Now that we’ve had a bit more time to digest the implications of the EU summit, I would be interested to hear more views on how the measures have strengthened or weakened the “ring-fence” beyond Greece, especially as it applies to Ireland. The idea of a ring-fence is that measures to improve debt sustainability and the reliability of a lender of last resort attenuate potentially self-fulfilling expectations of default; that is, expectations of default that lead to higher interest rates, thereby increasing the probability of default (in part because countries get pulled into European crisis resolution mechanisms that threaten debt restructuring as part of subsequent financing packages and also because of worsening debt dynamics).
I think it is fair to say there is general agreement that the interest rate reductions / maturity extensions strengthen the ring-fence given that they improve the chances of debt sustainability. However, there also seems to be a view that the private-sector involvement (PSI) that is being applied to Greece weakens the ring-fence, as it increases the threat of that PSI being applied to other countries at a later stage. The latter does not seem right to me. It is widely recognised that Greece’s debt to GDP ratio makes debt restructuring inevitable. From the point of view of the ring-fence beyond Greece, it would have been best to have decisive action on Greece’s debt, so that it is unlikely that the necessary PSI would have to be revisited in their case. As it is, it is likely that further restructuring of Greece’s debt will have to take place, creating ongoing uncertainty about what the PSI element of the Eurozone crisis-resolution mechanisms is going to look like down the road, increasing the uncertainty facing other countries. In other words, the problem (from the perspective of the ring-fence) is that too little PSI is being applied to Greece, not too much.