At some point the people in the town’s square had to acknowledge that all the available evidence did indeed indicate, all else being equal, that the Emperor was quite naked; the new clothes theory was merely wishful thinking and not a reasonable conclusion. Oh yes, there was no way around it, rational analysis could no longer be denied, it was the Emperor’s birthday suit that was on display and not an elegant new finery. “But he hasn’t got anything on,” never rang more true. The good people of the town did not want it to be this way, after all, they had done their best to convince themselves otherwise, but at the end of the day there was no way around it, plain as it could be, their Emperor was naked.Back in May 2010 when the EU/ECB and IMF developed a strategy to prevent a Greek financial collapse, all the participants said that debt restructuring was not a part of the talks. Last week, when the German Finance Ministry denied the report in Die Zeit, that there was a plan under consideration that would help Greece buy back its own securities, they stressed, “We are not working on a restructuring of Greek debt.” Greece’s government also reiterated that its position on debt restructuring was unchanged, no discussion of it, they said. But, if they can be taken at their word, these may be the only people, among those that have an iron in the fire, who are not contemplating such a scenario. It seems to me that regardless of the development of the next great plan to solve the problem of euro-peripheral debt, there have been more constituents willing to admit that restructuring, at least some form of it, is more likely than not.
But there are many competing interests, even within single countries. Germany, for instance does not want to always be the rich uncle to its more needy nieces and nephew in the EU. This reluctance has given rise to the euro-skepticism amongst the people of the country, which has become an important political calculation for Chancellor Merkel and her ruling coalition, especially with elections in seven of the sixteen German states from February through September this year; so there is a need to draw a line in the sand. Additionally there is a law suit working its way up to Germany’s highest court that challenges the legality of the Greek bailout and euro rescue fund. But on the other hand Merkel has concern for German bank holdings of the debt from the troubled periphery and she is more than aware that forty percent of German exports find a home in the Eurozone; the single currency has supported this trade relationship in a way that a surging D-Mark would not. Conversely, for all the good that membership in the EU may have done for the prospects of countries such as Greece, Ireland or Spain, now that times are tough they have lost the ability to a unilateral devaluation of their currency unit and instead must endure an austerity that has resulted in unemployment rates that are as high or higher than those that prevailed before monetary unification. And it is possible that popular sentiment among the people in these nations could force their governments’ hand; with the upcoming Irish election being front and center.
A key part of the bailout plan devised last May was the European Financial Stability Facility (EFSF). This Luxembourg corporation was created “for the purpose of making stability support to euro-area Member States in the form of loan facility agreements and loans made thereunder of up to EUR440 billion within a limited period of time.” The immediate concern was the ability of Greece to fund itself at a rate that it could afford, but of course the size of the commitment was such that it could go beyond that country if necessary. This is not to say the EFSF was funded with that much money, but that it would sell debt to raise those funds and that their debt offerings would be backed by “irrevocable and unconditional guarantees of the euro-area Member States.” Germany’s commitment to the new facility was EUR119 billion, or twenty seven percent of the entire kitty.
Now comes the new idea, one that is a morphing of the stated intention of the EFSF framework agreement in a manner that is not dissimilar to the repurposing that took place for the TARP in the US. The latest “permanent” solution to the debt crisis is to allow Greece to use EFSF funds to buy back their own debt, or some variation of that theme. “Such a package would involve a big increase in the existing EUR440 billion bailout fund,” writes Wolfgang Munchau in the Financial Times. But, he adds, “The EFSF needs more headroom to lend to Portugal, and even to Spain if needed. It may also need funds for other bond repurchases besides any large Greek programme.” Munchau says “The economic benefit of an EFSF bond swap programme would be to reduce interest rates on Greek debt, while also in effect rescheduling debt repayments. It would be market driven, too. No one would be forced into a ‘haircut’, in which some bond holders take involuntary losses. The risks to the EFSF are also moderate because secondary market prices are very low and already reflect certain default probability.” It all sounds so good why wouldn’t other countries that are now strained and paying for it with the high yields the market is demanding in order to sell debt, also opt for it. And if that is the case then the size of the EFSF must indeed grow and that of course means that so too will the “irrevocable and unconditional guarantee” for all Member States, including Germany, the one that is footing most of the bill. German Chancellor Merkel has of course already suggested that in a couple of year’s time there must be someone other than EU participants that are on the hook in case of an ongoing debt debacle. And she is not willing to up the German ante to the EFSF, so it seems that the latest solution will be road blocked in Berlin; although there are talks on the matter this week between Merkel and European Commission President Jose Manuel Barroso.
It is probably wrong to call all of these plans solutions, it is more apt to say they are postponements of the day of reckoning. They bought some time and that may turn out to be a valuable asset, but to delay the inevitable much longer may work against the cause; at least that is what The Economist magazine suggested in a recent editorial. “Restructuring is now more clearly affordable than it was last year,” they say, “It is also surely cheaper for everybody than it will be in a few years’ time. Hence the need for plan B…This newspaper does not advocate the first rich –country defaults in half a century lightly. But the logic for taking action soon rather than later is powerful. First, the only plausible long-term alternative to debt restructuring—permanent fiscal transfer from Europe’s richer core (read Germany)—seems to be a political non-starter. Some of Europe’s politicians favour closer fiscal union, including euro bonds, but they are unlikely to accept budget transfers big enough to underwrite the peripheral economies’ entire debt stock.” Their argument continues, “Second, the dangers from debt restructuring have diminished even as the costs of delay are rising. Eight months ago, when euro-zone governments and the IMF joined forces to rescue Greece, their determination to avoid immediate restructuring made sense. There were reasonable fears that default could plunge Greece into chaos, precipitate bond crises in the euro zone and spark a European banking catastrophe.” However they no longer see the benefit for kicking the can down the road. “At the same time the costs of buying time with loans have become painfully clear. The burden on the countries that have been rescued is enormous. Despite the toughest fiscal adjustment by any rich country since 1945, Greece’s debt burden will, on plausible assumptions, peak at 165% of GDP by 2014. The Irish will toil for years to service rescue loans that, at Europe’s insistence, pay off the bondholders of its defunct banks. At some point it will become politically impossible to demand more austerity to pay off foreigners. And the longer a restructuring is put off, the more painful it will be, both for any remaining bondholders and for taxpayers in the euro zone’s core. The rescues of Greece and Ireland have increased their overall debts while their private debts fall, so that a growing share will be owed to European governments. That means that the write-downs in any future restructuring will be bigger. By 2015 for instance, Greece could not reduce its debt to a sustainable level even if it wiped out the remaining private bondholders.”
It would seem to me that the time to admit the nakedness of the situation could be sooner rather than later and most likely with little warning.
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