* EU policymakers examine sovereign bond-backed security
* Author of proposal says central bank could issue bond
* Securitised model should soothe German resistance
By John Geddie
LONDON, Oct 12 A bond backed by a mountain of
euro zone government debt accumulated by the European Central
Bank in its latest stimulus programme could provide a way for
the ECB to eventually unwind that scheme, the author of a
proposal under review by EU policymakers told Reuters.
The idea of a securitised, trans-national bond, which the
European Union's financial watchdog instructed a team to
investigate last month, is seen as an alternative to a
long-debated common euro zone bond which has been resisted by
the bloc's economic powerhouse Germany.
Markus Brunnermeier, co-author of the paper outlining the
idea, said the ECB might eventually use such an instrument to
drain from the economy trillions of euros it has created under
its quantitative easing scheme.
He said the government debt the ECB has bought could be used
as collateral for a new securitised European "safe bond" which
would be issued by the central bank or another entity.
The proceeds of the sale could cancel out the money the ECB
has printed to purchase bonds and help to tighten monetary
conditions as Europe's economy improves.
"If you were to unwind QE to some extent then this would be
one way to do it," said Brunnermeier, a professor of economics
at Princeton University.
The European Systemic Risk Board, chaired by ECB chief Mario
Draghi, declined to comment. In September, it appointed Bank of
Ireland governor Philip Lane -- a co-author on an earlier
version of the "safe bond" proposal -- to lead a task force of
policymakers to consult stakeholders.
Two euro zone sources involved with the task force said one
of the aims of the group was to establish whether the issuer of
the bonds would be a public or a private entity.
Proposals for a euro-wide government bond mushroomed during
the 2011 debt crisis as one way to create an alternative liquid
and secure haven for investors and to wean banks off domestic
government debt, breaking the "doom loop" that ties the fate of
a country's banks to its sovereign and vice versa.
Most of these ideas involved some form of joint guarantee by
member states and faced objections from Germany, the bloc's
largest and strongest economy, which feared it might ultimately
have to pick up the bill.
But Brunnermeier said interest in his idea had revived due
to political pressures on regulators to overhaul the 'risk-free'
status of sovereign bonds, which means banks do not have to hold
capital against them and can also own as many bonds issued by a
single state as they wish.
One source said Germany was more open to this form of
euro-wide bond as it does not require an explicit guarantee for
new debt sales, and yet would provide an additional risk-free
asset that could convince regulators to apply risk weightings to
individual country bonds that would finally break the doom loop.
However, smaller countries might push back if the project
threatens to further exacerbate liquidity problems in their debt
markets and inflate yields on single country bonds as a result.
A second source said the fact the proposal was taken up by a
taskforce means "it's being dealt with rather seriously" but
also that "a policy decision is quite far".
Brunnermeier's paper lists the ECB among potential issuers
and says the underlying bonds could be divided up using the
weighting the ECB applies to its QE scheme. But it stops short
of tying the success of the scheme to the central bank.
"Perhaps we were too cautious on this front to not imply
explicitly the ECB doing that," said Brunnermeier.
"But, in general, there is broad support among the ECB.
Initially there was some resistance, but in general now all the
board members are on side."
The hurdles for the ECB to issue such a bond are high.
The central bank has so far only bought bonds from euro zone
countries, while the body looking into the proposal, the ESRB,
is pan-EU. Nineteen of the EU's 28 member states share the euro.
Also, the ECB does not plan on buying bonds forever, while
the project would require a pool of collateral kept permanently
topped up to maintain regular issuance.
The new instrument would comprise a safer senior bond to be
sold to insurance and pension schemes and a riskier junior bond
targeting hedge funds.
The danger of the ECB issuing these bonds would be that
without sufficient demand for the junior tranche, it would be
left owning the riskiest debt.
Brunnermeier said one way to address these issues would be
for a separate entity to be set up to purchase the ECB's debt
stock and then issue the safe bond.
He said without tapping the ECB's stock, putting the project
into practice would likely take longer and come at a higher cost
if investors were reluctant to sell bonds to the new entity.
(Additional reporting by Marc Jones in London and Balazs
Koranyi and Francesco Canepa in Frankfurt; Editing by Gareth