Idea No. 1, from ECB board member Lorenzo Bini Smaghi:
More generally, this crisis has shown the vulnerability of public finances to volatile structures in the economy. In good times, volatile sources of income, such as those from the financial sector or the housing market, may overestimate the soundness of public finances, while the adjustment costs in the downturn may be enormous. A case in point is that of Ireland…
Surveillance has clearly failed to understand this phenomenon. More attention needs to be paid to the overall size and interconnectedness of the financial sector as a whole in the various countries, and to the ability of these countries to absorb shocks affecting not only a single financial institution but the whole financial system. It is now fashionable to stress-test the banks. It would probably be appropriate to stress-test countries as well.
Which is interesting, but odd.
If Ruritania fails its stress test, what happens? Recapitalise it, we’d suggest, although we’re not sure with what, exactly: fiscal transfer from other states looks like a good idea, if it’s a currency union member.
But this hasn’t generally been very popular in the real world. And we don’t even want to go into what happens if the stress test shows that the entity concerned is best off being wound down.
A better idea for now, we think — make sure Europe’s latest stress tests (launched on Friday) strip out sovereign support for banks, ie via guarantee schemes. A case in point is that of Ireland…
Idea No.2, from Naomi Klein via the BBC’s Paul Mason:
Greek trade unions, academics and politicians issued a call to set up a Public Commission to examine their debts. It’s the first ever call for a Debt Audit in Europe…
The idea of a Debt Audit is inspired by movements in highly indebted developing countries. In 2007, President Correa of Ecuador established a Debt Audit Commission claiming his most important debt was to the people of Ecuador. In 2008, the Commission reported that Ecuador’s debts had caused “incalculable damage” to the people and environment of that country.
The Audit encouraged Correa to default on some of Ecuador’s bonds which the Audit found had been contracted illegally – and ultimately resulted in a write-down that saved the country billions of dollars in repayments.
A debt audit — interesting and not at all odd, given the continued questions over off-balance sheet sovereign exposure (whether it’s Greek securitisations or Irish bank liabilities).
But a post-audit repudiation or declaration of debt as odious because there is simply too much of it is just odd. Odious, actually.
(Klein’s is a very baggy understanding of how odious debts work. The odium is all about debts illegally imposed on populations by dictators or war. Here’s a 2006 paper that explains the concept well, by authors who have since turned to the practicalities of restructuring Greece. Key here is the idea that international tribunals are those who can best judge which debts are odious.)
So, beware declaring sovereign debt to be odium.
Especially when it comes to comparing Greece in 2011 to Ecuador in 2007. Ecuador already lacked any real market access when it opted for default, timed its cash-for-bonds exchange very well (as Felix explained back in 2009) and Correa had given two years of warning.
Greece doesn’t have cash; it doesn’t have time; and it really wants market access to be maintained. Furthermore, given who is holding Greece’s paper and how much of that paper there is – it’s a banking crisis, not a sovereign one.
Accordingly, any restructuring is going to be bonds retired in exchange for more (and hopefully more sustainable) bonds. Short of a total blow-up.
In that case, it really is time to talk about collateralisation, no?
Related links:
ECB wants to unload PIIGS bonds - Der Spiegel
Eurozone bond buybacks, unmoored - FT Alphaville
How to save the eurozone, by JPMorgan – FT Alphaville
Europe’s stress test was RIGHT – FT Alphaville