Common Currency in Trouble What Europe Should Do about the Euro Crisis

Euro-zone members will have to take radical measures to tackle its current currency crisis. Europe needs a far-reaching debt restructuring mechanism -- but strangely, politicians have shown a preference for issuing yet more mountains of debt.

Doubts are growing as to whether the euro has a future.

Doubts are growing as to whether the euro has a future.

The euro has never been popular with Germans. But now that they might have to atone for the financial sins of other EU countries, the number of euroskeptics has been swelling dramatically.

German Chancellor Angela Merkel would warmly welcome a chance to provide a bit of relief on the domestic front. The way to do so is through something the experts call "creditor liability." In layman's terms, it means that the scoundrels from the banks that lent all the money to the severely cash-strapped EU member states should bear some of the pain resulting from any defaults.

Merkel has publicly stated that the euro zone should no longer be a "land of milk and honey" for the financial institutions that cashed in on high interest rates from their loans without being held responsible when things collapse.

But, as we all know, that won't happen. Once again, Berlin has gone to Brussels and failed to push anything through, not against the alleged friends from France and not against the rest of the Europeans. The banks are apparently now only going to have to help bear the costs in "extreme cases," involving downright insolvency. If it is simply a matter of the countries having problems servicing their debts, the banks are supposed to be "encouraged" to hold on to the government bonds of high-debt nations a little longer.

With this decision, Europe is continuing to pile new debt on top of old, is letting itself sink deeper into a mire of debt, and is just putting off steps that will be unavoidable in the future. The end result will be that when the crash finally does come, it will be all the more devastating.

You Can't Liquidate a Country

The first step shouldn't be laboriously putting together an insolvency mechanism for state governments like the one that the members of the ruling parties in Berlin have been demanding for months. What would it look like, anyway? Countries are not companies. When the latter can't make their payments, one of two things happens: Either the creditors make some write-offs, and the companies carry on with an adjusted balance sheet. Or, if there really isn't anything that can be converted into cash, they are "liquidated" -- which is just a pretty way of saying that the company is dead.

But you can't liquidate a country. Unlike the equipment or real estate of a company, a country's assets can't be turned into cash. German law says as much. Section 12 of our Insolvency Statute states that "insolvency proceedings may not be opened for the assets owned by federal or state governments." A 1962 decision by Germany's Federal Constitutional Court found that "a country is not capable of going bankrupt."

Thus, even if the governments of all the EU member states agree, there will be no insolvency law for states that would be in any way comparable to company bankruptcy proceedings. The only thing that can happen is the following: Countries that have run up excessive debts will have to settle those debts and streamline their economies. In fact, for several EU member states, doing so is absolutely unavoidable.

Restructuring at the Paris Club

One vehicle for accomplishing this goal is called "restructuring," which has become a fairly standardized procedure. Since 1956, there has been something called the Paris Club. Though it is housed in France's Ministry of Finance, the informal club is not ruled by any regulations or bylaws. In this forum, state creditors can negotiate their claims with debtor countries that are having trouble paying back their loans, particularly ones from the developing world. As the club's website boasts, since its founding, "the Paris Club has reached 419 agreements with 88 different debtor countries." The counterpart for similar activities between private lenders and states is the so-called London Club.

When a country's coffers are bare, these institutions serve as mediators for determining how things should move forward. In recent years they have responded to Argentina's de facto state bankruptcy as well as to the crises in Asia and South America. In what are usually very painstaking negotiations with a whole cadre of creditors, debtor countries agree on: Whether interest payments can be temporarily suspended and, if so, for how long; how far payments can be pushed back (via a so-called "moratorium"); or -- in the most extreme cases -- whether the amount to be repaid can be reduced by a certain percentage (in what is called a "haircut").

Why can't Europeans agree to undergo such a well-established procedure? When all is said and done, neither Greece nor Ireland is in any better condition than some of the developing countries that have been forced to go to Paris or London to submit to this somewhat shameful treatment. Why are EU governments even shying away from establishing such a procedure to govern future crises -- crises involving bonds not even sold yet, one where lenders will know exactly what they're getting into? And why is it that, instead of doing this, they further burden their euro-zone partners, who have already created an unimaginable €750 billion ($1 trillion) euro rescue fund to take on additional debt that might never be paid back?

Hope is not Enough

Once again, European politicians are solely focused on a finding a short-term solution to the crisis. They are afraid that creditors could mercilessly punish financially stricken countries if they have to restructure their debt and withhold all further credit. Or that such countries would be force to pay exhorbitant interest rates, making the loans virtually impossible to pay back. Mostly, though, politicians are fretting over their domestic banks and insurance companies which have large amounts of Greek state bonds or Irish bank stocks on their books and who might be forced to write down billions.

Such losses would, incidentally, hurt both speculators in the banks' high-rises and many ordinary citizens. People like you and me, people who have parked their savings in supposedly safe retirement accounts, who have opened life insurance policies or who have invested their retirement money in pension funds. All of these institutional investors have been eager purchasers of Irish, Portuguese and Greek sovereign bonds.

The fact is that, before the financial crisis and the Greek debt crisis, no one would have even imagined these borrowers couldn't pay back their debts. Even professionals in the banks and insurance houses couldn't have known that Athens had grossly misstated its deficit. For these bonds, there were no risk premiums of five or more percentage points vis-à-vis German sovereign bonds as there are today. Instead, it was just one or two percentage points.


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