As the euro crisis will enter its final stages in 2011, and the debate on how to end it will heat up, I thought it important to update the Modest Proposal, in preparation for the debates to come. Click here for a copy.
The main difference from the last version concerns the first step: Rather than suggesting a tripartite agreement, following a meeting between representatives of indebted states, insolvent banks and the ECB, the Modest Proposal now suggests something simpler: The ECB makes continuing support of the banks conditional on them accepting an immediate haircut on the member-states’ debt. No negotiations, no delays, no ifs and no buts. Another difference is extra clarity regarding the role of the EIB and, lastly, a crispier (I hope) preamble. Let 2011 see a rational solution implemented, along these lines or perhaps alternative lines that someone else may sketch. Anything but the current madness will do.
Two additional questions:
1. Are sovereign spreads relevant to your plan? The various euro-zone countries will have different bund spreads at the time that your plan is enacted. Therefore, some countries will receive a larger subsidy than others.
2. How will you know when your plan will make economic sense to the core EMU policy makers? Are you watching, for example, the bund curve as a gauge of fear over the EMU and a proxy for the opportunity cost of your proposal?
Yes Mark, sovereign spreads are relevant because, even if the Modest Proposal is adopted, countries like Greece, Italy, Belgium will be left with large numbers of bonds that the ECB will not take over and which the member states will need to service. Moreover, those countries will have to issue bonds beyond the Maastricht-compliant level just in order to finance their day to day business. It is, therefore, important that they have access to the money markets at decent interest rates. My hope, indeed my conviction, is that the two first steps of the Proposal will lower the total size of Europe’s debt to such an extent that the spreads will shrink inexorably.
Turning to the second question, what I am watching is (a) the interest rates on Spanish bonds and (b) that which officials like Olli Rehn and politicians like Yuncker are saying. As long as the former remain high, and are getting higher, and the eurozone’s decision makers are constantly edging closer (as they are doing) to the idea of an overall debt restructure and non-synthesised euro-bonds, my optimism grows. Additionally, quite a few former EU leaders (including an ex Prime Minister of Italy, an ex President of Portugal etc.) have adopted the Proposal. Recently the current Greek Prime Minister too explicitly adopted signficant segments of our Proposal (e.g. spoke of the need to issue eurobonds and to use them in the context of large scale EIB-funded investment projects). My complaint is that he did not say so in the Summit but reserved it for a briefing with a Greek newspaper – quite lame, I fear…
If the banks take a haircut on sovereign debt holdings, won’t that decrease the value of the banks’ ECB-eligible collateral? I thought that the amount of ECB-eligble collateral held by Greek banks was already dangerously low. Or would this be a non-issue once the ECB support is available?
Also, is the private placement of Spanish bonds a sign that the crisis has finally reached Spain? Ireland and Portugal made the same desperate decision.
http://www.bloomberg.com/news/2011-01-11/spanish-stocks-acciona-bbva-duro-shares-move-in-madrid-trade.html
Sure, in principle, if the banks take a haircut the value of the collateral held by the ECB will diminish. But, do not forget that the ECB has already factored in at least 30% of a haircut. Moreover, many banks are now drawing loans and liquidity from the ECB without any serious collateral – they have run out of bonds (e.g. at least one Irish bank). So, as you implied, the ECB was forced long ago to provide liquidity without receiving collateral of note in return. A haircut by the banks, in this sense, is the least the ECB can impose on them. Lastly, you are right about Spain. Though not in the eye of the storm, strong winds are already blowing its way.