At long last, the New York Times has decided that the eurozone crisis merits a lead editorial
. Here are some brief excerpts from “Europe at the Brink”:
Time is running out for salvaging Greece and, beyond it, Europe’s shared currency, the euro. Thursday’s emergency summit meeting looms as a Lehman Brothers moment.
If Europe’s leaders fail to extricate Greece from its current unsustainable debt-servicing obligations — by lowering interest rates and lengthening maturities at a minimum — the market reaction, for all of Europe, may be unforgiving, and uncontainable as investors conclude that no European sovereign debt is safe from possible default.
[...] The first, and perhaps immediate, consequence of a failed summit meeting could be a disorderly and destructive Greek default. The shock waves could spread to Ireland and Portugal as lenders conclude that if Greece can default despite European Union bailout programs, so could those countries.
Spain and Italy could also be drawn in. They are large, solvent economies threatened by liquidity crunches if their interest costs keep rising. But credit markets, seeing Europe paralyzed, have started to back away from these two as well. The European Union can afford a sustainable bailout of all three smaller economies. It would be far more costly to have to rescue the two larger ones.
What matters is that the relief Europe chooses results in a lower debt-servicing burden with longer payback periods and greater chance for growth for Greece and the other heavily indebted economies. Europe as a whole can raise money at much lower interest rates, and those funds can be used to restructure and refinance Greek debt.
No such solution is possible unless Chancellor Merkel steps back from her unrealistic insistence that Greece’s bank creditors first bear some of the cost of any debt restructuring. German taxpayers, and all of Europe, must be told that everyone will pay a disastrously high price if Greece is allowed to go under. Europe’s leaders need to make hard choices. And they need to make them now.
I find it strange indeed that today’s Wall Street Journal doesn’t editorialize on tomorrow’s meeting. Instead, there’s a criticism of Spain’s contribution to Europe’s systemic financial risk.
Tomorrow, the eurozone’s leaders will hold what has been billed as an “emergency summit” having two purposes: (1) to reach an agreement on a second international bail-out for Greece, and (2) to formulate a solution to a spreading sovereign debt crisis that now includes Italy.
To set the stage for the summit, the Financial Times has published an analysis that addresses both items on the agenda. The Greek predicament can be summarized as follows: (1) very large debt repayments are scheduled for 2012, 2013, and 2014; (2) at the same time that the mandated repayments will be increasing, the contributions from the current bail-out package will be decreasing; and (3) against a backdrop of growing repayments and declining external assistance, the Greek banking system is falling prey to deposit withdrawals.
An many have said, Greece’s debt burden is so large that it may never get paid. Adds the FT:
Officials cannot acknowledge this, however, for fear of spooking bondholders into believing default is at hand. Similarly, private investors face political pressure to bear the burden of a new bail-out – but among the largest investors in Greek bonds are Greek banks, which would take huge losses (and need more international aid) if their holdings were cut in value.
Institutional conflict complicates matters, as “[a]lmost every participant in the debate – Athens, the European Central Bank, the IMF, the European Commission and national capitals – holds different and sometimes mutually exclusive interests.”
The Frankfurt-based ECB, for instance, is responsible for making sure Europe’s banking sector remains solvent. But the sector (as well as the ECB itself) holds vast quantities of peripheral bonds – meaning any undermining of their value could hit their capitalisation levels, limiting their ability to survive a Lehman-like collapse. The German government, on the other hand, under pressure from the Bundestag, wants some of those banks to accept less than they were originally promised for their bond investments.
[...] There is intense pressure on the Germans and the Dutch to drop their insistence that bondholders pay a price, a stance that has held up an agreement and led to most of the market panic. But Berlin and the Hague argue that without bondholder participation a new deal will not be credible, since it will not lower Greece’s overall debt burden.
Here’s the list of banks with the most exposure to Greek sovereign debt:
Nobel Prize-winning economist Joseph Stiglitz says that the eurozone’s problems are political, not economic. The economic issue is “simple and clear.”
Greece’s debt has to be brought to a sustainable level. That can only be done by lowering the interest rate that Greece pays, lowering its indebtedness, and/or increasing gross domestic product.
The reason why the efforts of the past 18 months haven’t worked is that they have raised, not lowered, Greek interest rates.
Official lending (from the International Monetary Fund and the European Union) has seniority over the private sector. The riskiness of new private sector lending is thereby increased, with obvious implications for interest rates. Meanwhile, as official lending replaces private sector lending, the risks associated with past lending is shifted to the public.
Citing evidence from Ireland, Greece, Spain, Latvia and a “host of other experiments,” Stiglitz rejects the notion that austerity programs work. Instead, such programs induce economic downturns that reduce tax revenues. The improvement in the fiscal position of countries implementing austerity programs is therefore “inevitably disappointing.”
If Europe were to issue eurobonds — bonds that would be supported by the collective commitment of all eurozone governments, the debt problem would become manageable. Such bonds would have lower interest rates than the sovereign bonds of the troubled countries. The resulting decline in interest payments would make it easier for Greece and the others to escape from the financial wilderness.
What has prevented eurobonds from being issued? Economic nationalism (shades of the 1930s, anyone?). In Stiglitz’s words:
Those who, putting aside any sense of European solidarity, worry about creating a “transfer union” should be comforted: at such low interest rates the likelihood of a need for real subsidies is limited. But even if there were some subsidy, Europe could afford it. With a $16,000bn dollar economy, even if Europe had to bear costs commensurate with the size of Greece’s debt, these are minuscule compared to what will be lost if Europe does not come to the assistance of the countries facing trouble.
Mario Monti (president of Bocconi University and former European commissioner) and Sylvie Goulard (a member of the European Parliament) continue the eurobond discussion in their FT article.
Commissioner Olli Rehn said last month in the European Parliament that, as part of an economic governance package, the Commission will be ready to propose the setting up of a system of common issuance of euro-denominated government bonds before the end of the year. This would be aimed at strengthening fiscal discipline and increasing stability in the euro area through market mechanisms, ensuring that those member states that enjoy the highest credit standards would not suffer from higher interest rates . . . The proposal is for the use of eurobonds as an instrument of debt management, not as a financing instrument for new expenditures.
[...] There is growing consensus that it would be difficult to find a lasting solution to the eurozone crisis without the use of eurobonds. This week’s eurozone summit could give at least a clear political signal that it is worth considering the eurobond proposal. A European vision, based on the creation of a European instrument, backed by a precise timetable, could be a good way to restore trust and stability.