ECB’s New Plan B? Synthetic Structured Eurobonds

“Near-zero risk” derivatives… the banks are on board.

By Don Quijones, Spain, UK, & Mexico, editor at WOLF STREET.

We could be about to be treated to a brand new central bank-coined acronym, ESB, or in its somewhat catchier plural form ESBies (as in “esbies”). ESB stands for “European Safe Bond,” which in today’s Europe may sound like a contradiction in terms but is in fact an idea that has been gathering dust on the drawing board for close to seven years. It could soon be brought to life, however, if the ECB approves a plan being drawn up to launch the new financial instrument by an independent task force under Irish central bank governor Philip Lane.

Here’s how the scheme would work: private or public institutions, such as large banks or the European Stability Mechanism — the euro zone’s bailout fund — would repackage sovereign debt from the Eurozone’s 19 nations into three tranches: a senior tranche that would have a credit rating of AAA or thereabouts, a junior tranche that would be rated lower but would still be investment grade, and the lowest level which would contain the riskiest securities, might be below investment grade (“junk” rated), and would yield around 5-6%.

Essentially the securities would be derivatives — based on sovereign bonds.

The basic goal behind the plan is to diversify public debt risk in the Eurozone so that it will be able to withstand default by one or more countries without sparking contagion throughout the system, one of the members of the task force told Bloomberg. It’s also hoped that ESBies would partially fulfill the role of Eurobonds, but without the joint and several liability that would demand treaty changes.

The European Commission would need to publish a regulation to allow ESBies to receive the same regulatory treatment as sovereign debt, the person told Bloomberg.

Naturally, there is a danger that trying to solve the Eurozone’s chronic structural problems with even more extreme forms of financial engineering could end up backfiring. Lest we forget, it was the mass securitization of subprime mortgages that hugely magnified the contagion effect of their eventual collapse in 2007-08. As a new paper by leading economists from France and Germany warns, the introduction of ESBies could carry the risk of similar unintended consequences, including the possibility of a mass selloff of the lower-rated tranches in times of crisis.

There are also concerns in some northern capitals that ESBies could serve as a halfway house to full-on debt mutualisation in the Eurozone, raising fears that they would end up paying for others’ debt through the back door or even bailing out the ESB issuer in case of market stress. To allay such fears, Phillip Lane said the issuing entity would have to follow strict guidelines and be shielded from political interference.

“These sovereign bond-backed securities are issued by a robot,” the Irish central bank governor said in Helsinki. “There is no possibility for anyone to interfere with the robot.” Seriously, that’s what he said.

Banks Already on Board

Unsurprisingly, European banks have already expressed a keen interest in ESBies, according to Bloomberg:

The securities could be a new liquid “near zero-risk asset” that serves as an alternative to sovereign bonds, the heads of Europe’s biggest lenders said in a recent document seen by Bloomberg. Banking regulators are considering whether to impose limits on banks’ holdings of sovereign bonds and increase the capital they have to put aside to cover their exposure.

In other words, the timing could not be better. And not just for Europe’s banks. One major consequence (presumably unintended) of the ECB’s almost €2 trillion sovereign bond buying program is that it has spawned a culture of financial dependency among some Eurozone governments, in particular those with high levels of public debt like France, Spain, Italy, Belgium and Austria. And now, as the ECB tries to ween them off its QE program, those countries could begin suffering severe withdrawal symptoms as the price of their bonds falls and yields rise.

A new study by the German economist Friedrich Heinemann of the Centre for European Economic Research (ZEW) in Mannheim has shown that the more the ECB pares back its asset purchases, the more of what remains is being used to support heavily debt laden economies like Italy. “The ECB’s bond-buying program is increasingly asymmetrical,” said Heinemann. “More and more, the ECB is buying the bonds of the heavily indebted euro states.”

Exiting a Catch 22

In 2015, when the ECB launched its QE program, the concentration of sovereign bond purchases was supposed to reflect the amount of capital each Member State’s central bank contributes to the ECB’s coffers — what’s commonly referred to as its “capital key.” But in recent months the bond purchases have been increasingly skewed toward more indebted countries.

The study found that the share of government bonds from Spain, France, Italy, Belgium and Austria in the 2015 purchases was 59%. In 2017, it would reach about 63%, the study says — well above the ECB’s capital key of 58.2% for those counties and their total share of Eurozone GDP of 54.4%.

