The crisis of the single currency is political as much as financial
ANYONE struggling to understand why Europe has proved incapable of putting an end to the euro’s crisis might find answers in a bad-tempered dinner at a summit on October 28th 2010. The argument was over a demand by the leaders of Germany and France, made days earlier at Deauville, for a treaty change to create a permanent system to rescue countries unable to pay their debts. Everyone groaned. It had taken years of tribulation to agree on the European Union’s Lisbon treaty, which had only recently come into effect. But they bowed to Angela Merkel, the German chancellor, who wanted to prevent any challenge to the new system by Germany’s constitutional court.
However, Jean-Claude Trichet, president of the European Central Bank (ECB), worried about something else: her demand that future bail-outs must include “adequate participation of private creditors”, meaning losses for bondholders. That could only alarm the markets, he thought, still jittery after the Greek crisis in the spring. “You don’t realise the gravity of the situation…” began Mr Trichet. But he was cut off by the French president, Nicolas Sarkozy, who interjected, one Frenchman to another: “Perhaps you speak to bankers. We, we are answerable to our citizens.” Mrs Merkel chimed in: taxpayers could not be asked to foot the whole bill, not when they had just paid to save the banks.
The politicians won the day. But Mr Trichet’s worries have also been vindicated, as contagion has spread and is now engulfing Italy. The dinner-table row illustrates how, throughout the sovereign-debt crisis, the requirements of financial crisis-management have collided with political, legal and emotional priorities. Indeed, the euro’s woes are as much about politics as about finance. European officials such as Mr Trichet parrot that the euro zone’s overall debt and deficit are sounder than America’s. Yet Europe lacks the big federal budgets and financial institutions to redistribute income and absorb economic shocks. And it has no single polity to mediate tensions within and between member countries. It is hard enough to get Californians to save Wall Street bankers; no wonder Germans bristle when they are asked to rescue Greek bureaucrats.
But Europe’s politicians cannot blame everything on their lack of tools. Their inconsistency, even incoherence, over getting creditors to pay has done much to spread contagion. Their first emergency loans imposed tough conditions on Greece, but none on the bankers. Indeed, the creation of a big bail-out fund was meant to make default unthinkable. At Deauville, though, Mrs Merkel and Mr Sarkozy wanted default to become a possibility: current debt would be safe, they said, but leaders later agreed that from 2013 countries should issue new types of bonds that could be more easily forced to take a hit if a country ran into trouble. Now Greece needs another rescue, default is nearer and the Germans and Dutch, threatening to stand in the way, want private creditors to contribute right away. This has led to an open dispute with Mr Trichet, who says even the mildest of debt rescheduling risks an upheaval comparable to the collapse of Lehman Brothers; he has threatened, if there is any sort of default, to cut off credit to Greek banks—pushing many into bankruptcy. Is it any surprise that investors are fleeing vulnerable euro-zone bonds?
To cap it all, in talks with Greece’s creditors euro-zone countries have spent the past few weeks pursuing contradictory aims. At the behest of Berlin and The Hague, they sought a “substantial” contribution by bondholders, but to satisfy the ECB in Frankfurt, this would have to be “voluntary”—as if someone would willingly take a large loss when a smaller one is on offer. Finance ministers in Brussels this week more or less accepted a “selective default”, so long as it is short-lived (no longer than a few days) and does not trigger a payout on credit-default swaps (a form of insurance against default). To ease the burden on Greece, ministers seem ready to lend it money to buy back existing bonds, and to lower the interest rate they charge on loans.
This deal may not come cheap. Depending on the degree of coercion, private creditors will give up at most €30 billion ($43 billion) for Greece’s financing needs to 2014. But officials say that merely to lower Greece’s debt-to-GDP ratio to that of heavily indebted Italy, the unofficial goal, would require a sum several times bigger. Ireland and Portugal may need similar treatment.*
Think bigger and bolder
There are good reasons to make the private sector pay. Taxpayers should not bear the whole cost of bondholders’ losses—after all, investors received higher returns for their risk-taking (if not high enough). But the present policy brings the worst of both worlds: too little money from creditors to make a big difference to Greece, too much turmoil to make the effort worthwhile.
Explore our interactive guide to Europe's troubled economies.It is time to think differently. If there is to be a default, then it might as well be a big one, with a large haircut on creditors that gives Greece relief and a greater chance of recovery. Even then, Greece will need help for years to come. And some banks will have to be recapitalised. One useful means of allaying the panic might be for euro-zone countries to issue part of their debt as joint bonds. Jointly guaranteed bonds sold to raise money for the current bail-out funds are being eagerly snapped up by investors.
This may make financial sense. But the near-insurmountable obstacle is, as always, political: there is huge resistance to what would become a more overt “transfer union”. In a group of democracies, where big decisions are taken by unanimity, consensus is hard to come by and takes time. Hence, leaders have acted only in the face of impending disaster, and then with half-measures. Markets operate on a faster timetable. They will not wait for Europe’s leaders, like Churchill’s Americans, to do the right thing after having exhausted all the alternatives.
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* Interactive guide
* Interactive guide
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