The €5 Trillion Question

How Europe Can Create Its Own Treasury Market

The pandemic forced Europe to finally issue true Eurobonds: common debt backed by the EU budget.¹ This debt was important for Europe: it marked a historic leap towards a fiscal union; it was a powerful act of solidarity, with richer member states agreeing to help those hit hardest by the crisis; and it created a large common European safe asset, strengthening the euro's role in the world and the EU's economic power.²

But the construction was unfinished: we did not set up a common EU treasury able to service this debt, nor did we agree on common EU public good provision, nor on a set of revenues that flow directly to the European Union. As a result, issuing significantly more EU debt now is (except for some concrete exceptions such as defense) quite difficult.

But with the US looking less plausible as an issuer of truly safe assets, there will be much more demand for alternative safe assets, which Europe can offer. Just when the EU and its member states need money to finance defense, we may have a window to strengthen our position in debt markets at favorable prices.

The obstacles to issuing joint debt are not just political, but also legal. The pandemic plans were authorized with an emergency authorization.³ Issuing new eurobonds would require new legislation, which would still face political hurdles. There is fortunately a synthetic solution that would allow Europe to seize the moment, without increasing total indebtedness.

Synthetic Solutions

Understanding the state of play today requires revisiting history. After the Greek crisis, economists scrambled for solutions that would avoid flights to safety (savers pulling their money from unsafe countries towards perceived safe havens) from South to North. Angela Merkel's 2012 declaration—“As long as I live, there will be no Eurobonds”— meant any fix had to avoid explicit debt mutualization.

One early idea, proposed by Jacques Delpla and Jakob von Weizsäcker, was to split each country's debt in two: “Blue Bonds,” for national debts up to 60% of GDP, would be jointly guaranteed; “Red Bonds” for debt above that, would remain national, with higher rates to discourage excessive deficits.

This idea is elegant and useful, but never gained enough political support. Northern countries rejected joint guarantees as backdoor transfers, while Southern countries feared their large red tranches would face prohibitive yields, creating self-fulfilling crises.

Then came ESBies (Brunnermeier et al, 2011, 2016), or sovereign bond-backed securities (SBBS), their official name. Together with a group of European economists, we proposed a market-based Eurobond alternative requiring no political guarantees. An intermediary would buy diversified portfolios of all eurozone sovereign bonds, weighted by GDP. Then it would issue securities in tranches against this portfolio.

Think of it like a building. The senior tranche is the ground floor and gets paid first. The junior tranche is the top floor and gets paid only after the senior part is made whole. The junior tranche acts as a buffer. If a country defaults, the junior investors take the loss first. Because the portfolio was spread across all of Europe, even a total Greek default would barely dent the 30% junior buffer protecting the senior bonds. This financial engineering creates an ultra-safe asset from a pool of riskier ones.⁴

Crucially, individual member states' debt would lose the (empirically false, but so far regulatorily established) risk-free status, which only the senior ESBies tranche would receive. This would immediately create large demand from banks, who would enjoy a truly risk-free asset, by virtue of its diversification and seniority.

The European Systemic Risk Board analyzed SBBS and concluded that properly structured they could work. The European Commission drafted enabling legislation in 2018.

But the proposal died in the Council of Ministers. The public servants running the treasuries of the member states disliked the proposal. Governments value their ability to lean on domestic banks to purchase their own securities, even with high default risks. Without common debt, they can prevail on an Italian bank to buy Italian bonds. After the introduction of SBBS, they will not be able to do that. This “moral suasion” channel would weaken if banks could only hold diversified and low risk European instruments without incurring capital charges.

The Next Generation EU Program

Then came COVID-19. Faced with economic catastrophe, the NextGenerationEU (NGEU) program authorized the Commission to borrow €750 billion on behalf of all members. These were real EU bonds backed by collective guarantees.

Many of us saw this as a significant step forward for European integration. NGEU bonds were to be repaid through new EU taxes—plastic levy, carbon border adjustment, digital tax, laying a foundation for future common fiscal capacity. One step further – a treasury – and Europe would have a fiscal union. Sadly, that was not to happen. I leave that story for a later post.

But despite the success of NGEU (not least due to very significant purchases by the ECB), it would be fanciful to imagine that there is the political support needed to enable the explicit issuance of new joint European debt. This is where the opportunity of synthetic eurobonds comes in.

The political realities, economists Olivier Blanchard and Ángel Ubide (2025) proposed on May 30th a new Eurobond plan. Instead of joint guarantees, countries would pledge a share of their VAT tax revenues to pay for new “blue bonds.” This would make the blue bonds ultra-safe by giving them first claim on tax revenues from multiple countries.

The target is ambitious: €5 trillion in blue bonds, about 25% of eurozone GDP, which would create a liquid market rivaling the U.S. Treasuries. The remaining e.g. 75% of a country's debt (assuming its debt to gdp ratio was 100%) stays national but becomes explicitly subordinate.

Blanchard and Ubide argue this threads the political needle. No joint guarantees mean no treaty changes. Each country services its own share through dedicated taxes. Yet markets get massive safe assets backed by senior claims on national VAT revenues that effectively become European tax revenues.

The proposal's elegance masks some serious problems. First, any parliament can change its own laws. What prevents a future Italian parliament, facing 15% unemployment and pension protests, from redirecting “ring-fenced” VAT revenues to finance pensions? History shows such commitments crumble under pressure. Spain reversed pension reforms when convenient. Italy's budget rules disappeared with Superbonus spending. The Stability Pact was “inviolable” until Germany and France broke it in 2003. National law dedication is only as strong as political will.

