ESBies: Safety in the Tranches
Prepared for the 64th Panel Meeting of Economic Policy, 14-15 October 2016
52 Pages Posted: 21 Sep 2016
Date Written: September 18, 2016
The euro crisis was fueled by the diabolic loop between sovereign risk and bank risk, coupled with cross-border flight-to-safety capital flows. European Safe Bonds (ESBies), a union-wide safe asset without joint liability, would help to resolve these problems. We make three contributions. First, numerical simulations show that ESBies would be at least as safe as German bunds and approximately double the supply of euro safe assets when protected by a 30%-thick junior tranche. Second, a model shows how, when and why the two features of ESBies – diversification and seniority – can weaken the diabolic loop and its diffusion across countries. Third, we propose a step-by-step guide on how to create ESBies, starting with limited issuance by public or private-sector entities.
Keywords: ESBies, safe assets, sovereign debt, default, sovereign exposures, diabolic loop, tranching, pooling
JEL Classification: E44, F36, F45, G01, G15, G28, H63
Suggested Citation: Suggested Citation