A German-led eurozone rescue
By Wolfgang Münchau
Published: January 16 2011 20:51
Not too long ago, the European financial stability facility was greeted as a “shock and awe” strategy to end the eurozone bond crisis. Today, it is considered too small. The European Commission and some member states want to raise its lending capacity. They also want to change its operational rules. At present, the EFSF can give credits only to sovereign governments. It cannot lend to the private sector, it cannot purchase government bonds in the secondary market and the interest rates it charges are too high.
Would a higher ceiling and a wider remit constitute a solution to the crisis? The answer is that this depends on how it is done. The notional size of the entire eurozone rescue package is €750bn. This is made up of €440bn from the EFSF, €60bn from the European Commission and €250bn from the International Monetary Fund. But this is only a number for headline writers. It is not real. Greece and Portugal cannot be expected to pay for Ireland, and vice versa. To obtain a triple A rating, the EFSF has to over-collateralise its lending so that, instead of €440bn, it can lend only €250bn. That reduces the total from all three sources combined to a little over €450bn. Germany has expressed readiness to turn a notional €750bn into a real €750bn, perhaps by increasing the guarantees. That may be just enough to cover a three-year sovereign programme for Ireland, Portugal and, maybe, Spain.
If you add the costs of some of the proposed changes in the EFSF’s operating rules – such as secondary market bond purchases – that ceiling may soon prove insufficient. Not much would be gained by such a decision. The markets would celebrate the agreement for a few days and would test the higher ceiling shortly afterwards.
Such a construction would, over time, turn the EFSF and its successor into the kernel of a European debt agency, and turn the bonds it issues into eurozone sovereign bonds. As a first step there would need to be a much higher lending ceiling – not €750bn, nominal or real, but more like €2,000bn. Second, as Mr Buiter points out, the guarantees would have to be “joint and several” – in other words a joint liability of all eurozone states – as opposed to a collection of guarantees by national governments.
Pooling the bond issues of the European periphery, and allowing the EFSF to guarantee them, would be a big leap indeed. One could go further and endow the EFSF with the ability and funds to recapitalise the financial sector. A few hard-to-understand technical changes and voilà : we have in fact created a European bond and a fiscal union via the backdoor.
As Barry Eichengreen, professor of economics and political science at the University of California at Berkeley, has remarked in a recent article, there are only two principal solutions to this crisis. A messy default by member states, or a German-led bail-out – bail-out meaning actual money paid, not the seemingly cost-free EFSF guarantees so far granted. These two solutions correspond to the two EFSF models. A widening of the EFSF’s role as just described would effectively amount to a German-led bail-out. The alternative, a more modestly-sized EFSF, preferred by Germany, would probably end, later, in a messy periphery default, followed by a eurozone-wide banking crisis requiring recapitalisation.
It is not clear that the small EFSF/default option would be cheaper. On the contrary, for the system as a whole it would probably be more expensive and riskier. But for national governments it might be politically more expedient, because the inevitable transfer occurs inside the country – from the government to domestic banks – as opposed to cross-border. Of course, no matter which option is pursued, Germany ends up paying.
I fear we are heading towards the small EFSF/default solution. The German political and legal establishment may not intend to damage the eurozone, but they are prioritising limited liability. The recent alarmist essay by Otmar Issing, former chief economist of the European Central Bank, responding to rather modest joint economic governance proposals, is typical of the reaction Angela Merkel can expect if she were to move down the road of joint and several liability. The German chancellor takes a pragmatic approach but, given the political opinion in Berlin and the legal constraints, she is not going to take the kind of risks a genuinely expanded EFSF would entail.
So we will end up with a moderately larger financial umbrella, austerity, more austerity, and ultimately a messy default and more banking crises. A comprehensive crisis-resolution strategy remains elusive, despite claims to the contrary..*www.nber.org/~wbuiter/DoN.pdf
munchau@eurointelligence.com
Would a higher ceiling and a wider remit constitute a solution to the crisis? The answer is that this depends on how it is done. The notional size of the entire eurozone rescue package is €750bn. This is made up of €440bn from the EFSF, €60bn from the European Commission and €250bn from the International Monetary Fund. But this is only a number for headline writers. It is not real. Greece and Portugal cannot be expected to pay for Ireland, and vice versa. To obtain a triple A rating, the EFSF has to over-collateralise its lending so that, instead of €440bn, it can lend only €250bn. That reduces the total from all three sources combined to a little over €450bn. Germany has expressed readiness to turn a notional €750bn into a real €750bn, perhaps by increasing the guarantees. That may be just enough to cover a three-year sovereign programme for Ireland, Portugal and, maybe, Spain.
If you add the costs of some of the proposed changes in the EFSF’s operating rules – such as secondary market bond purchases – that ceiling may soon prove insufficient. Not much would be gained by such a decision. The markets would celebrate the agreement for a few days and would test the higher ceiling shortly afterwards.
But there is a way to construct the EFSF so that it could be part of a genuine solution to the crisis. There are some influential people in Brussels who have been working out the details. Willem Buiter, chief economist at Citigroup, also dissected this option in his most recent paper* on the subject – possibly the best analysis so far about the short and long-term economics of this crisis.
Such a construction would, over time, turn the EFSF and its successor into the kernel of a European debt agency, and turn the bonds it issues into eurozone sovereign bonds. As a first step there would need to be a much higher lending ceiling – not €750bn, nominal or real, but more like €2,000bn. Second, as Mr Buiter points out, the guarantees would have to be “joint and several” – in other words a joint liability of all eurozone states – as opposed to a collection of guarantees by national governments.
Pooling the bond issues of the European periphery, and allowing the EFSF to guarantee them, would be a big leap indeed. One could go further and endow the EFSF with the ability and funds to recapitalise the financial sector. A few hard-to-understand technical changes and voilà : we have in fact created a European bond and a fiscal union via the backdoor.
As Barry Eichengreen, professor of economics and political science at the University of California at Berkeley, has remarked in a recent article, there are only two principal solutions to this crisis. A messy default by member states, or a German-led bail-out – bail-out meaning actual money paid, not the seemingly cost-free EFSF guarantees so far granted. These two solutions correspond to the two EFSF models. A widening of the EFSF’s role as just described would effectively amount to a German-led bail-out. The alternative, a more modestly-sized EFSF, preferred by Germany, would probably end, later, in a messy periphery default, followed by a eurozone-wide banking crisis requiring recapitalisation.
It is not clear that the small EFSF/default option would be cheaper. On the contrary, for the system as a whole it would probably be more expensive and riskier. But for national governments it might be politically more expedient, because the inevitable transfer occurs inside the country – from the government to domestic banks – as opposed to cross-border. Of course, no matter which option is pursued, Germany ends up paying.
I fear we are heading towards the small EFSF/default solution. The German political and legal establishment may not intend to damage the eurozone, but they are prioritising limited liability. The recent alarmist essay by Otmar Issing, former chief economist of the European Central Bank, responding to rather modest joint economic governance proposals, is typical of the reaction Angela Merkel can expect if she were to move down the road of joint and several liability. The German chancellor takes a pragmatic approach but, given the political opinion in Berlin and the legal constraints, she is not going to take the kind of risks a genuinely expanded EFSF would entail.
So we will end up with a moderately larger financial umbrella, austerity, more austerity, and ultimately a messy default and more banking crises. A comprehensive crisis-resolution strategy remains elusive, despite claims to the contrary..*www.nber.org/~wbuiter/DoN.pdf
munchau@eurointelligence.com
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Copyright The Financial Times Limited 2011.
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