 indicated this is really a group project so just to call it something we got the website Euronomics.com we needed a hyphen because Euronomics.com was seven and a half thousand euro whereas Euro hyphenomics was basically nothing so we have a mix of people involved everyone is European even if they're exiled in New York City or New Jersey and everyone in this group you know it's a mix of finance professors and macroeconomics professors because clearly the European crisis has both the macro and the financial market dimensions but I think it's fair to say everyone here is quite involved in their own national economic debate whether it's in Germany where Marcus Brenner Meyer, Lewis Garacano and Tano Santos are you know quite prominent in the Spanish debate, Marco Pagano in Italy, Ricardo Riis is a Portuguese and he's very involved there a lot of them write in national newspapers every week that kind of thing. David Césmar is on the Cancer Economic Advisors in Paris, Stein van Neuerberg is a Belgian and they have their own debt problems he has no government to talk to in Belgium but they still have to think about these things and Dimitri Vianos is Greek and he's at the LSE so overall we essentially are writing a book about the European crisis about where it came from what it is and most importantly probably what the future of Europe should look like and so we're writing on what the future fiscal arrangements for Europe should look like the future European banking system and also the future of the sovereign debt markets and you know all of these interact and so what I'm going to talk about today about the European safe bond idea is mostly about how to get the sovereign debt market to work better in the context of a monetary union. You know the other name for this group really should be EuroSkype.com because with Skype group calling you know we have like six or seven hour long group conversations and you know without Skype it's hard to see how this kind of group which is dispersed could work. I should also say again going back to the European infrastructure but Marcus Brunomar and Marcus Pagano are on the European Systemic Risk Board Council of Academic Advisors so you know two of various channels what we're talking about here gets fed into a European level and national level discussions so it's an interesting process. So really you know clearly you can spend a lot of time on the day-by-day you know how should we think about the crisis on any particular day but the you know the solution of the crisis in the end is you know we're not going to talk here about the disintegration of Europe. More the focus here is what a new Europe should look like and so you know what we think the long run should look like. You know we think they should be essentially a European banking system of which the European safe bond idea is just one element. There needs to be a European resolution regime so the equivalent of the FDIC for Europe so that the European authority that can go in and close down banks safely or force recapitalization etc. On fiscal clearly there needs to be a lot more you know monitoring and surveillance of national fiscal policies but as a group we don't particularly think a common treasury such as the Soros letter this week. That's one way to go but we don't think it's necessary. So you know what is necessary is sufficient fiscal coordination to provide banking stability because if you have a stable banking system then diversity in fiscal policy within limits is quite possible. So I think that's an important message is this idea that the only way to have a monetary union is to have like a high level fiscal union is you know it's not it's not necessary. You need more than what we have but full-scale not necessary. There's obviously transition issues about how you get from today towards the new system and you can spend time talking about that but what we want to talk about is this European safe bond idea. So the the you know this is well known here in Ireland especially but the rest of Europe is learning this graph which is the interaction the diabolical loop between banking problems and sovereign debt problems. So you know the problem is you know if banks are big holders of national bonds clearly if sovereign risk goes up then the banks become weaker. In turn if the banks become weaker risk of tax payer costs whether directly through bailouts or indirectly through all sorts of mechanisms such as you know credit screes meaning slower economic growth and so on. There's a lot of loop you know feedback loops there. So you know one only one dimension but one dimension of that is the fact that banks disproportionately hold national sovereign debt. So even national loop here you know Greek banks being overexposed to Greek debt and so on. And the problem inside a currency union and this is again a lot of what you need to think about here is the division the gap between sovereign markets and the money market in the European context. So the world history of financial crises is you know for every sovereign debt crisis there's a local central bank who you know can get involved in resolving the situation. Whereas within Europe within a single currency union you can you can run you can run from the sovereign debt market and without currency risk because if you don't like Italian debt or Spanish debt the German bond is right there for you. So you can run out of the local sovereign debt market without cost without currency risk and so on. And that provides a big source of volatility which is unnecessary. And so you know the issue is how do you cater towards the desire for safety which is very important while at the same time stabilizing these sovereign debt markets. And it's important that there is a safe asset. So you know right now in Europe it's hard