With the European sovereign debt crisis spilling into core members, as evidenced by Germany’s failed bond auction last week, and into the private sector, there appear to be three key steps needed to save the Eurozone, as NYU economist Nouriel Roubini and Poland’s Foreign Minister Radoslaw Sikorski explained in op-ed pieces on Tuesday.
First and foremost, Italy’s debt must be restructured to avoid a disorderly default, according to Roubini in a piece for EconoMonitor.
And second, and maybe even more importantly, Germany has to recognize it is the biggest beneficiary of current arrangements, substantially ramp up its contributions to the EFSF, and push the ECB to become a true lender of last result, as Sikorski noted.
There is no doubt anymore that the resolution of this crisis lies with Germany.
The largest and most powerful economy in the Eurozone, the country led by Angela Merkel is the only one with a balance sheet large enough to shoulder the cost.
It’s the only big player with a AAA rating that is not under fire, and it’s the one pushing against further support from the ECB and in favor of austerity.
“I demand of Germany that, for its own sake and for ours, it help the Eurozone survive and prosper. Nobody else can do it,” explained Sikorski, who in an op-ed column for the FT added:
“
We ask Berlin to admit that it is the biggest beneficiary of current arrangements and that it therefore has the biggest obligation to make them sustainable.
As Germany knows best, she is not an innocent victim of others’ profligacy. In addition, Germany, which should have known better, broke the stability and growth pact, and its banks recklessly bought risky bonds.
This takes us to Italy, the Eurozone’s largest bond market, third largest economy, and currently most dangerous member. At €1.9 trillion ($2.5 trillion), Italy’s massive debt burden has clearly become unsustainable, argues Roubini, given skyrocketing bond rates that have almost pushed it out of the market. Roubini breaks it down:
“
With public debt at 120 per cent of gross domestic product, real interest rates close to five per cent, and zero growth, Italy would need a primary surplus of five per cent of gross domestic product – not the current near-zero – merely to stabilize its debt. Soon real rates will be higher and growth negative.
Moreover, the austerity that the European Central Bank and Germany are imposing on Italy will turn recession into depression.
Without a lender of last resort, Italy, and others in a similar state (Spain and Belgium, for example) are doomed, noted Roubini.
The problem is that beyond the €400 billion ($534 billion) in Italian debt maturing over the next 12 months, many investors holding Italian debt are looking to get rid of it as soon as possible, given the loss of credibility and tanking bond prices (i.e. surging yields).
“At this point most investors would dump their entire holdings of Italian debt to any sucker [ECB, EFSF, IMF, etc] willing to buy it at current yields […] so using precious official reserves to prevent the unavoidable would simply finance the exit of others,” wrote Dr. Doom.
Italy’s economy remains stuck in a recession that will turn into a depression, according to Roubini, if draconian austerity is indeed imposed.
It faces the contradictory task of having to stabilize its debt through growth-killing policies which will in the end raise its debts. Thus, a lender of last resort is needed to guarantee that Italy won’t default, even it is forced out of markets in the next 12 months.
Roubini believes about €2 trillion ($2.7 trillion) is needed to backstop Italy, “and soon Spain, and possibly Belgium, for the next three years. ”
He asks the core, which by now has been reduced to just Germany, to raise its own contributions, and the ECB to play the role of lender of last resort, if any bailout plans (those including the IMF, BRICs, sovereign wealth funds, and anyone else) are to avoid failure.
A debt restructuring could occur via a choice between a par bond (“with longer maturity and a low enough coupon to reduce the net present value by 25%”) and a discount bond (“that has a face value reduction of 25%) to take Italy’s debt-to-GDP ratio to 90%.
“
The par bond would suit banks that hold bonds to maturity and don’t mark to market [“it would allow banks to pretend for a while that no losses had occurred and thus give them more time to raise fresh capital”].
There should be a credible commitment not to pay investors who hold out against participating in the offer – even if it triggers the payment of credit default swaps.
Even a debt restructuring wouldn’t solve “the problems of lack of growth and outright recession, lack of competitiveness and a large current account deficit” in the Eurozone.
