BRUSSELS — The European Commission, the EU executive, believes that the joint issuing of eurobonds by the 17 euro nations would be the most effective way to tackle the financial crisis, according to a draft paper seen Monday.
The study by the European Commission, the EU’s executive branch, will be presented Wednesday and could intensify a rift with Germany, which rejects eurobonds as a viable option at the moment because it would expose its taxpayers to weaker countries’ bad debt. Germany already funds the bulk of the existing bailouts.
The draft, published by the Financial Times and confirmed by the Commission, said replacing national bonds with one jointly-backed bond would have to be matched by tight financial and budgetary coordination. It also says discipline woul be needed to make it impossible for profligate nations to live on the back of budget-concious member states.
Since Greece pushed the eurozone into its ever-worsening financial mess last year, many member states have seen their cost of government borrowing rise to record levels. Germany’s borrowing rates, meanwhile, have dropped sharply as investors buy up its bonds as a safe haven. That has created a huge imbalance in debt markets within a zone ruled by one currency.
Germany has long been reluctant to bail out member states like Greece, Ireland and Portugal, insisting it was up to their governments to live by sound economic principles and win investor confidence.
The situation worsened dramatically over the past weeks, when Italy was put under such intense market pressure that Prime Minister Silvio Berlusconi had to resign to make way for a government of experts led by former EU commissioner Mario Monti.
As the EU’s third-largest economy with debt approaching €1.9 trillion ($2.5 trillion) and 120 percent of its gross domestic product, Italy is seen as too big to bail out. Faced with a breakup in their currency union, the euro nations have been scrambling for new solutions.
The eurozone currently has a bailout fund, the so-called EFSF, but it still lacks the firepower and nimbleness to support Italy’s finances if it were to be frozen out of bond markets.
The European Central Bank for now is limiting bond market pressures by buying up the government bonds of weak countries like Italy. That has helped keep Italy’s key borrowing rates below the crucial 7 percent threshold that has eventually caused Ireland and Portugal to need bailouts.
But the ECB says its bond purchases are limited and temporary. To materially lower eurozone borrowing rates to sustainable levels, the ECB would have to embark on a massive program of bond purchases.
Germany — and the ECB, which is heavily influenced by Berlin’s policies — opposes such a massive bond program, saying it is up to governments to get their finances straightened out.
As a result, the EU study is pushing for eurobonds — or Stability Bonds, as it calls them — instead of national bonds as the best way to avoid financial disaster.
"In this way, the severe liquidity constraints currently experienced by some member states could be overcome and the recurrence of such constraints would be avoided in the future," the draft of the study said.
EU Commission officials were due to pore over the study on Monday but no fundamental changes were expected.
The draft said that eurobonds would "provide the global financial system with a second safe-haven market of a size and liquidity comparable with the U.S. Treasury market."
The political difficulty, however, would be to impose the same fiscal rigor across the 17 euro nations and fundamentally change the balance of power between the European Union and the national capitals.
The draft says that such fundamental changes would "almost certainly require" changes in the treaty underpinning the EU. In the past, any treaty change has proven to be a tough political task.
On Monday, the issue will almost certainly come up when Greece’s new Prime Minister Lucas Papadimos meets with top EU officials to discuss Greece’s financial difficulties.
Italy’s Premier Mario Monti will visit EU headquarters on Tuesday to discuss similar issues. On Thursday, Monti is to join German Chancellor Angela Merkel and French President Nicholas Sarkozy in Strasbourg for what he calls a permanent club of the eurozone’s three largest economies to confront the debt crisis.