Liability gridlock could scupper German piggyback scheme

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Plan might founder due to federal stance akin to that for a wider Eurobond.

When Angela Merkel was busy implementing the European fiscal compact last year, one of the ideas she came up with was the joint issue of bonds by the federal government and German states. Announced in June, these Huckepack (piggyback) bonds are envisaged as large and liquid deals that will be severally – but, crucially, not jointly – guaranteed by the federal government and the individual states.

And therein lies the rub. The structure of the scheme is similar to that already in place for Ländergemeinschaftsbonds, which are joint benchmark issues from various German states under which each state is liable only up to its own share of the deal and bears no contingent liability. The federal government has adamantly refused joint and several liability for Huckepack bonds and will only be liable for its own portion of issuance – whatever proportion that might be.

If all this sounds rather similar it is because it is: the situation with German Huckepack bonds is the Eurobond debate writ small. Regional issuers would like to piggyback on attractive Bund pricing levels but the German government is not prepared to assume full liability for them so doing.

The Huckepack scheme embodies two crucial differences to the Eurobond scheme, however. First, the German federal government can exert some control over the budgets of the various states – a crucial difference from its spendthrift peripheral partners in the eurozone and a disincentive for the states themselves to get involved. Secondly, the spread differential between existing funding options for these issuers and new Huckepack bonds will be far smaller than that between the sovereign bonds of Germany and, for example, those of Spain or Italy.

Although peripheral eurozone borrowers would likely leap at the prospect of a Eurobond, the reception from the German states has, therefore, been far more muted. The states of Bavaria, Lower Saxony and Saxony have already stated that they will not participate in the scheme. Baden Württemberg, Brandenburg, Mecklenburg-Western Pomerania and Berlin are all reportedly still unsure whether it would be a cheaper source of funding. Not surprisingly, it is the smaller states, such as Saarland and Bremen, that have shown the most support.

Despite this, however, there is substantial political will in Germany to drive this through. Germany’s debt management office, Deutsche Finanzagentur, is now in consultation with banks over issuance levels, pricing, rating and whether issues should be bookbuilt or run as auctions. Some involved in the consultation have questioned to Euromoney where these bonds would fit in what is already quite a crowded field of sovereign and state-related options and what message they send. The first deal is due in 2013.

But as long as federal involvement remains structured as such, the extent to which German states intend to piggyback on their powerful parent’s borrowing power remains very much up in the air.