ESBies: safety in the tranches. (6th April 2017)

• Record Type: Journal Article
• Authors: Brunnermeier, Markus K; Langfield, Sam; Pagano, Marco; Reis, Ricardo; Van Nieuwerburgh, Stijn; Vayanos, Dimitri
• Is Part Of: Economic policy. Volume 32:Number 90(2017)
• Page Start: 175
• Page End: 219
• Publication Date: 2017-04-06
• Subjects: E44 -- G01 -- G28; Economic policy -- Periodicals; 338.94
• DOI: 10.1093/epolic/eix004
• Languages: English
• ISSNs: 0266-4658

Abstract

SUMMARY: The euro crisis was fuelled by the diabolic loop between sovereign risk and bank risk, coupled with cross-border flight-to-safety capital flows. European Safe Bonds (ESBies), a euro area-wide safe asset without joint liability, would help to resolve these problems. We make three contributions. First, numerical simulations show that ESBies with a subordination level of 30% would be as safe as German bunds and would increase safe asset supply. 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 how to create ESBies, starting with limited issuance by public or private-sector entities.