Abstract
When the Greek crisis exploded in the spring of 2010 the eurozone countries collected funds to refinance Greece’s debt in order to stave off a banking crisis. Later Ireland and Portugal asked for similar eurozone assistance. Because refinancing (bailout) was not sufficient to enable these peripheral countries to solve their debt problems, they agreed to implement austerity programs so that they could use eurozone countries’ public funds. But these austerity measures, even if politically affordable, will not suffice. It is exceedingly possible that the peripheral countries will not outgrow their problems and will be unable to return to capital markets at their pre-crisis levels. Their debt-to-GDP as well as debt services-to-income ratios are likely to grow and additional debt reorganization programs including debt reduction (haircut) will be required. At the heart of the issue is the potential impact of a reduction of the peripheral economies’ debt on the monetary financial institutions of all European Union countries. As a result of the restructuring and partial debt reduction, banks may need to receive public support. To address these problems a new solution in the form of the European Stability Mechanism (EMS) has been proposed. It is expected to change the way in which the eurozone functions. However, the EMS idea is based on the same philosophy as the existing bailout instruments. It does not address the equal treatment and moral hazard issues, while the conditionality programs proposed so far have not softened the adverse impact of the growing debt burden on the economic performance of the debt-laden countries. The entire European Union financial system is at risk and remains vulnerable as long as the refinancing mechanisms are not supported by debt restructuring and reduction. Debt managers do not seem to know how to draw on past experience and so ad hoc measures prevail. To effectively manage that kind of debt reorganization, the European Union should create the necessary procedures to efficiently address the economic future of all heavily indebted economies. The EU should also be prepared politically to accept the costs of debt reduction or of a fundamental reorganization of the eurozone.
Highlights
Differences between the treatment of external and domestic debt; seniority and the selection of priority of bond holders; and the interconnection between sovereign and private debt [Hornbeck, 2004]. Some of these problems can be only partially solved by using collective action clauses (CAC) standards [Haldane at al., 2004]
It should be kept in mind, that the ultimate success of a bailout depends upon the continuous availability of sufficiently large resources and the correctness of the adjustment programs which should be implemented in the debtor countries and which should lead to their sustainable GDP growth
Ireland’s total bank assets as a percent of GDP soared from 360% in 2001 to 705% in 200714. French banks grew their books by 60%, Spanish banks were similar and Italian banks were up by 50%.During the last 10 years the bank of eurozone exposure to the PIGS rose from EUR 200 billion to ca EUR 1144 billion
Summary
It is harder to be objective in applying the solutions of debt restructuring and reduction when the country is large and/ or systemically important In these cases there is a political tendency to consider the country as “illiquid” rather than “insolvent” as it is easier to explain why public money is involved in the bailout process. It is difficult to argue against the principle that investors in bonds issued by sovereign governments should suffer haircut if the government cannot redeem its bonds This would represent a “bail-in” as opposed to a bailout (where banks and bondholders are paid total amounts due at the expense of the public sector). Some of these problems can be only partially solved by using collective action clauses (CAC) standards [Haldane at al., 2004]
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