A BRADY PLAN TO END EUROPE´S CRISIS / THE FINANCIAL TIMES EDITORIAL ( A MUST READ )

Editorial

July 3, 2011 10:01 pm

A Brady plan to end Europe’s crisis


Not for the first time, the leaders of Greece and of the eurozone have stepped back from the brink only after taking too long a look down the precipice. With the clock ticking toward a Greek default, Europe found the fig leaf of private creditor sacrifice it needed to commit to more loans. The Greek government passed a new austerity plan, but not before eroding the little trust it still enjoyed at home and abroad.


The eurozone must stop putting its peoples, economies and financial markets at the mercy of last-minute fixes. Debt markets’ ostracism of Greece and two other countries will not be reversed by buying time. The monetary union now needs an ambitious and comprehensive solution: it should commit to a Brady plan for Europe. A debt swap with guarantees, based on the policy that ended Latin America’s debt crisis, is the best option.


Europe’s sovereign debt crisis is most obviously rooted in the Greek state’s reckless borrowing and failure to reform. But it reflects market failure, too. Financial markets turn on self-fulfilling beliefs: even if Greece has a fighting chance to overcome its debt burden if it can refinance at modest interest rates, that is not a chance uncoordinated bond investors will grant it. Hence the need for official lenders to step into the gap, as they have done – but too timidly to trust that they will do “whatever it takes”.


Devising a better plan requires the right diagnosis of the current one. Structural reform and privatisation are both bogged down. But Athen’s deficit-cutting is an undeniable success: the primary deficit fell by 7 per cent of output in 2010. It is not impossible to stabilise and eventually reduce Greece‘s debt burden. Those who complain austerity is strangling the economy should bear in mind that Athens would have to cut even faster without the aid programme.


Where the rescue has failed dismally is in the market. Investors will not lend to Athens at any tolerable rate. And the rescue precipitated rather than prevented contagion. Europe must finally make it a priority to reopen the market for peripheral debt. That means no brinkmanship with disorderly default and no forced restructuring until all alternatives have been exhausted – not least since whatever solution is chosen for Greece will immediately be seen as the endpoint for Ireland and Portugal.


That leaves a Brady-like plan as the best policy. The original Brady plan had Latin American countries undertake economic reforms in return for loans with which to buy US Treasuries. These were used as collateral for Brady bonds: securities offered in exchange for loans they could no longer service. The banks faced a choice of bonds, some with hair cuts, others with the principal intact but longer maturities. Debtors secured lighter payment schedules, while creditors were compensated with more liquid and secure assets than before.


A eurozone Brady plan could look as follows. First, Greece and its partners agree on a long-term fiscal path to sustained primary surpluses. Second, in exchange for outstanding bonds Athens offers a new series to fit the fiscal path, smooth out redemptions, and give a choice between maturity extensions and face value reductions. Third, the eurozone ends its rescue loans, instead providing collateral for Greek bonds. The easiest way is for the European financial stability facility to issue zero-coupon bonds and lend them to Athens, which posts them as collateral for Brady bonds of similar maturities.


Such a plan has the most to offer both Greece and investors. Brady bonds will be rated similarly to the collateral – and the European Central Bank can accept them even if not – so banks can hold them to long maturities. This can save Greece’s moribund banking system and end contagion to other banks at a stroke. Some bondholders – certainly those who bought Greek debt on the cheap – will take hair cuts in return for liquid bonds. A well-designed debt swap could lock in current market discounts for Greece’s benefit. Tying interest rates to growth rates would align Athens and its creditors further.


The main obstacle is political. Lending collateral to Greece may not contravene the letter of the EU treaty, but it is a guarantee. Current policy exposes the eurozone to Athens‘ debt already, but a Brady plan would make it explicit. There are political advantages: no cash would be sent to Athens, unlike now. Debt swaps – especially with principal reductions – could honestly be presented as private sector participation. Still, it is a formidable political sales job; all the more after a year of wasted trust and time. Europe’s leaders must either muster the necessary statesmanship or face the political burden of explaining why it all went wrong.


Copyright The Financial Times Limited 2011.