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The Eurozone's Last Stand
NEW YORK "“ The eurozone crisis is reaching its climax. Greece is insolvent. Portugal and Ireland have recently seen their bonds downgraded to junk status. Spain could still lose market access as political uncertainty adds to its fiscal and financial woes. Financial pressure on Italy is now mounting.
By 2012, Greek public debt will be above 160% of GDP and rising. Alternatives to a debt restructuring are fast disappearing. A full-blown official bailout of Greece's public sector (by the International Monetary Fund, the European Central Bank, and the European Financial Stability Facility) would be the mother of all moral-hazard plays: extremely expensive and politically near-impossible, owing to resistance from core eurozone voters "“ starting with the Germans.
Meanwhile, the current French proposal of a voluntary rollover by banks is flopping, as it would impose prohibitively high interest rates on the Greeks. Likewise, debt buybacks would be a massive waste of official resources, as the residual value of the debt increases as it is bought, benefiting creditors far more than the sovereign debtor.
So the only realistic and sensible solution is an orderly and market-oriented "“ but coercive "“ restructuring of the entire Greek public debt. But how can debt relief be achieved for the sovereign without imposing massive losses on Greek banks and foreign banks holding Greek bonds?
The answer is to emulate the response to sovereign-debt crises in Uruguay, Pakistan, Ukraine, and many other emerging-market economies, where orderly exchange of old debt for new debt had three features: an identical face value (so-called "par" bonds); a long maturity (20-30 years); and interest set well below the currently unsustainable market rates "“ and close to or below the original coupon.
Even if the face value of the Greek debt were not reduced, a maturity extension would still provide massive debt relief "“ on a present-value basis "“ to Greece as a euro of debt owed 30 years from now is worth much less today than the same euro owed a year from now. Moreover, a maturity extension resolves rollover risk for the coming decades.
The advantage of a par bond is that Greece's creditors "“ banks, insurance companies, and pension funds "“ would be able and allowed to continue valuing their Greek bonds at 100 cents on the euro, thereby avoiding massive losses on their balance sheets. That, in turn, would sharply contain the risk of financial contagion.
Rating agencies would consider this debt exchange a "credit event," but only for a very short period "“ a matter of a few weeks. Consider Uruguay, whose rating was downgraded to "selective default" for two weeks while the exchange was occurring, and then was upgraded (though not to investment grade) when, thanks to the exchange's success, its public debt became more sustainable. The ECB and creditor banks can live for two or three weeks with a temporary downgrade of Greece's debt.
Moreover, there would be few holdouts that refuse to participate in the exchange. Previous experience suggests that most hold-to-maturity investors would accept a par bond, while most mark-to-market investors would accept a discount bond with a higher coupon (that is, a bond with a lower face value) "“ an alternative that could be offered (and has been in the past) to such investors.
At the same time, the best way to contain financial contagion would be to implement a pan-European plan to recapitalize eurozone banks. This implies using official resources like the EFSF not to backstop an insolvent Greece, but to recapitalize the country's banks "“ and those in Ireland, Spain, Portugal, Italy, and even Germany and Belgium that need more capital. In the meantime, the ECB must continue to provide unlimited resources to banks under liquidity stress.
To reduce the risk of financial pressures on Italy and Spain, both countries need to press ahead with fiscal austerity and structural reforms. Moreover, their debt could be ring-fenced with a larger package of EFSF resources and/or with the issuance of Eurobonds "“ a further step towards European fiscal integration.
Finally, the eurozone needs policies to restart economic growth on its periphery. Without growth, any austerity and reform will deliver only social unrest and the constant threat of a political backlash, without restoring debt sustainability. To revive growth, the ECB needs to stop raising interest rates and reverse course. The eurozone should also pursue a policy "“ partially via looser monetary policy "“ that weakens the value of the euro significantly and restores the periphery's competitiveness. And Germany should delay its austerity plan, as the last thing that the eurozone needs is a massive fiscal drag.
The eurozone's current muddle-through approach is an unstable disequilibrium: kicking the can down the road, and throwing good money after bad, will not work. Either the eurozone moves toward a different equilibrium "“ greater economic, fiscal, and political integration, with policies that restore growth and competitiveness, including orderly debt restructurings and a weaker euro "“ or it will end up with disorderly defaults, banking crises, and eventually a break-up of the monetary union.
