What is a joint obligation
A joint obligation, or a joint and several obligation, is one where two or more parties guarantee interest and capital. In the event of default, bondholders have the right to claim the assets of all the issuing institutions, companies or individuals. This dual responsibility reduces the risk and cost of borrowing.
Breaking joint obligations
Joint obligations can include any combination of parts. They are common when a parent company is required to guarantee the obligations of a subsidiary. A parent company is a company that controls another smaller company by holding a significant amount of shares or control with voting rights. Parent companies are generally larger companies that control one or more small subsidiaries in the same sector or in complementary industries.
When the small business wants to undertake a capital project, it may not be able to float a bond without the help of the parent company. In such a case, debt holders may not be interested in borrowing from an affiliate that does not share a credit rating as high as its parent company. Thus, the parent company will act as an additional guarantor of the debt, in the same way that a parent will co-sign a car note for a child.
Joint Federal Home Loan Obligations
The Federal Home Loan Bank System (FHLB) is another example of a long-standing joint bond issuer. The bank, founded by Congress in 1932, was to help finance housing and community loans. The FHL Bank’s Finance Office issues a joint bond guarantee to finance the country’s 11 federal mortgage lending banks. This funding is then transferred to local financial institutions to support loans to owners, farmers and small businesses.
The Federal Home Loan Bank’s joint and several liability organizational structure makes it unique among government-sponsored housing-related businesses and helps it serve as the backbone of the national housing and small business financing system.
Lessons from Greece on the need for joint obligations
Many economists argue that the European Union should consider issuing joint bonds to strengthen the European currency. The threat of Greece leaving the euro zone in 2020 illustrates their point of view. Greece was unable to get out of the local recession because it had no local currency to devalue. Proponents of joint obligations have argued that, for this reason, Greece needs the support and credit of fellow eurozone members to be able to pay its bills until growth picks up.
Proposals for joint European bonds or common European bonds are issued intermittently. The latest iteration, called European Safe Bond, as proposed in 2020 by a committee chaired by the governor of the Irish central bank Philip Lane.
European banks and many governments would support such proposals because they would meet the demand for secure public debt. In addition, it will reduce the risk of financial panic. However, these recommendations are generally blocked by Germany. The German representatives fear that a common European obligation will encourage fiscal irresponsibility in the European periphery.