The leaders of the euro zone held an important conference on Sunday to try, once again, to resolve its destabilizing debt crisis. And though a final agreement wasn’t reached — and probably won’t be until Wednesday — we can already read the writing on the wall. The new grand agreement is likely to be dead on arrival.
Why so? On every major issue that Europe’s leaders are debating — from the second Greek bailout to recapitalizing the region’s enfeebled banks — they are putting their own, narrow political interests over the desperate needs of the monetary union. We’ve seen this again and again (and again), and it has been the fatal flaw in every deal reached in the two-year quest to stamp out the debt crisis. You know the saying: Those who fail to learn from history are doomed to repeat it. The leaders of Europe have to go back to high school.
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First, let’s look at the bank-recapitalization plan emerging from the conference. The good news is that the Europeans have finally yanked their heads out of the sand and admitted that their banks need help. The problem is that what they’re demanding probably falls short of what is necessary. The banks, they have agreed, require €108 billion (or $150 billion) of fresh capital, which they’ll have to raise on their own or get from Europe’s governments. That’s a nice big number. But it is still at best half of some private estimates on the amount of capital the banks need to shore up their balance sheets against the debt crisis. As we’ve witnessed month after month in Europe, half measures don’t even produce half results.
Second, the Greek bailout. Pressure from Germany is nudging the euro zone toward a do-over for parts of the second Greek bailout package, formed in July. Most notably, the new arrangement could include a much more drastic reduction of Greek debt, with private creditors suffering a 60% haircut on their bond holdings, up from 21% in the original deal. I am all for a more brutal restructuring of Greek debt. The adjustment being hoisted onto Greece is simply impossible while the continued austerity measures demanded by Germany and others are causing an economic free-fall and social upheaval. And any investor stupid enough to still be holding Greek bonds deserves to lose money, in my opinion. Yet imposing such drastic losses onto bondholders carries its own perils. The original second bailout envisioned voluntary participation by private creditors in a debt-swap scheme. That was uncertain with only a small haircut; now that Europe’s leaders are taking out the heavy-duty razors, we can’t expect private creditors to happily line up to get sheared. So we’re looking at a higher possibility of some sort of imposed or unruly restructuring, with unknown consequences. Meanwhile, there are even some voices in Greece who are opposed to the big haircut, arguing that it would undercut the wealth of Greeks who hold Greek sovereign debt. So who knows what, in the end, may actually be possible.
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Third, the expansion of Europe’s rescue fund, the European Financial Stability Facility (EFSF). There is good news here as well. Economists have been screaming that the fund (currently at $1 trillion) is too small to have the firepower it needs to combat contagion. Now Europe’s leaders, after resisting pressure for months, are finally facing that. The problem is, they don’t want to dump in the money themselves. Instead, they’re scheming up complex arrangements to expand the ammunition of the fund through leverage by, for example, guaranteeing investors in sovereign-bond issues against losses. Will such a method work? Wolfgang Münchau neatly pointed out the risks in the Financial Times today:
A leveraged EFSF is attractive to politicians for the same reason that subprime mortgages once appeared attractive to borrowers. Leverage can have different economic functions, but in these cases it simply disguises a lack of money. The idea is to turn the EFSF into a monoline insurer for sovereign bonds. It is worth recalling that the role of those monolines during the bubble was to insure toxic credit products. They ended up as a crisis amplifier.
Admittedly, I might be jumping the gun here. To make a real determination of the euro zone’s efforts this week, we’ll have to wait for the final agreement. My colleague Leo Cendrowicz, who closely monitors the happenings in the euro zone from his perch in Brussels, is more optimistic than I am. He argues that even if the final agreement underwhelms, it may turn out to be enough to start rebuilding confidence among investors. Here’s what he sent me in an e-mail:
Even if a splendid master plan is agreed, it may indeed be inadequate. But the real issue is about confidence: can the EU and the euro zone show they are willing and able to turn this crisis around? There have been signs amid the chaos of recent weeks that they might be turning a corner. And crucially, markets are ready to give them a certain amount of leeway on their less-than-perfect plans so long as they project confidence. The question is now political: Is there enough solidarity in the well for Europe to collectively pull itself out?
And there is the real core of the issue. Politics. So far, Europe’s leaders haven’t been able to stop the debt crisis because of a lack of political will. Can they muster enough now? Hopefully Leo is right, and this time will be different. I’m not getting my hopes up. It seems to me that the good intentions of Europe’s leaders are again getting undercut by domestic political concerns. Politicians want to minimize the scale of the bank-support program, maximize losses for Greece’s private creditors and expand the EFSF without expanding the EFSF because of rising opposition among European voters to continued bailouts of profligate Greeks and insensitive bankers. We can all sympathize with their plight. But as long as the euro’s economic problems are tackled through political calculations, the debt crisis won’t end. And I’ll have to keep repeating myself on this blog. Neither is good for anybody.