR 100 Euro of Spanish debt might swap for EUR 90 Eurobonds.

While no such proposals have been officially canvassed, it is only a matter of time in my opinion, particularly following the opportunistic behaviour by the rich European states driving the Greek restructure. Beware of Eurobonds.