Wednesday, December 7, 2011

Finally, a solution to the Euro crisis that might work

Pay the politicians with bonds whose values are tied to the market's estimate of their credit worthiness:

...allow euro-zone countries to issue so-called "blue bonds" and "red bonds." Blue bonds would be jointly guaranteed by all members of the euro zone and allow member states to borrow up to 60% of GDP. To fund borrowing beyond that, countries would have to issue red bonds, which would be backed only by their national treasuries and therefore trade, under most circumstances, at higher yields.

To complement joint bond issuance, I would suggest that all euro-zone politicians receive a significant part of their compensation in the form of blue or red bonds. If a country has to issue red bonds because its debt-to-GDP ratio exceeds 60%, politicians would be paid in red bonds.

Otherwise they would be paid in blue bonds. Bonds would have to be held for five years but would be convertible: If the debt-to-GDP ratio falls below 60%, red bonds would be converted into blue. Likewise, if this ratio rises above 60%, blue bonds would be mandatorily converted into red bonds.

This way, politicians would be rewarded when their countries are able to borrow cheaply and punished when their countries' cost of funds goes up. Politicians would be well-compensated when their countries are perceived as solvent; they would take heavy losses if their countries fell into serious financial difficulty.


  1. Red bonds would have a higher interest rate because they are higher risk than blue bonds.

    This might perversely lead politicians to keep their country perpetually in the red. Not hugely, just enough so they could earn a higher "salary" by increasing their rate of return.

    "For every complex problem there is an answer that is clear, simple, and wrong." ~ H.L. Mencken

  2. That is not true. The higher risk associated with the red bonds would be reflected in a lower market price for these bonds. The price for blue bonds would be higher because they are less risky and require a lower return.

    If you pay the politicians in bonds, they are incentivized to keep debt below 60% so that they will receive the higher price for the blue bonds when they are able to sell.