This post was written more than two years ago following L'Aquila earthquake in Italy. Here we are again in the Emilia Romagna region...

This post was written more than two years ago following L'Aquila earthquake in Italy. Here we are again in the Emilia Romagna region...

Is an earthquake in Italy really a Black Swan?

An earthquake could normally be characterized as Black Swan to the extent that "first, it is an outlier, as it lies outside the realm of regular expectations, because nothing in the past can convincingly point to its possibility. Second, it carries an extreme impact. Third, in spite of its outlier status, human nature makes us concoct explanations for its occurrence after the fact, making it explainable and predictable".

Yet in Italy earthquakes are not exactly unpredictable one offs for which there are no precedents and so nothing to learn from. There is a great deal of information in the occurrences of an earthquake.

It appears that geophysicists know they still cannot predict when an earthquake will occur, how much its magnitude will be and where it will strike. We say that economists suffer from the same problem in their predictions: if they say when they cannot tell you how much and vice-versa. If they tell you when and how much they will fail the prediction.

However in the prediction of earthquakes, some empirical laws (e.g. power law) are known to hold, which are remarkably simple. There exist also some interesting approaches based on peculiar properties of precursory phenomena observed within complex seismic time series.

The fact that earthquakes like financial markets could be affected by the Black Swan frequency problem does not impel us to do nothing! Not at all. We can focus more and more on prevention rather than prediction and establish some ground smart rules in order to avoid financial systems to collapse in turmoil and earthquakes to raise the death toll and damages.

The recent earthquake in Italy, along the same lines of the world financial crisis, shows that somebody, particularly in Italy, still have some difficulties in making prevention to work and abide by the rules of, for example, seismic construction. Thus the debate is easily shifted from prevention and regulation to failure of predictions so that nobody is accountable. The same is in fact happening in the financial crisis. Sad similarities and news.

Euro- bonds: what are we waiting for?

The debate on Euro-bonds seems stuck somewhere...A Curious Bull-Bear Stalemate. The European Commission's report on the public consultation on the European Commission Green Paper on the feasibility of introducing Stability Bonds showed only 40 responses sic! Basically nobody cares...?

I still contend that Euro-bonds are bonds to be alive. Unless Euro-bonds are launched pretty soon there will be big problems ahead, particularly for the ECB. The latter is indeed likely to incur big losses if Greece were to exit the Euro. The ECB is already running on nominal and fictitious Euro-bonds buying all EU member states bonds, which have to be sterilised on all operations with repo operations. But the recent ECB longer-term refinancing operations cannot go forever. What if Greece exit the Euro?
Euros can still be printed but operations would be far easier if the Euros are backed by Euro-bonds. If investors are at present more concerned about solvency than liquidity, LTRO by the ECB will not help that much. Full scale quantitative easing will be needed and this is definitely more effective with Euro-bonds, that is monetising EU sovereign debt not national one.

If Euro-bonds were adopted borrowing costs for many countries will be lower (along the same lines of when the Euro was introduced) but net costs for Germany will not necessarily be higher. Even if borrowing costs for Germany will be a bit higher then at present (which can be initially compensated), costs of defaults, Euro exits and ECB losses are far higher for everybody, particularly Germany. The costs of not having Euro-bonds could be far higher than the cost of having them.

On the other hand ,the Euro-zone currency union saved Germany’s major banks from insolvency, and German taxpayers from the burden of a massive bailout.  European bank exposure to the PIGS wasn’t altruistic economic development and cooperation funding; it was very often speculative and without due diligence investment. Moreover Germany relies on the EU for exports, so a stable and not in recession area is on its interest.

One variation on the Euro-bonds idea that has gained traction in recent weeks is something called "project bonds". It's not a big deal as it's exactly what was proposed in 1993 by the European Commission President's Delors.  It will not help as the money involved is too little.

Euro-bonds may not resolve the current crisis but  I think would avoid having a bigger one.
I also expect Euro-bonds “soon”.