A framework to assess European policy decisions
May 16, 2011 Leave a comment
According to the market, the short-term default of Greece is a near certainty, with 3 years yield around 24%. Indeed, debt service is estimated to reach 25% of the budget revenues by 2013, which is extremely hard to bear.
Greece is facing a set of three interlinked problems
- Short term liquidity, as they have a budget deficit and no borrowing ability
- Long term insolvency, as for the foreseeable future, their economy is not expected to grow fast enough to cut governmental debt
- Structural problems linked to the Euro and Greece low competitiveness
The following options are available to European decision makers (ranked by political cost)
a. Status Quo (new bailout money, extending the terms)
- Make the real situation worse (new bailout money) or just as bad (extending the terms)
- More debt increase (usually more expensive) the long-term insolvency risk
- Austerity measures – despite being popular within creditor countries – are further weakening the economy, increasing the future costs.
b. Debt restructuring (haircut, interest reduction) or debt moratorium for 5 – 10 years
- It would cost a significant amount of money to German & French banks, and thus there is much resistance to take these steps. However, the amount directly owed by the greek government to EMU banks is 48.5bn USD. Assuming a 50% recovery rate, that’s a total loss of 24 bn USD, an amount that the euro banking system will absorb without trouble. Moreover, it’s still cheaper than an exit of the euro-zone (for Greece, there is a total euro-zone exposure of 196 bn USD)
- That’s – I think – not enough to justify resisting this outcome so much. Other reasons for delaying could be : fear of restructuring spreading to other PIIGS as well as the fear of a fair assessment of French & German banks balance sheets. They are probably still hiding toxic products from the 2008 crisis, especially germanlandesbanks (regional savings banks), and bidding for time for the bank to build enough capital cushion to absorb those losses.
- This move would truly help Greece, while not solving the long-term imbalances caused by the euro and the low productivity of the country
c. Collateralized lending / euro bonds (allowing Greece to buyback its own debt with “eurobonds”)
- This solution is very interesting as in terms of costs, it is equivalent to a restructuring (bonds would bebough at market prices, which are reflecting the probability of default)
- The result for Greece is essentially similar to the previous solution
- Problem is that until now Germany has refused any solution including eurobonds
d. Fiscal union
- The ideal solution to the euro crisis, but currently politically impossible
- The only other way to solve the structural imbalances without breaking the Euro would be to manage to bring the competitiveness of the southern countries to the level of ‘exporting europe’ (germany and its satellites : austria, holland). If this is to happen, it’ll take generations – the only to change millenia old habits
- A potential scenario is the a sudden formation of fiscal unity during a time of crisis and panic. A the height of the Eurozone crisis, there could be a massive run on even the strongest Eurozone bank, and fear of total collapse would lead to fiscal union.