to find a safe asset but for all sorts of modern finance you do need a safe asset for collateral and transactions. I mean if you think about how markets are organized having a safe asset is is a fundamental characteristic. And you know the the situation in Europe is historically until now all of these sovereign debts were essentially treated as safe by regulators. So under the Basel regulations they didn't have a zero risk rate for a local sovereign. Under ECB the haircuts are pretty low in terms of collateral treatment. And so this meant that banks had a big incentive to hold sovereign debt. And there's all sorts of ways that you know local governance might have provided incentives to especially hold a domestic sovereign debt. So the European Safe Bond proposal is essentially a bit of financial engineering and a bit of regulatory change can weaken this diabolical loop. Because essentially if you can create a safe asset which pools across all the national sovereign bonds then this this means that you know panics when there's a desire for safety can be accommodated without these big capital flows from one part of the Monterey Union to another part of the Monterey Union. So this is this is only one issue. We're not saying it's going to solve the crisis. You need the European resolution regime and so on. But in terms of stabilizing the debt market this can help. So as I say the what's going on right now is the flight to safety is a flight to Germany and that kind of creates cross-border capital flows which can amplify the problems in the national economies. And of course we know we know that holders of German debt have had a great crisis in the sense of you know the value of German debt has been shooting up. And so many banks are saying well you know okay mark us down on what we hope in Greece but mark us up on the fact that we now are sitting on German bonds which are now more valuable. So this you know shuffling of portfolios within the European system is generally destabilizing. So what we suggest is we suggest is that a European debt agency is formed and the European debt agency is essentially a transformer. It's buying up to 60% of GDP of sovereign bonds. So and then it's issuing two types of debt. Asbestos which are super safe. So essentially you need a lot of default before the asbestos lose value. And then you have a junior tranche you know so it would say the first x% of any default is absorbed by the holders of the junior debt. And by having that buffer there then the asbestos the senior debt will be perceived as much safer. And so that is the core of what we think is that if you have that structure is that generates a truly safe European bond. It's safe because of diversification but mostly it's safe because of this tranching that you've got a first loss junior bond before the asbestos would get hit. It's attractive because there's no common guarantee. There's no government here saying we guarantee to repay the asbestos. So each national government is still on its own. So you get around any Euro bond issues about joint and several guarantees of debt. The Euro bonds are big issues with moral hazard. I mean we saw that in August once there was some deal being done at a European level we saw the Italian parliament backsliding pretty rapidly about their level of physical commitments. And until fiscal monitoring, surveillance, cooperation is a lot further advanced the idea of you know even you know of other countries guaranteeing the debt of Italy and Greece in particular stands without. So having a system which does not provide debt guarantees to countries which you don't really want to guarantee is a big benefit. And the reason we're saying is you can get a lot of safety without that joint guarantee. You can get a lot of safety just by saying how realistic is it that defaults across Europe will be so extensive that they ever get towards this senior type debt. And now you know when you think about it what's going to be happening you know in good times the junior debt will be seen as pretty safe as well saying you know no government is going to default because remember this is only up to 60% of GDP the junior debt is within the 60% of the GDP envelope. So it might be 20% of GDP are essentially in the senior debt the next 40% in the junior debt. So even the junior debt should be safe during normal times. And then the question is well you know if you start to get a panicky you would run out of the junior debt into the senior debt if you're a normal fund or whatever but from each national government point of view that's okay because that's just a you know shuffling within this common structure. It doesn't favor Germany over Spain or Germany over Greece and so on. It's all a common structure. So you can deal with fluctuations in risk tolerance without this cross-border element. And so we think that would be that would be a safer system. And importantly in terms of regulation is if banks had regulatory incentives to hold just the SBs then they'd be a lot safer because essentially banks would now have this safe asset so that you know regional problems in Spain or Italy whatever would not imply that their banking systems would get into trouble because you've cut that loop because the regulator would be saying you know you can hold on anything but if you don't hold if you hold on to the SBs you pay a penalty in terms of an extra capital charge. So banks would have the incentive to hold the European safe bond and that would make the banks a lot more stable in terms of that safe asset. And so you know we would envisage a situation where essentially banks and others who really require a super safe asset will hold the senior bonds and the junior bonds will still be you know pretty you know low risk just a tad riskier and you can imagine