Safety Without Tranches: Creating a 'real' safe asset for the euro area

CEPR Policy Insight No 93

Alvaro Leandro, Jeromin Zettelmeyer

There is a recent resurgence of interest in proposals to create ?safe? euro-area level debt instruments that would help to break the doom-loop sovereign risk and bank risk. The leading idea is to create ?sovereign bond backed securities? issued in multiple tranches, the most senior of which (?ESBies?) could play the role of a safe asset (Brunnermeier et al 2017, High Level Task Force of the European Systemic Risk Board 2018). This paper explores alternative approaches to creating a euro-wide safe asset that rely neither on tranching nor on joint and several guarantees. They include (1) sovereign bond backed securities that do not rely on tranching but instead on a capital cushion to achieve the desired debt level; (2) plain vanilla debt issued by a leveraged euro area sovereign wealth fund investing internationally; (3) plain vanilla debt issued by a senior official financial intermediary (?E-bonds?). The three proposals are compared to ESBies in terms of the ?safety? of the asset generated, their impact on sovereign borrowing costs, and their redistributive implications. We show that a safe asset issued by an intermediary that is both senior and endowed with a small capital cushion would lead to values at risk that are equal or lower than those of ESBies, even in correlated default events affecting most euro area sovereigns.