The ECB now faces a Catch-22, Heidemann says. On the one hand, the dependence of some national governments on bond purchases has become very high, which could rule out a quick exit of QE. On the other hand, the longer the program goes on, the worse this dependency will become.

And that is where ESBies could come in handy, by essentially providing the ECB with a means of continuing to taper its QE program without visiting untold damage on weak, heavily dependent economies like Italy’s or Spain’s. The new instruments might even provide the ECB with a way of gradually liquidating the massive sovereign bond exposures — more than €1.9 trillion so far — accumulated in its QE program, if it all works out according to plan and nothing breaks. By Don Quijones.

Right at the front of the monetary welfare queue is the government of Italy. Read…  ECB Spawned Mass Culture of Financial Dependency that’s Now Very Hard to Undo

Enjoy reading WOLF STREET and want to support it? You can donate. I appreciate it immensely. Click on the beer and iced-tea mug to find out how:

Would you like to be notified via email when WOLF STREET publishes a new article? Sign up here.

  55 comments for “ECB’s New Plan B? Synthetic Structured Eurobonds

  1. Joan of Arc says:

    QT is a joke. Central banks need not ever shrink their balance sheets. What for? Let them guarantee every bond at face value and let the PIGS issue unlimited debt!

    • Justme says:

      What is QT again?

      • Wolf Richter says:

        QT = Quantitative Tightening = Balance Sheet Normalization (Fed’s term) = QE Unwind (my term).

        • d says:

          Balance Sheet Normalization (Fed’s term) = QE Unwind (my term).

          That would be the language .

          Why do peopel try to invent terms for and act when there is already a term for it.

          Its like trying to reinvent the wheel then claim you’ve done something new.

          On top of this, the QT people are trying to bandie about suggesting they know something.

          Would logically be a Tightening action from Normal not a reversal of the QE operation.

          A spade is a spade not a F(*&^%$ shovel.

        • Joan of Arc says:

          Likewise, a club is a club, not a stick to whack someone over the head with. A diamond is a diamond, not a baseball field. A heart is a heart, not a chamber that pumps blood. Or are they?

        • False assumption because there won’t be a tightening of credit in any case. Consumers who have credit balances will have to pay more to carry that balance, there will be nothing to restrict them from adding additional credit purchases. Some people may not be able to pay as much for a house where your score is based on the mortgage rate. (many workarounds including longer paper). The Fed wants to push bond buyers to longer maturities, and ergo credit will follow. Auto makers still offering zero APR at 72 mos? Where is the cred in all this?

  2. Phil Collins says:

    This has the smell of desperation about it.

    We are entering final days now.

    • cdr says:

      Agree strongly.

      Goofy plan. Sell sovereign bonds to outsiders bunched as CDOs and tranched.

      Won’t work.

      Somebody still has to pay interest and interest payments involve actual cash outlays, unless this plan has finally figured out how to capitalize interest without anyone caring …. very doubtful if real borrowers are involved.

      How will Greece, Italy, Spain, or Portugal save interest expense on this? How will this goofy plan prevent rates from normalizing without continued massive ECB money printing and forced negative rates? Answer, they won’t. Thus, what good are these new CDOs other than as a distraction from the day of reckoning.

      • Mel says:

        The only way I can figure it is that it could create a kind of sovereign-debt investment that wouldn’t be vulnerable to financial failure by any one sovereign government. A “halfway house to full-on debt mutualisation in the Eurozone” as the article says. Private investors might like that. If the ECB winds up buying them all, then it changes nothing.

        • cdr says:

          “The only way I can figure it is that it could create a kind of sovereign-debt investment that wouldn’t be vulnerable to financial failure by any one sovereign government.”

          Would that be:

          ECB printed money as portfolio insurance?

          Germany paying higher rates so Greece can pay lower rates?

          Same as above except ECB prints a rebate to Germany?

          You selling a default swap to guaranty the debt?

          The next kick the can invention?

          (Sorry for the thread comment overflow. This idea is so contemptuous it put me in overdrive.)

      • Old Codger says:

        No problem with paying the interest, just BORROW (or print) it!

        We used to call that ‘capitalising interest” back in the olden days, and is the other side of ‘the miracle of compound interest’.

        Worked so far!


        • cdr says:

          great minds think alike. see my comment below. got it a the same time you wrote this.