Second, creating senior blue bonds violates pari passu clauses standard in sovereign debt—promises that all unsecured creditors rank equally. Suddenly subordinating trillions in existing bonds would risk triggering credit events, CDS payments, and lawsuits. Even if structured carefully, litigation risk alone would make blue bonds trade at a discount. Holders of newly subordinated national bonds will seek compensation or sue to block the scheme.

Third, and lastly, the ECB still holds over €2.5 trillion in sovereign bonds bought during quantitative easing. Many trade far below purchase price—unrealized losses exceed €650 billion. If the ECB swaps these for blue bonds at market prices, it crystallizes massive losses. If it swaps at book value, it's monetary financing.

The proposal certainly has problems. But there are more reasons than just political reasons to urgently want common debts. As readers of the blog know, the euro's weakness is the risk of a “doom loop” between governments and the banks that hold their debt. When a government looks risky, its country's banks suffer, since they are stuffed with that government’s debt. When the banks weaken, the government must bail them out. This spiral nearly destroyed the euro in 2011 and persists by design: banking regulators treat government bonds as “risk-free,” while governments pressure their banks to buy the national debt.

Breaking this loop would be much easier with a safe asset—like a European Treasury bond—that is not tied to the fate of any single country.

A European safe asset along the lines of the original SBBS proposal would create a €5-10 trillion market, deep enough to rival the U.S. dollar as a global reserve asset. By pooling risk, it would lower borrowing costs for weaker countries while barely affecting stronger ones. By design, it would help break the “doom loop” between banks and their national governments, as banks could hold truly safe SBBS instead of overloading on their own country's debt. The safety of the bonds would come from diversification and tranching, not from fiscal transfers or joint guarantees, requiring no changes to European treaties. Furthermore, it would stabilize the financial system by redirecting a "flight to quality" during a crisis into the senior ESBies tranche, rather than having capital flee from one country to another.

Additionally, and assuming the institutional reforms that are required (explained in our Substack post together with Cochrane and Masuch and in “Crisis Cycle”) Europe could profit from the “exorbitant privilege” the U.S. has long enjoyed, as Markus Brunnermeier argued recently. This would mean Europe could borrow at lower interest rates, as global investors seek out its safe bonds, and continuously refinance its debt. Crucially, during a crisis, capital would flow to Europe as a safe haven instead of fleeing from it. This shift would lower borrowing costs when help is most needed, making it possible for Europe to run countercyclical policies rather than austerity ones.

That this opportunity exists is hinted at by the recent surge in euro denominated bond issuance by non-euro area corporations (see Figure).

Large increase in EUR-denominated bond issuance by non-euro area corporations

Source: Lane (2025). Accumulated flows in EUR bn since the beginning of every year.

In sum, in my view, the original ESBies proposal remains most promising. Unlike blue bonds, which rely on political commitments, ESBies use legally binding contracts. They require no treaty changes and no dedicated taxes.

As ECB Chief Economist Philip Lane (2025) noted recently, the work on ESBies is already done—the legislation is drafted and the structure is tested:

An alternative, possibly complementary, approach that could also deliver a larger stock of safe assets from the pool of national bonds is provided by the sovereign bond backed securities (SBBS) proposal. The SBBS proposal envisages that financial intermediaries (whether public or private) could bundle a portfolio of national bonds and issue tranched securities, with the senior slice constituting a highly-safe asset. The SBBS proposal has been extensively studied (I chaired a 2017 ESRB report) and draft enabling legislation has been prepared by the European Commission. Just as with the blue/red bond proposal, sufficient issuance scale would be needed in order to foster the market liquidity needed for the senior bonds to act as highly liquid safe assets.

Europe's synthetic bond proposals respect the current truth: we're still a union of sovereign states, not a federal republic. But while perfect solutions are politically impossible, market-based imperfect ones offer a path to progress. The demand for safe assets is growing, as is the urgency of creating them. Synthetic eurobonds offer a solution we can implement now, strengthening the euro and fostering a more stable financial system for all.

Thanks to Markus Brunnermeier, Marco Pagano, Tano Santos for comments and Klaus Masuch for many useful discussions on this.

References

Brunnermeier, Markus, Luis Garicano, Philip R. Lane, Marco Pagano, Ricardo Reis, Tano Santos, David Thesmar, Stijn Van Nieuwerburgh, and Dimitri Vayanos. "European safe bonds (ESBies)." Euro-nomics. com 26 (2011).

Brunnermeier, Markus K., Luis Garicano, Philip R. Lane, Marco Pagano, Ricardo Reis, Tano Santos, David Thesmar, Stijn Van Nieuwerburgh, and Dimitri Vayanos. "The sovereign-bank diabolic loop and ESBies." American Economic Review 106, no. 5 (2016): 508-512.

Lane, Philip R. Lane, Keynote speech at the Government Borrowers Forum 2025, Dublin, 11 June 2025

1. While other forms of European common debt existed before the pandemic, they were fundamentally different. Previously, joint borrowing was typically issued by separate entities (like the European Stability Mechanism or the European Investment Bank) and was used for “back-to-back” lending to member states, not for direct EU spending. The NGEU program was novel because it was the first time the EU itself borrowed on such a large scale to directly fund its own expenditures, with the debt guaranteed by the EU budget itself. See my piece with some charts here.

2. I was quite heavily involved at the time—discussing the details with several finance ministers in late March to mid April 2020 and proposing on a concrete and precise plan on April 2nd which was credited by senior Commissioner Josep Borrell for finding the way forward. I was also a shadow rapporteur on the Recovery and Reconstruction Fund legislation.

3. My early views on legal avenues are in the Appendix here.

4. My coauthor Klaus Masuch worries (probably rightly) that details such as how in the case of a government default, the intermediary or fund holding sovereign debts and issuing SBBS would come to a decision in favor or against a debt exchange offer, have not been fully been thought through.