The status quo is no longer sustainable. Only a comprehensive strategy can rescue the eurozone now.
Nouriel Roubini is Chairman of Roubini Global Economics (www.roubini.com), a professor at the Stern School of Business at NYU, and co-author of Crisis Economics.
Copyright: Project Syndicate, 2011. www.project-syndicate.org
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Username Password New registration Forgotten password TheAmazingReset 02:30 19 Jul 11There is but one real option and that is to do a global reset and stabalize currencies and debt. The only way to do this is to make banks take the haircuts but then print just enough money to loan back to them as an off balance sheet liability that gets paid out of profits. Shareholders get wiped out. The only way this works is for central banks to stop printing money after this happens to keep the value of currencies in check. I hate this idea but I see no other option that has some concept of justice to it. Go to www.amazingreset.blogspot.com for more information on global economic issues. I just can't understand why the ECB, IMF and other groups can't see that the markets are not going to allow the kicking the can dow the street option anymore. The bond Vigilantes just go from one country to another. At some point (3-5 Years) if the USA does not get its house in order we too will get a visit.
jaysan 05:57 19 Jul 11A hedge fund manager pal of mine responded as follows:
Some problems. For Greece maturity extension is not enough. Current market prices discount bounds by 60%+ and pure maturity extension would cover only half of this – at these levels Greek debt is still not brought down to a sustainable level. The idea might work for banks, but restructure/default will be needed outside of banks to bring Greece's debt levels down to sustainable levels (70%debt/GDP or so).
Where is the money going to come from for the ESFS to back up European banks and ring-fence Spain and Italy? You're talking trillions.Germany doesn’t want to pay very much, a big part of the problem. A Eurobond may require voter approval that will take too long to quell the crisis., although many are talking about this and the EU may be able to find a loophole to again avoid voter participation. Finally a lower EUR doesn’t do much to solve the competitiveness problems of Greece and Portugal in particular. They are not big exporters outside of the Eurozone, so a lower EUR doesn’t effect their prices to their biggest market within the Eurozone.
In addition the fact that the paper EUR doesn’t balance trade is a key part of the instability that led to massive debt accumulation in the uncompetitive periphery. Without trade balancing, future problems will simply evolve again.
Growth does need to be enhanced, and growth-enhancement needs to be emphasized much more than it is, but a lower EUR and low ECB rates won’t do enough. Massive tax cuts for business formation and investment are needed. Whether through ESFS or whatever, total debt levels need to be brought down to a sustainable level in all troubled countries. Perhaps a temporary Latin-EUR to bring competitiveness down via devaluation only in troubled countries (not in German competitor).
Devaluation only of troubled countries, debt reduction through restructuring that is large enough to make debt levels sustainable, growth enhancement relative to the rest of EU, and reform of the monetary system so trade balances (via gold would be best). This is what would work. Of course what would work is going to be nearly impossible politically, so either the crisis needs to become existential clearly or at least some of these components need to be built quickly to try to get ahead of the crisis.
European313 08:26 19 Jul 11
Sorry, but it is just so funny to hear all these comments from U.S which, just a reminder; started the global crisis, not to mention has by far the biggest national debt, that is maybe greater than all the European countries combined. To add from a country that is due to a political comedy may not be able to pay its abbreviations within next few weeks. Not to mention how much the most debt country is spending in warfare in a year but still unable to take care of its own citizens in its own soil (Healthcare, wellfare and so on). Please Americans, take care of domestic problems before you can be appreciated as an example to the rest of the world!
AUTHOR INFO Nouriel Roubini Nouriel Roubini is Chairman of Roubini Global Economics, Professor of Economics at the Stern School of Business, New York University, and co-author of the book Crisis Economics. MOST READ MOST RECOMMENDED MOST COMMENTED What's Happening to the US Economy? Martin Feldstein The Ideological Crisis of Western Capitalism Joseph E. Stiglitz That Stalling Feeling Nouriel Roubini Technology and Inequality Kenneth Rogoff Is Pornography Driving Men Crazy? Naomi Wolf A New World Architecture George Soros No Time for a Trade War Joseph E. Stiglitz Did the Poor Cause the Crisis? Simon Johnson America's Political Class Struggle Jeffrey D. Sachs Avatar and Empire Naomi Wolf The Ideological Crisis of Western Capitalism Joseph E. Stiglitz Technology and Inequality Kenneth Rogoff Europe without Turkey Ian Buruma The Autism Generation Allen Frances Bank Regulation's Capital Mistake Amar Bhidé ADVERTISEMENT PROJECT SYNDICATEProject Syndicate: the world's pre-eminent source of original op-ed commentaries. A unique collaboration of distinguished opinion makers from every corner of the globe, Project Syndicate provides incisive perspectives on our changing world by those who are shaping its politics, economics, science, and culture. Exclusive, trenchant, unparalleled in scope and depth: Project Syndicate is truly A World of Ideas.
