The Germans are fast picking up support for their Sovereign Debt Restructuring Mechanism (SDRM) — along with new acronyms. So please welcome the ECRM.
Bruegel, a Brussels-based think tank, announced on Tuesday that “one of the main benefits of creating an ECRM would be the public acknowledgement that the default of a government on its debt is a real possibility in the euro area.”
From the paper:
We propose in this paper the creation of a European Crisis Resolution Mechanism (ECRM) consisting of two pillars:
- * A procedure to initiate and conduct negotiations between a sovereign debtor with unsustainable debt and its creditors leading to, and enforcing, an agreement on how to reduce the present value1 of the debtor’s future obligations in order to re-establish the sustainability of its public finances. This would require a special court to deal with such cases…
*Rules for the provision of financial assistance to euro-area countries as an element in resolving the crisis. Should a euro-area country be found insolvent, the provision of financial aid should be conditional on the achievement of an agreement between the debtor and the creditors reestablishing solvency. The task of supplying financial assistance could be given to the [European Financial Stability Facility] provided that it is made permanent and an institution of the European Union…
In fact, the authors (all US and European university professors, in case you’re wondering) outline a pretty straightforward argument for why Europe needs such a mechanism. For a start, they reckon the eurozone can handle defaults of its member(s) provided there’s an orderly — ECRM-ish — way of dealing with them.
… Sovereign-debt resolution involves a combination of fiscal adjustments by the defaulting government on the one hand and, on the other, cutting the amount of debt outstanding, prolonging the maturity of the remaining debt and reducing the interest paid on it. Its main purpose is to return the debtor-country back to a state of sustainable public finances. At the same time, it aims at a fair distribution of the cost of restructuring between the borrower and the creditors … Furthermore, the mechanism must set clear rules for involving the creditors in the crisis resolution, which would give creditors stronger incentives to care about the credit worthiness of sovereign debtors ex ante and thereby strengthen market discipline …
The aim is to reintroduce the concept of ‘risk’ into the sovereign debt market. Make investors really think about the government bonds they’re buying before they buy them.
A ‘fun’ data point that we can throw into the discussion of markets doing due diligence, is the fact that Greek debt was trading much higher than its actual ratings (then around the A1 bracket) would imply as late as 2007 and for much of 2008.
Defaults? Not there.
Back to the paper:
In past international sovereign-debt crises, resolutions were managed by the Paris Club and the London Club. The Paris Club brings together defaulting sovereign debtors and their sovereign lenders to negotiate a solution, while the London Club brings together defaulting sovereign debtors and their international bankers. Neither of these institutions is suited to sovereign-debt problems in the euro area, since most of the outstanding public debt in the euro area is in the form of government bonds rather than bank loans or intergovernmental credit. Hence a new institutional solution has to be found.
As we’ve noted previously, such a mechanism is ages away, as it would require legislative changes. Plus, as Alea mentions, it might not be applicable to older debt.
Still though, we’re going to go ahead and dub this the ‘Berlin Club.’ That has a much nicer ring to it than the EFSF, ECRM, SDRM, or any other EMU acronyms.
Related links:
EU should create crisis mech which allows default: think tank – MNI
The elusive cost of sovereign defaults - World Bank paper
Beyond Europe’s bailout fund – a Q&A - FT Alphaville