various investment funds hedge funds and so on trying to hold out. So you know you might say well you know this is just financial engineering but that's true but the this is the world where so much financial engineering takes place that essentially you know in that complex world you know adding a bit more may make sense. As I say it reduces the volatility in the sovereign debt market and then the second of all and this one the traditional gains from a Euro bond but we think the SBs will get it which is the having the liquidity premium of having trade in a large-scale bond issue which is safe. So in the same way the Treasury bill market in the US or the 10-year bond market in the US or US government is pretty liquid. Here you've created the European bond which will have those features. There'll be a global demand for such a European bond and in terms of earning 0.7% interest on that issue that's something that all participating governments can benefit from. So the Euro bond gain from liquidity and a deeper market will be there. You might say well you know if there's such an opportunity why don't you know individual investment banks you know who like to create structures why don't they go out and do it. Well you know it's there's a general concept about missing financial markets. How do you get a missing market to develop because there's a kind of lemons type issues about why is this investment bank introducing this product you know what are their five incentives you know are they are they really going to be able to operate this what if that bank you know implodes. So having a public agency a European debt agency running this system you know what is that typically seen as a better way to create quickly a large market in these things. And you know it goes hand in hand because this thing works in terms of improving bank sector safety by having it as a privileged asset for open market operations collateral operations by the ECB and so on. And again that kind of safety dimension that's a public good you know as policy makers the stability of the financial system is something that's desirable but any individual investment bank that's not their job that's not what they go around creating products for. So it seems to us it is a public good type operation. Now clearly there would be bigger transition issues you know because right now banks hold all sorts of stuff and how do you get them from here to there. So you know we think this is part of a package where recapitalization is necessary so beforehand. So recapitalization right down of the Greek debt and then the thing can get going. But it's important to say is the level of recapitalization will be less because here the value of Spanish debt Irish debt Italian debt will rise because with this new player in the market there's going to be a much more stable because right now people say well you know if I buy Italian debt will there be a anyone I can sell it to in a month's time. You know who else is in this market and often there's a fear of you know I'm not going to even though I think the fundamentals are fine I'm scared that everyone else will stay at home and there'll be no market in this product when I want to sell. Whereas if you announce there's going to be a major new actor in the debt market that kind of liquidity issue is not there. So the announcement of of European safe bonds the European debt agency would mean that the value the yields would come down on you know anything that's seen as just a liquid but solvent. And so the level of recapitalization will be less if you have that element to it. You know the most common question we've gotten the last month since we floated this idea is who's going to buy the junior trance. The mechanics because you might say well the hedge funds can you know do a lot of diversification right now they could buy a portfolio of European sovereign bonds but all the time with individual bond purchases and so on there's all sorts of risks they face. Whereas when they have a large scale junior bond market here it's going to be a much more stable market and it's going to be you know more attractive for those hedge funds to participate. You know so another question we get is well you know how exactly is this European debt agency going to work? Well a number of key principles is it's basically very little discretion. It could just be a computer actually. It could because the rule is the cap is 60% of GDP and the cap is 60% of a historical average of GDP because you don't want to get into the pro-cyclical business where a bigger session means a country's GDP level falls. Therefore it's debt to GDP ratio gets bigger. Therefore whoever needs to sell the debt to maintain a rule. So if you have an average of the last five years or ten years of GDP then that kind of a negative cycle will be avoided. And you know to create a yield curve so that you know the markets who want a good mix of short-term, medium-term, long-term debt they might their rules will say we'll buy up to five percent of GDP of your one-year debt up to x percent of your two-year debt and so on. So you can build out a yield curve which will be helpful for various financial planning. So this means you know the individual countries are going to adjust their you know issuing practices which again would be implicit in a Eurobound idea. And again remember here you know there's no guarantees being offered. So the individual countries this is all in the secondary market so the individual countries are issuing debt. There's going to be a big purchaser in the market the the European Debt Agency but you know if your debt is above 60% which is it is going to be for most of these countries for quite a while no matter what. It's still the case that these countries will have to find other buyers you know for their