Common Currency in Trouble What Europe Should Do about the Euro Crisis
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.
Domestic banks must not be plunged into anymore turmoil; citizens should be spared direct losses. Instead, governments are offering credit to floundering countries using taxpayer money. "Buying time" is how experts refer to the strategy. Governments are doing it in the hope that Greece and Co. will have made enough of an economic recovery in a few years to be able to pay back the money. This method could also be called delayed bankruptcy.
The principle of hope simply won't work. The Greek and Irish mountains of debt have become so high that none of the experts believe in a punctual repayment. Already, almost furtively, the credit extended to Greece has been extended from an initial three years to seven-and-a-half.
The governments in Athens and Dublin are currently in the process -- under pressure from their rescuers -- of instituting drastic, potentially ruinous, austerity measures. They will pay 5 percent interest on the money they receive from the euro fund -- much more than donor countries like Germany do for their sovereign bonds. And of course they have to pay it back. "With what exactly?" asks a top German banker. "With olives?" The Irish, absurdly, are taking on loans this year worth one third of their economic output. Greek national debt will climb from 140 percent of the gross domestic product today to about 156 percent in 2012 -- and that's despite desperate budget cuts that are tearing the country apart.
The Check is on the Table
Even the bankers -- who it seems are to be protected from a general debt restructuring and any fresh pressures -- doubt that this is the correct strategy. Andreas Schmitz, president of the Association of German Banks and head of the bank HSBC Trinkaus & Burkhardt says: "The check's on the table. The question of who's going to pay is still open." To the question of whether the governments would be better advised to let creditors such as banks and insurance companies foot some of the bill as well, Schmitz says: "Private banks are fundamentally in favor of such a concept."
It would indeed be more reasonable if governments were to negotiate debt rescheduling packages together with the banks of each of the individual countries. There are well established procedures for this, and no new regulations would be required. If such a haircut would burden individual financial institutions in the donor countries so much that they faced bankruptcy, then they must be closed up. For those banks whose failure would threaten the entire financial system, the state may have to jump in -- and become a stakeholder.
This may not be a great prospect, but it is a solution that doesn't just shift European debt problems into the future -- rather it solves the problems here and now. Instead of the current practice of issuing new, and new kinds of, debt -- an increase and extension of the euro rescue fund is already under discussion -- the bill would instead be settled in full. This is a lesson for the future, and Angela Merkel is right: both donor and taxpayer must bear responsibility when credit goes bad.
Putting an End to the Confidence Crisis
Such a mechanism would not mean that debtor countries could no longer borrow on the financial markets or that they must pay fantastically high rates to do so. Clearly it is this fear that is causing the majority of euro-zone states to vote against such debt rescheduling.
The difference between what more stable governments must pay in interest versus the more shaky countries is at a record high -- even though European finance ministers promised that all these debts would be paid in full. And even though the European Central Bank is diligently buying bonds, the original sin, comparable to printing money. Financial professionals are deeply skeptical.
If the slate were wiped clean, if rescheduling were to include the involvement of private lenders, there may be some hope of ending this crisis of confidence. And then the euro could once again regain the respect that it needs -- provided that governments finally put an end to their unspeakable debt spiral.