      • jim says:

        I agree. One of the problems the EU and ECB has it does not have a federalized bond backed by all member countries and probably never be. This would be like Germany then backing all sovereign debt and I just do’t see that happening. Taking sovereign debt, placing these in pools and then selling a derivative doesn’t change the fact that if one country defaults it creates a domino effect. Since most sovereign debt in the EU is worthless who in their right mind would buy a derivative based on worthless debt? The only thing propping up the EU is the ECB creating 60 billion euros a month out of thin air and buying all the toxic sovereign and corporate debt from banks. The reason for this is most banks, many corporations and countries have been cut off from capital markets. Europe will collapse as we move into the middle of 2018 to 2021. The EU, euro, many banks, corporations and countries will not survive as we move forward.

    • Bobber says:

      Just as things look absolutely desperate, they tend to turn around. I think inflation will arrive pretty soon. As bonds, stocks, and RE rise in value, they become less attractive relative to real investment in productive capacity (wages, technology, and equipment, etc.).

      I think equity capitalization to wages is an interesting metric. This ratio has been going through the roof. It tells you the time for making real investments in productive capacity is now. If you don’t, your competition will.

      Corporations that have favored buybacks in the past will start to worry about competition. They’ll have to retain more of it for capital investment and growth, unless they want to shrink.

      As this inflation comes on strong, I think the Fed (and other central banks) will have to accelerate interest rate increases. With GDP growth increasing, they’ll have plenty of opportunity to do this. This period of rising investment, higher interest rates, and higher wages won’t be good for stocks, bond, and RE, but it will be great for wages and the 99%.

      The market is fantasizing that this latest pickup in growth is good for stocks. In reality, it will kill stock and bond prices.

    • cdr says:

      Wait – I have it.

      ECB monetization continues. ECB creates the synthetic debt CDOs and designs tranches. Low/negative rates prevail for monetized junk sovereign debt. ECB sells CDO at higher rate and prints money to pay higher interest payments as needed. Subordinate never matures – is always refinanced. CDO holders received printed money as income. An actual free lunch.

      • cdr says:

        In other words, the ECB pays the interest using printed money and uses CDOs, tranches, funny acronyms, and exceptional kick the can BS to obfuscate the simple truth that …

        the ECB is printing the interest on euro sovereign debt and functioning as a conduit between the initial financing of the debt and the ultimate holder of the debt. Sheer brilliance in financial engineering. They only print the interest, not the full debt load.

        • cdr says:

          Reminds me of the plan in the book Catch-22 where eggs were sold for less than their cost and everyone made a profit. The more eggs sold, the more profit. And lots of people wanted to keep the plan going.

          Life using art and printed money to create reality. And it’s all legal and lots of people will use OPM to invest in it for the massive fees that can be earned if it catches on.

          I finally understand Yossarian.

        • Tom says:

          Yes indeed : That is where synthetic interest payments come into flay (You know it’s a cut above the old style bonds.)

  3. Continue to spread risk, its like a little bit of arsenic in the water, who notices?

  4. Big Surprise

    A fiat derivative with the word “Safe” or “trust” or “secure” in it’s name

  5. OutLookingIn says:

    “Near Zero-Risk”.

    Wait…. What? Just how close to zero is near?
    I thought that only grenades and horse shoes count as “near”.

  6. Drango says:

    If European banks buy these bond derivatives, I’m sure it will be with the understanding that the ECB will bail them out if the bonds go bad. If the bonds are profitable, the banks keep the profit. If not, the ECB will be “forced” to buy them back in order to save the banks. Of course, only certain countries can actually afford to pay for these bail outs. “Mutualization of debt” is just another way of saying that Germany will eventually be presented with a very large bill.

    • cdr says:

      ““Mutualization of debt” is just another way of saying that Germany will eventually be presented with a very large bill.”

      This plan is yet another example of the EU genius ability to kick the can. They will do it if they can force it down the throat of the Eurozone. If the alternative is real money going out to pay the bills, this type of scam goes to the top of the list. Never spend real money if the printed stuff will work. You and I are horrified. They say winner winner chicken dinner. It won’t end until the end is forced upon them and nobody has that in their sights for any time soon.

    • Matt P says:

      Or the plan of Germany to own all of Europe.

      • d says:

        Everybody in Europe wants Germany to pay for everything, so why should Germany not OWN everything.

