An EU Solution For Both The Short And Long Term

 |  Includes: EU
by: Carl Dincesen

Political union may be a pipe dream, but a public finance union should have already been in place. What the EU lacks is a central treasury. An arm of government that taxes the combined economies of all the states in the union equally.

Just as the ECB was created without a "federal" government, so can a central treasury for the EU, albeit with limited authority. An agency that does not conflict with the constitutions of member states or require any aid from the State of Germany.

The new treasury or EPFA (European Public Finance Authority) could be authorized to issue tax revenue bonds. Those bonds would be secured by a first lien on and security interest in a fixed and equal percent of each nation's tax revenue.

That pledged revenue would constitute a limited obligation of each member state but not a general (all resource) obligation of any one of them.

Pledged revenue would have to be limited in its use to paying debt service on EPFA revenue bonds. Bonds issued only for the benefit of a member state and only at that nation's request but subject to a limit, that is exampled latter.

The obligation of a member to pay debt service on EPFA bonds in the manner described must survive exit from the EU. All as a matter of right under national and international laws. Only EU members would have the right to borrow via the new authority.

The whole point is separating the cash flow for bond payments from the national operating entity. The inability of a member state to balance its budget or repay national debt does not threaten payment of EPFA bonds. Or for that matter the euro or the European banking system, but not the Central Bank, so far.

Because the obligation is a limited not general obligation, borrowing has to be subject to a limit. The lower the limit the higher the credit rating on the bonds.

For example, let's say the agreed upon "rate" or pledged revenue is eight percent. The amount that can be bonded might be limited to what can be serviced (annual principal and interest) by 75% percent of that, or 6% of each nation's total tax revenue.

All EU member states with the possible exception of Germany currently pay at least 6% of total tax revenue to service their national debts. Greece much more than the others.

These types of provisions would assure repayment of EPFA bonds as long as the borrowing nation's tax revenue does not decline by more than 25%. It also makes it impossible for a member to borrow through the finance union unless the numbers support that.

This would provide 1.33x historical debt service coverage. It is also the recommended test or condition to meet in order to issue additional bonds.

Protection beyond 25% would come in the form of a cash funded debt service reserve requirement equal to the maximum amount of principal and interest due in any year on outstanding and proposed additional bonds. Reserves funded from bond proceeds and amortized over the life of the issue.

The reserve extends the ability of the security to withstand an additional 10% decline in pledged revenue for ten years before pledged revenue would be insufficient. It would not matter whether this occurred in all union nations at the same time or in only one member state.

We would place the odds of monetary on authority bonds very much like this at less than .05% over 10 years; the largest protection margin available to investors, a real triple - A. Investors would also get paid back defaulted amounts with interest when revenues recover.

All member nations except Germany would flock to refinance their national debt with fixed rate 30 year amortizing EPFA bonds. Interest rate paid should be close to those paid by Germany when it borrows in its own name, if not immediately then soon after.

All bonds issued by the new authority should amortize in level payments of principal and interest like a fixed rate mortgage. Keep it conservative, simple, fair and out of the short term lending market.

Germany does not have to do anything, but no doubt would be a major investor in EPFA bonds if not also a borrower.

As trustee and paying agent for the benefit of EPFA bondholders, the ECB could hold the reserve funds and administer the new intercept accounts that would be needed to pay debt service.

Such an agreement would take more than a year to complete. It must be approved by all EU member states and found constitutional in each.

Time is a wasting.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.