debt. But the point is the marginal buyer will be different because right now you know for countries that say a hundred percent of GDP if you like the the market yield is determined by who is that purchaser at 100% who is the marginal purchaser. Here you've taken out 60% of GDP because this European Debt Agency is buying up 60% of GDP. So the identity of who the marginal purchaser is is going to shift in and I say most important as I said earlier on if you know there's a big purchaser in the market the liquidity issue is much less severe than it is now where people are saying who's buying European sovereign debt. Here you have a bigger anchor for the market. Now everyone's interested in leveraging up the EFSF or the EFSF providing insurance and so on. So we agree that can be helpful if you really want if you want to add an extra layer of protection is you could also have these bonds being insured and this is where the EFSF comes in and this is one of the proposals which apparently is gaining some traction because you can envisage saying well okay you claim that these European safe bonds are extremely low risk for default. But let's say you know I'm totally irrational totally you know I believe in you know really extreme scenarios you know I want some extra guarantee. So the EFSF can come in and say the first 10% is guaranteed by the EFSF and that insurance policy provides extra extra safety. So you know this proposal here is coherent with the insurance of bonds proposal which I think Aliens and others are floating at the moment. And you know I think there's a lot of interest in this idea which is throughout the whole leveraging of the EFSF idea which is you know if you've got X amount of funding do you really want to spend on directly purchasing assets or is it not enough to just provide insurance to assure private sector purchases of you know at the last distribution. That you know you know I think it's quite important. I mean there's going to be an issue that the insurance has to be provided by some entity or it provided through some type of asset which is not going to be sovereign bonds because right now the problem is well if Italy is providing EFSF funding to ensure against EFSF default you know when you want to call upon that insurance it's a payout going to be there. So you need a super safe insurer you know not me but some of my co-authors like a big pot of gold out there but I won't advocate that. You know and you know this there are issues about you know how do you introduce this. We're not saying tomorrow this agency goes out and buys about 60% of the current stock. It could be done in stages that there's going to be particular issues over the next year or two years and so the debt agency initially buys up those issues and over time incrementally it reaches the 60% of GDP limit because again that should work once the market knows this this agency is coming in even if it's only incremental in its actual holdings the fact that it's in the market is going to be important. So you might say well you know compare this to to Eurobonds. One fundamental issue is are Eurobonds realistic and I know people will differ about you know their view of reality and probabilities and so on but even if you thought Eurobonds were a good idea the fact that you need treaty change to get real Eurobonds out there well you know when is that going to happen. Whereas we think and we haven't heard even you know we've had this idea is being floated in a lot of different official circles. We haven't heard yet that there's any legal impediment to our idea so it looks it could be ready to go. Big problem with Eurobonds is you know what are the incentives facing national governance. You know Ireland is obviously very well behaved country which wouldn't wouldn't be subject to moral hazard but maybe some other countries in Europe moral hazard is a real issue and if you have Eurobonds as I said earlier on you know what are the incentives to have fiscal discipline. Whereas here every sovereign is still responsible for its debt you know if it defaults you know there's going to be a lot of problems for that sovereign and no one else is bailing it out. The rest of Europe can be indifferent because their banks are safe because their banks are only holding the European safe bonds which will only be hit if basically nearly every country in Europe simultaneously defaults in a big way. So the European banking system can you know look on with supreme indifference if a country defaults because it's just not big enough deal to hit their banking systems. And so you do want to have price signals that the sovereign individual sovereign debt markets are still active so you know if you see your yields go up it's not because of illiquidity it's because you know you're following a risky policy and that's a signal to you know get you know restore some fiscal prudence. The blue bond red bond proposal of Royal which also is a 60 percent of idea but there they have you know the joint guarantee under 60 percent. There's a number there's a number of problems but the core of it is this issue of even at 60 percent GDP do you want to guarantee some of the other countries in Europe. You might say well do you still face the contagion risk that if one country badly behaves is it not going to you know cause the junior bond here to shoot up in risk premia and so on. You know I think that's going to be true just to some extent but but you know I think it's going to be more limited under this structure than under the current regime. So here you might say well you know what we've seen in Europe is you know policies are unpicked in a crisis firm promises are waved away because in the heat of the crisis politicians will be tempted to do whatever is most convenient at that time. So here it's