Time for EU to wake up and embrace default. Bailouts happen when countries cannot raise debt at reasonable costs. In other words, they are temporary liquidity fixes. But larding new debt on top of old debt does not improve solvency. It makes it worse.
Time for EU to wake up and embrace default
ERIC REGULY - The Globe and Mail
A new financial revolution is gripping the European Union and its main product is delusion.
When the financial crisis hit in 2008, the EU deluded itself into thinking the weakest countries could avoid bailouts. Today, the EU is deluding itself into thinking the bailed-out countries, present and to come, can avoid restructuring their debt. They cannot, which does not mean their finance ministers will force bondholders to take losses in the near term. For that you can blame politicians bent on delaying the inevitable.
Greece and Ireland had to be bailed out last year, and Portugal pushed the “help me” button Wednesday. It has been clobbered by a failed austerity vote in parliament, a collapsed government, a series of debt downgrades and painfully high bond yields of almost 10 per cent.
Sovereign bailouts, care of the EU and the International Monetary Fund, are awkward beasts that both help and hurt. Bailouts happen when countries cannot raise debt at reasonable costs. In other words, they are temporary liquidity fixes. But larding new debt on top of old debt does not improve solvency. It makes it worse.
Look at Greece and Ireland. In spite of their bailouts, aggressive spending cuts and efforts to make their economies more competitive, the undynamic duo continue to pile on debt and are doing so as interest rates are set to rise (the European Central Bank is expected to boost rates by a quarter percentage point on Thursday because of above-target inflation).
According to the European Commission’s latest economic forecast, published in the late autumn, Greece’s national debt, as a percentage of gross domestic product, is expected to reach 156 per cent by 2012, up from 127 per cent in 2009; Ireland’s to 114 per cent from 65 per cent; and Portugal’s to 92 per cent from 76 per cent (a pre-bailout estimate). The euro zone’s average for 2012 is forecast at 88 per cent.
How will they pay off these mountains of debt? It seems impossible when almost nothing is going in their favour.
The economies of Greece and Portugal are expected to shrink this year and Ireland could go either way. All three have unemployment rates in the teens, well above the euro zone average. All three have austerity packages that threaten to prolong their recessions or keep a tight lid on growth. Rising oil prices will damage their recoveries. In Ireland, the banks are money-sucking zombies. In Greece, social unrest could flare up at any moment (again) as entitlements disappear. In Portugal, little has been done to make its perennially sluggish economy more competitive.
The three countries are effectively bankrupt. That is what the bond market is telling us. The expectation that their debts will have to be restructured keeps their bond yields at unsustainable levels, making it all the harder to pay off their debts.
So why not restructure and get it over with? Because the politicians are terrified that a default, followed by a restructuring (“haircuts” to bondholders, to use investor argot), would deliver a crippling blow to Europe’s weakest banks, potentially giving birth to Son of Financial Crisis.
In a note published this week, Nomura Securities estimated that the restructuring of Greek, Irish and Portuguese debt alone would result in direct and indirect losses of $240-billion (U.S.) for euro zone banks. The figure would rise to $480-billion if the restructuring were to include Spain, the euro zone’s fourth-largest economy.
The German banks are heavily exposed to the four countries, Nomura said. If the debts of the four were to be restructured, it would cost the German banks $185-billion, equivalent to a third of their total capital. “Ultimately, German and French government balance sheets have the capacity to fund bank recapitalizations resulting from losses linked to peripheral debt restructuring,” Nomura said. “Whether this is politically feasible is a different matter.”
Indeed. Germany, with the European Central Bank at its side, has opposed debt restructurings, at least until mid-2013, when a new, permanent bailout fund is to be launched. There is no way German Chancellor Angela Merkel would bear the political risks of sovereign restructurings before the German national elections in the same year. That explains her preference to fund bailouts.
Too bad. While German (and French) banks would take a hit if the weakest euro zone countries were to restructure their debts, the damage would be far from fatal. Some of the banks are still weak, but most are far stronger than they were two years ago and would survive. Spain’s turnaround is in place; it seems unlikely to vanish in the debt sinkhole.
Debt restructurings now will cost less than debt restructurings in two or three years, when Greece, Ireland and Portugal will be drowning in loans they can’t pay off. If the restructurings are inevitable, the sensible thing to do is end the delusions and get them over with |