The possibility of a breakup in the common currency is now higher than ever, as Moody’s made clear on Monday, but, while “exit can be postponed for a while,” restructuring would avert an even worse scenario in the short run.
forbes.com
First and foremost, Italy’s debt must be restructured to avoid a disorderly default, according to Roubini in a piece for EconoMonitor.
And second, and maybe even more importantly, Germany has to recognize it is the biggest beneficiary of current arrangements, substantially ramp up its contributions to the EFSF, and push the ECB to become a true lender of last result, as Sikorski noted.
There is no doubt anymore that the resolution of this crisis lies with Germany.
The largest and most powerful economy in the Eurozone, the country led by Angela Merkel is the only one with a balance sheet large enough to shoulder the cost.
It’s the only big player with a AAA rating that is not under fire, and it’s the one pushing against further support from the ECB and in favor of austerity.
“I demand of Germany that, for its own sake and for ours, it help the Eurozone survive and prosper. Nobody else can do it,” explained Sikorski, who in an op-ed column for the FT added:
“
We ask Berlin to admit that it is the biggest beneficiary of current arrangements and that it therefore has the biggest obligation to make them sustainable.
As Germany knows best, she is not an innocent victim of others’ profligacy. In addition, Germany, which should have known better, broke the stability and growth pact, and its banks recklessly bought risky bonds.
This takes us to Italy, the Eurozone’s largest bond market, third largest economy, and currently most dangerous member. At €1.9 trillion ($2.5 trillion), Italy’s massive debt burden has clearly become unsustainable, argues Roubini, given skyrocketing bond rates that have almost pushed it out of the market. Roubini breaks it down:
“
With public debt at 120 per cent of gross domestic product, real interest rates close to five per cent, and zero growth, Italy would need a primary surplus of five per cent of gross domestic product – not the current near-zero – merely to stabilize its debt. Soon real rates will be higher and growth negative.
Moreover, the austerity that the European Central Bank and Germany are imposing on Italy will turn recession into depression.
Without a lender of last resort, Italy, and others in a similar state (Spain and Belgium, for example) are doomed, noted Roubini.
The problem is that beyond the €400 billion ($534 billion) in Italian debt maturing over the next 12 months, many investors holding Italian debt are looking to get rid of it as soon as possible, given the loss of credibility and tanking bond prices (i.e. surging yields).
“At this point most investors would dump their entire holdings of Italian debt to any sucker [ECB, EFSF, IMF, etc] willing to buy it at current yields […] so using precious official reserves to prevent the unavoidable would simply finance the exit of others,” wrote Dr. Doom.
Italy’s economy remains stuck in a recession that will turn into a depression, according to Roubini, if draconian austerity is indeed imposed.
It faces the contradictory task of having to stabilize its debt through growth-killing policies which will in the end raise its debts. Thus, a lender of last resort is needed to guarantee that Italy won’t default, even it is forced out of markets in the next 12 months.
Roubini believes about €2 trillion ($2.7 trillion) is needed to backstop Italy, “and soon Spain, and possibly Belgium, for the next three years. ”
He asks the core, which by now has been reduced to just Germany, to raise its own contributions, and the ECB to play the role of lender of last resort, if any bailout plans (those including the IMF, BRICs, sovereign wealth funds, and anyone else) are to avoid failure.
A debt restructuring could occur via a choice between a par bond (“with longer maturity and a low enough coupon to reduce the net present value by 25%”) and a discount bond (“that has a face value reduction of 25%) to take Italy’s debt-to-GDP ratio to 90%.
“
The par bond would suit banks that hold bonds to maturity and don’t mark to market [“it would allow banks to pretend for a while that no losses had occurred and thus give them more time to raise fresh capital”].
There should be a credible commitment not to pay investors who hold out against participating in the offer – even if it triggers the payment of credit default swaps.
Even a debt restructuring wouldn’t solve “the problems of lack of growth and outright recession, lack of competitiveness and a large current account deficit” in the Eurozone.
The possibility of a breakup in the common currency is now higher than ever, as Moody’s made clear on Monday, but, while “exit can be postponed for a while,” restructuring would avert an even worse scenario in the short run.
forbes.com
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