important that this European debt agency is strictly governed and in particular the bonds issued by this European debt agency these Europeans safe bonds are super tight in terms of legal structures. So you need you know so basically you write the law saying if we ever you know change the rules here to expand amount of debt the European debt agency buys or to disproportionately buy the death of risky countries and so on you know you can take you can take a lot from us. So you need to have a set of where existing bondholders will be a big lobby group that there would there will be no way for a national for the European debt agency to in a crisis be tempted to start buying outside of its real structure. So you know we realize this is essentially a CDO and you know there is a level of irony about the fact that you know the kind of securitization business is responsible for a lot of problems in this financial crisis. But I think the reality is you know an awful lot of what you see is essentially recognizing this is the way the modern financial system works and you know all the stuff that leveraging the EFSF structure of NAMA here for that matter there's all sorts of things which are essentially structured financial vehicles and essentially you know you can use all sorts of little you know responses to that but this is a bit different because publicly issued collateralized debt and structured debt in the sense of junior versus senior debt is very different in terms of incentive schemes versus a private operator because remember the private operators the problem was what they were calling AAA the senior self in fact was not all that safe. So when you know the real problem was it turned out you know these AAA mortgage backed securities were a lot of the mortgages in that you know apparently safe element were not that safe. Whereas here we think it's a lot easier to analyze you know the correlation structure across 17 sovereigns in Europe than it is across thousands and hundreds of thousands of mortgages. In terms of incentives there'd be a lot more transparency there's not that many underlying bonds here to analyze to think about whether this thing is going to be safe or not. And you know we've run a lot of we have it on the website urinomics.com there's a quite a long document and we go through a lot of correlation analysis about under what scenarios would these European safe bonds ever get hit by default and it's non-zero but it's pretty close to zero probability. And again if you use EFSF to provide further insurance that probability gets even tinier even closer towards zero. So you know as I mentioned these things can be phased in the the Basel or requirements or the ECB collateral policies can be you know adjusted over time. You can conceive of swap policies so that banks currently holding you know a range of sovereign debt issues could swap them into SBs. And as I mentioned with bank recapitalization you know the fact that this data agency will stabilize sovereign prices will mean that the scale of recapitalization is going to be smaller. Now we think in general not just vis-a-vis that the recap is probably going to be mandated because if you do it on an individual country by country basis the incentives to deny you need it are so strong to avoid stigma issues you know a kind of coordinated recapitalization is probably going to be important. You know you might say well you know I'm not buying anything right now because if you include Greek debt and what you're going to use to build these SBs I'm not interested. So yeah we think this will work a lot better after the large-scale Greek restructuring which seems to be coming down the tracks. And you can do it in advance with this you know differential price in the Greek debt also. So I'm then just to finish up here you know this is not saying this is you know does not a civil bullet to solve this multi-dimensional European banking crisis but this could be one element. And as I said earlier on it does definitely needs the European Bank Resolution scheme a way to shut down fading banks all of that stuff. This is really just directed at stabilizing the sovereign debt market because you know I think our view would be you know lots of countries have debt levels that are too high but the market is dysfunctional at the moment. The run for the exit problem is it's a natural response but collectively it's damaging. So having a safe bond which is essentially when the benefits are common across Europe rather than just accruing to Germany and the other super safe countries we think would be a better system. It is an open question whether Germany would vote for it but at a collective level we think it's a better idea. So you know in terms of conclusions is remember what is the issue here. The issue really is how to make banks safer in the sense of you know breaking the link between bank positions and sovereign debt positions. While at the same time the Euro bond idea suffers from you know the moral hazard problem of you know national governance being having less incentive to behave fiscally. We think this is going to fix the liquidity panic problem where if you don't like a Spanish risk you run out of Spain towards Germany. Here you run from the junior debt to senior debt. We think you know this can be well designed, lagged to GDP and you know very tight rules about not changing the purchase policy of the European debt agency. And you know you know and then there's a collective gain which is if there is a bigger more deeper bond market for these SBIs the average interest rate is going to be lower than what is currently paid and that creates real resources for governments everywhere. And so that is where the collective interest is in setting this up. So let me stop there and take questions or comments.