FRANKFURT (MNI) – Eurobonds can help a country that is solvent but
has lost access to the market, but they do not come without risks,
European Central Bank Executive Board member Lorenzo Bini Smaghi said on
Thursday

“Without stringent constraints, the eurobonds risk favoring fiscal
policies that, on average, are more expansionary, and a higher debt,
whose cost is also shared among the more disciplined countries,” Bini
Smaghi said in the text of a speech given in Rome.

“The experience of other countries, both federal and non-federal,
outside the euro area, however, shows that a single federal budget is
not necessarily more virtuous. On the contrary.”

The central banker also said that Eurozone authorities needed to do
more to convince markets that Greece is a “special” case and that “the
modalities to resolve the crisis will not be repeated.”

No doubt referring to the ECB’s SMP program, Bini Smaghi stressed
the need for monetary policy-makers to “avoid covering the liabilities
of fiscal policy and printing money to finance the public debt, thereby
coming to the aid of the fiscal authorities and allowing them to
postpone the adjustment.”

However, the central banker also took aim at those criticising the
ECB’s bond-buy program.

The criticism is “the result of inadequate economic analysis, of
insufficient knowledge of the crisis in which we find ourselves and of
anxiety resulting from experiences in the distant past that are not
relevant to the current situation,” he said.

Though calling the separation of fiscal and monetary institutions
“healthy”, Bini Smaghi added that the framework would only function
properly if markets can correctly evaluate how solvent a country is and
assess risk, thereby “distinguising solvency problems from liquidity
problems.”

“But when markets do not work properly, because of the high level
of uncertainty, because there is contagion or a general fear of systemic
risk, market participants are no longer able to properly assess the
risks and distinguish between them,” the central banker noted.

“Expected difficulties, even temporary ones, in meeting a
borrower’s (sovereign’s) financing needs can cause expectations of a
liquidity crisis and then create a perceived risk which may be reflected
in the uncertainty about the price at which to sell a particular
security, notably government bonds.

“Such a development, especially if it is prolonged, can degenerate
into a solvency risk which jeopardises the economic and financial
stability of the country and the whole area,” he added.

Bini Smaghi said that the initiatives undertaken so far or
currently being discussed by the authorities in Brussels to boost
fiscal
discipline were “going in the right direction” and could be strengthened
further.

“However, the possibility of a crisis and of a country losing
access to financial markets can never be completely ruled out,
especially in a context of global instability like the current one,” he
warned. “We must not repeat the mistake of assuming that thanks to some
‘magic’ Europe is immune to any crisis.”

The central banker also highlighted that markets can “behave in
unstable ways and fail to assess the fundamentals correctly” during
periods of uncertainty.

“There is extensive literature showing that in some circumstances
the markets are subject to crises of confidence and self-fulfilling
dynamics, worsening the instability,” Bini Smaghi said. “Even when a
country is solvent and follows an appropriate fiscal policy it may not
be able to borrow on the markets.”

— Frankfurt bureau: +49 69 720 142; email: frankfurt@marketnews.com —

[TOPICS: MT$$$$,M$$CR$,M$X$$$,M$$EC$]