        The logical continuation of the above.

        If Germany has to pay for everything. Why does Europe need the ECB, or all the other EU Entities?

        Brexit is going to caause some serious EU budgetary issues no matte rhow much teh Eu extorts from England innteh Brexit process.

        All this talk of united Ireland, Scottish and Welsh, independence.

        A simple FACT.

        Just like the EU, Scotland, Ireland and Wales, have ALWAYS taken more from London, than they sent. ALWAYS.

  7. Rates says:

    It might just work. After all muppets don’t know the difference between ESB and USB (the stick).

    • cdr says:

      Muppet saves enough to offer OPM to market

      OPM goes to financial adviser

      Financial adviser buys piece of new Euro debt CDO and collects a percentage as commission.

      CDO agent gets commission for sale to financial adviser

      ECB gets cash from CDO agent … used to offset actual sovereign debt bought by ECB

      next … interest due

      ECB collects low to negative interest from sovereign borrower

      ECB prints balance of interest due for CDO

      Muppet makes money

      conclusion ….

      Winner Winner Chicken Dinner

      problem …. how does ECB contain interest rate on CDO? Eventually it will be Venezuelan in scope. Probably a new kick the can problem for later.

  8. AV8R says:

    Praemonitus, praemunitus.

    Its fine with me, I see the merit in it, and at least the bond buyer is forewarned the contents are somewhat toxic so what’s not to like? Since the ESBies can only partially default, the idea here seems to be to dilute those defaults which are, if not imminent, inevitable. One wonders how large the total offering will have to be to sufficiently cover these inevitabilities.

  9. Gershon says:

    Small wonder that gold surged more than $20 today to a new one-year high, as the infinitesimally small yet fast-growing portion of the population that sees through the corporate media lies and propaganda and recognizes the Fed and its fellow counterfeiters and racketeers at the central banks are leading us down the road to ruin. The flight to quality, when it begins in earnest, is going to quickly turn into a stampede of epic proportions.

  10. Raymond Rogers says:

    I’m beginning to think the US system is going be saved by Euro foolishness. As long as the ECB continues to pour liquidity into the markets, the US can raise rates and offload its balance sheet. It can speed up the offload if it wanted too.

    • cdr says:


      econ 101 –> capital flows to where it gets the highest return with the least risk.

      What would you want …..

      a) Euro negative rates where you get back less than you invested where they use money that’s printed when the real stuff isn’t available.


      b) Normalized rates that reflect a reasonable rate of return with reasonable risk?

      This is why globalization needs everyone in at the same time for it to work and going bigger for longer is a firm requirement. Now, there’s a big credit bubble in Euroland that needs continual printed money and subsidized rates to continue.

      Capital will flow to the US due to higher rates. The ECB will have to print more and monetize even more debt of even more types just so the Eurozone exists a few months longer.

      You can count on Europe and Germany for the really big economic disasters. Tick … tick … tick … tick ….

      Personally, I think the EU is in much worse financial shape than China.

      I’ve been binge watching Mr Robot. Draghi is doing to the Eurozone and EU what the fictional Elliot did to E-Corp. In plain sight and with massive approval. Weird.

  11. Paul Morphy says:

    The Governor of the Irish Central Bank.

    I stopped reading this article at this point. The Office of the Governor of the Irish Central Bank is in total disrepute. The current governor inherited a Central Bank which has been proven to be clandestine, complicit and in connivance with criminality on a scale which is hard to describe.

    I would place zero faith in the mechanisms and structures of the Irish Central Bank to perform even the most rudimentary oversight.

    And I say all of this as an Irishman living in Ireland. I bear Philip Lane no ill will but he presides over a fucking disaster.

    • Don Quijones says:


      It’s not just the Irish central bank that’s calling for this. It’s a task force assembled by the European Systemic Risk Board. It just happens to be led by Mr Lane.

      The idea also enjoys the broad support of the Centre for Economic Policy Research (CEPR), an influential Franco-German research network that is calling for much closer EU integration. The CEPR is financially supported by a large number of central banks, private financial institutions, and international organisations. You can see the full list here:

      • cdr says:

        And it’s a masterful innovation.

        Rather than monetized debt, they’ve figured out how to monetize both the debt and the interest so that, I strongly assume, normal rates will appear to exist. However a big red hole in an account will still grow unless the EU creates a fiction that says the printed interest payments and deficit balance in that account are just fine.

