Restructure Debts - A Shadow Fiscal Union is not the Way
Each day seems to bring a new idea that proponents claim will get us out of the crisis. No matter which of these policy paths politicians eventually choose they are likely to find it blocked by neither Greece nor Ireland being able to repay all of their outstanding debts. The way out can only be cleared by a decisive restructuring of these debts – the sooner the better.
The EU is at a crossroads. One way is the high road towards a fiscal union and the low road takes us back to each state fending for itself, the paradigm that prevailed before Greece was ‘rescued’. Euro-federalists have suggested everything from minimalist E-bonds to a complete fiscal union. Sceptics have called for kicking troubled countries out of the Euro zone.
Political expediency and economic logic rules out such a break up and political stalemate and public opinion stand in the way of a fully fledged fiscal union. The only feasible option lies in the middle. Since the announcement of the Greek aid package, the EU seems to be moving along this mid-path towards a 'shadow fiscal union'.
The loans provided to Greece, the ECB’s purchase of Euro zone sovereign bonds, the setting up of the European Financial Stability Mechanism (EFSM), have all been gradual steps advancing us in this direction. EU countries have, directly and indirectly, provided or underwritten financial support to troubled member states.
Despite the anger in Germany over the bailout of Greece and now Ireland, fact is that that no German money has been lost, at least not yet. No fiscal transfers have taken place and if politicians are to be believed, none are planned. The money has merely been loaned and that too at a profit making interest rate. The official discourse is that this money will be fully repaid. Since this is highly unlikely, this public stance is irresponsible and probably dishonest.
Fast forward to 2013 when the existing EFSM runs out; by then, a majority of the outstanding Greek and Irish public debt will be owed to or held by the public sector in the EU.
The 1) bilateral loans from Member States 2) loans provided by the European Financial Stability Mechanism (backed by the EU budget) 3) loans provided by the European Financial Stability Fund (backed by Member State guarantees) 4) ECB purchases of sovereign bonds and 5) sovereign bonds held by the ECB as collateral against the provision of liquidity support to troubled banks (both backed by the capital in Euro system central banks and eventually by Member States) will amount to tens if not hundreds of billions of Euros worth of exposure to troubled Member States.
With debt burdens 1.2-1.5 times the size of their economies, growth rates below or close to 1% and skyrocketing borrowing costs, the only choice for Greece and Ireland at this stage would be to restructure outstanding debts by imposing significant haircuts on creditors. Creditor losses are likely to run into tens of billions (hundreds if Spain and Portugal also seek aid) of Euros.
The realization of large taxpayer losses in 2013 will no doubt be a fatal blow to the fast diminishing trust that EU taxpayers have in their leaders. It would also poison member states’ relations with each other, perhaps irreparably. Losses at the ECB will damage its credibility inflicting serious damage to the Euro project. Delaying this inevitable restructuring of debt will also impose punitive and unnecessary deflationary burdens on Irish and Greek citizens. Come 2013 and Germans will be furious at having to foot the large bill and the Irish would be angry at the punitive conditions imposed on them.
The longer we wait, the greater the proportion of creditor losses will fall on EU taxpayers. Moving quickly will not only reduce the aggregate losses by restoring the possibility of growth but will permit a much fairer burden sharing between the private and public sectors. This is the only economically logical and political honest course of action.
That is why Greece needs to use its legislative powers to initiate an immediate restructuring of its sovereign debts and Ireland needs to combine a revocation of the sovereign guarantees for bank bondholders with large scale debt equity swap to recapitalize its banking system. Spain and Portugal may also need to take this course of action.
These are preconditions for moving down the high road towards fiscal union and the unavoidable outcomes of doubling back to take the low road. Otherwise, the project to introduce E-bonds or even just set up a minimalist ESM would be stillborn into an EU torn apart by a loss of trust and mutual recriminations. Decisive action on Irish and Greek debt is the only way to revive the European project.