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There is but one real option and that is to do a global reset and stabalize currencies and debt. The only way to do this is to make banks take the haircuts but then print just enough money to loan back to them as an off balance sheet liability that gets paid out of profits. Shareholders get wiped out. The only way this works is for central banks to stop printing money after this happens to keep the value of currencies in check. I hate this idea but I see no other option that has some concept of justice to it. Go to www.amazingreset.blogspot.com for more information on global economic issues. I just can't understand why the ECB, IMF and other groups can't see that the markets are not going to allow the kicking the can dow the street option anymore. The bond Vigilantes just go from one country to another. At some point (3-5 Years) if the USA does not get its house in order we too will get a visit.
A hedge fund manager pal of mine responded as follows:
Some problems. For Greece maturity extension is not enough. Current market prices discount bounds by 60%+ and pure maturity extension would cover only half of this – at these levels Greek debt is still not brought down to a sustainable level. The idea might work for banks, but restructure/default will be needed outside of banks to bring Greece's debt levels down to sustainable levels (70%debt/GDP or so).
Where is the money going to come from for the ESFS to back up European banks and ring-fence Spain and Italy? You're talking trillions.Germany doesn’t want to pay very much, a big part of the problem. A Eurobond may require voter approval that will take too long to quell the crisis., although many are talking about this and the EU may be able to find a loophole to again avoid voter participation. Finally a lower EUR doesn’t do much to solve the competitiveness problems of Greece and Portugal in particular. They are not big exporters outside of the Eurozone, so a lower EUR doesn’t effect their prices to their biggest market within the Eurozone.
In addition the fact that the paper EUR doesn’t balance trade is a key part of the instability that led to massive debt accumulation in the uncompetitive periphery. Without trade balancing, future problems will simply evolve again.
Growth does need to be enhanced, and growth-enhancement needs to be emphasized much more than it is, but a lower EUR and low ECB rates won’t do enough. Massive tax cuts for business formation and investment are needed. Whether through ESFS or whatever, total debt levels need to be brought down to a sustainable level in all troubled countries. Perhaps a temporary Latin-EUR to bring competitiveness down via devaluation only in troubled countries (not in German competitor).
Devaluation only of troubled countries, debt reduction through restructuring that is large enough to make debt levels sustainable, growth enhancement relative to the rest of EU, and reform of the monetary system so trade balances (via gold would be best). This is what would work. Of course what would work is going to be nearly impossible politically, so either the crisis needs to become existential clearly or at least some of these components need to be built quickly to try to get ahead of the crisis.
Sorry, but it is just so funny to hear all these comments from U.S which, just a reminder; started the global crisis, not to mention has by far the biggest national debt, that is maybe greater than all the European countries combined. To add from a country that is due to a political comedy may not be able to pay its abbreviations within next few weeks. Not to mention how much the most debt country is spending in warfare in a year but still unable to take care of its own citizens in its own soil (Healthcare, wellfare and so on). Please Americans, take care of domestic problems before you can be appreciated as an example to the rest of the world!
Project Syndicate: the world's pre-eminent source of original op-ed commentaries. A unique collaboration of distinguished opinion makers from every corner of the globe, Project Syndicate provides incisive perspectives on our changing world by those who are shaping its politics, economics, science, and culture. Exclusive, trenchant, unparalleled in scope and depth: Project Syndicate is truly A World of Ideas.
Project Syndicate provides the world's foremost newspapers with exclusive commentaries by prominent leaders and opinion makers. It currently offers 54 monthly series and one weekly series of columns on topics ranging from economics to international affairs to science and philosophy.
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