        They’ll probably be offset with 100 year interest payment bonds, which will be purchased with printed ECB money.

        As I said above Winner Winner Chicken Dinner. I suspect the rest of the world will ignore them and assume this stunt is just fine. And it will work until somebody in another country notices the Euro is junk currency and EU import prices rise far above anyone’s ability to pay.

        For Draghi … no worries. He’ll be gone and somebody else will have to clean up the mess while an idiotic business press wonders what happened out of the blue like that.

        • d says:

          “work until somebody in another country notices the Euro is junk currency”

          Currency union without fiscal union is untenable short term insanity.

          For this reason the Eur HAS ALWAYS BEEN a “Junk” payments medium.

      • Paul Morphy says:

        Thanks Don – and thanks for your article.

        I have a very deep distrust of anything attaching itself to the Irish Central Bank, and anything which the Irish Central Bank attached itself too.

        This institution played a central role in not managing the Irish banking industry. A horrendous price has been paid for their ineptitude.

        I do take your point that this synthetic Eurobond concept is the work of European Systemic Risk Board.

    • Steve clayton says:

      Hi Paul, as an Irish person do you want to see further euro integration bearing in mind the games as above that are going on with the ECB ? Regards Steve.

  12. raxadian says:

    The banks will buy these bonds with the understanding they must get rid of the riskier ones as soon as possible.

    That means going to pension funds and or idiots.

    You know at this rate pension funds seem like just losing money. Just enjoy life now and do not retire, keep working until you drop dead.

    Maybe you should stop obeying doctors, who wants to live to retirement age if it means poverty?

  13. R Davis says:

    It defies my sense of reason…why would anyone invest in junk bonds?
    But hey, there’s a sucher born every minute – right.
    Running round & round in the mouse wheel seem to be some investors ideal.

  14. R Davis says:

    Sucker looking for a hot shot investor image,
    “I’ve got money to invest dude.”
    “Maybe I should err on the side of caution & only invest 1/2 my monies.”
    “Na, don’t be squeamish, here take it all.”
    “That’s right man invest all of it on that junk bond.”
    “$100, $200, $300, &, $50 … there you are man , knock yourself out.” … “You will look after my money man, ok.”

  15. mean chicken says:

    If the ESB is equipped with WIFI, integrating to the network-attached storage server will be a breeze.

    Thus the ECB wants authority to tax via currency debasement?

  16. Yancey Ward says:

    As someone above mentioned, the interest payments have to come from somewhere. It sounds to me that the interest payments will be shared among the Euro countries- probably based on the key they use that is derived by economic size.

    It is a mutualization, of course, but they already have that with the QE and various stabilization funds.

  17. Ian says:

    Is this tiered approach not against the whole principle of the EU and its goal of ever closer financial control? if you recognize that bond rates of countries must differ according to risk and economic conditions then how can you then say that one interest rate and one exchange rate can fit all? This after all has been the cause of the whole mess in the first place.

  18. unit472 says:

    Once again financial legerdemain is used to create a AAA product when NONE of the underlying assets alone is AAA rated.

    The ESF is nothing but the promise of the member nations to make good on the bonds issued in their name. If Italy, e.g., cannot make good on its share of ESF debt it would fall to Germany to take up the slack and given the size of Italy’s obligations doing so would erode Germany’s rating.

  19. Dr Lexus says:

    None of which is going to stave off T2mageddon when, inevitably, one of the beggared southern states takes on too much water.

  20. hendrik1730 says:

    Another trick to print money out of thin air. Government-debt based CDO’s given AAA credit ratings and ECB bail-out guarantee while junk is being sold to investers.

  21. Alessio says:

    Gold and silver.
    No matter what.

  22. andy says:

    European Suckers Bonds

  23. FDR Liberal says:

    In the ever hunt for yield and with a appreciating euro, I dare say there will be buyers. The usual suspects I am sure will be purchasing them from hedge funds, private equity, some central banks, insurance companies, etc.

    As with the securitization of home mortgages, all that it takes is that the lesser quality bonds begin to detoriate that the house of cards falls upon itself since junk is usually the canary in the coal mine.

    Why don’t investors learn? I guess greed is just too strong to moderate one’s rational response to ponzi scheme when it only happened a short 10 years ago.

Comments are closed.