Back where we started?
Euro-zone leaders took some measures last week to save their currency. But the deal agreed at the EU summit rests on some heroic assumptions. Moreover, with the confusion over figures and formulas that arose in its wake, citizens have again been left with a worrying feeling that politicians do not quite understand what they have signed up to.
The deal contained three main elements:
- reduced interest rates on the bail-out loans to Greece, Ireland, and Portugal;
- some losses for private investors to reduce Greece’s debt; and
- a transformation of the euro zone’s temporary bailout fund, the EFSF, into a cash-point that banks and possibly Spain and Italy could tap, but so far without the necessary funds.
In addition, euro-zone leaders finally came back to reality by accepting that Greece will enter some form of default—a “restricted default”—given its huge debt mountain; and one has to ask whether Ireland can be far behind.
These outcomes appeased the financial markets for something less than a week. So, the euro-zone crisis is far from over.
For starters, the deal is a huge political gamble on the willingness of taxpayers throughout the euro zone to continue to underwrite other countries’ debts. By expanding the scope of the EFSF the agreement is providing greater avenues through which risk can be transferred from private-sector bond-holders to taxpayer-backed institutions. In fact the deal hints at nothing short of unlimited bail-outs, which means that the EFSF has to be radically increased in size to serve as a credible backstop.
This may sit well with investors who will continue to see their losses socialised, but convincing Dutch, Finnish, German, Slovak or even French taxpayers (under the agreement the French government could face higher borrowing costs than those it is bailing out) to provide not billions but trillions (think Italy’s €1.8 trillion bond market) in loan guarantees to struggling banks and governments around Europe—a mighty task indeed.
Despite the likelihood of a Greek default being declared, the president of the European Central Bank, Jean-Claude Trichet, came out in support of the package, saying, “Everything has been set up in order to face any eventuality,” although he refused to “pre-judge” the issue of a Greek default. Speaking after the summit the French President, Nicolas Sarkozy, said the package agreed for Greece is “an exception,” stressing that similar deals will not be forthcoming for Ireland and Portugal. “Our ambition is to seize the Greek crisis to make a quantum leap in euro-zone government . . . The very words were once taboo . . . We have done something historic. There is no European Monetary Fund yet, but nearly.”
The hotly disputed topic of private-sector involvement also seems to have provided more questions than answers. In the days following the summit, politicians throughout the euro zone have struggled to get to grips with the deal that they supposedly masterminded. The confusion was illustrated by a bizarre moment when the Commission and the Dutch government gave two completely different figures for the actual size of the bail-out:
- €109 billion said the Dutch,
- €159 billion said the Commission
(leaving the Dutch Parliament, which had already provisionally approved the deal, utterly perplexed).
The agreement estimates that €37 billion will be raised from private-sector involvement (through a bond swap or rollover); Reuters reports that this is equal to a 21 per cent loss on private-sector holdings. The agreement also estimated that the private-sector involvement up to 2019 will be €106 billion net—yet another guess! Nevertheless, this move is likely to be declared a default, or some new form of default, by the main credit-rating agencies. To counter the effect of this it was also agreed that the scope of the EFSF should be widened so that it can issue “precautionary lines of credit,” aid in the recapitalisation of struggling banks, and purchase government bonds on the secondary market.
But beneath the complexity, the level of debt reduction achieved by involving the private sector falls far short of what is needed. To return Greece to solvency at least a 40 per cent “haircut” to the country’s debt is needed, while this deal achieves a mere 7½ per cent debt reduction, according to most estimates. So, where is the rest supposed to come from?
The proposal also glosses over a couple of important problems that have remained since the first bail-out. Will the Greek population put up with continued austerity measures, given the resistance already brewing in the country? And what happens if the austerity targets are not met?
The failure to address the fundamental causes of this crisis, and a suspicion that the euro zone’s political leaders fail to understand what their new deal actually means, suggest that we may well all be back here again before too long.
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