Time for euro zone to revisit debt default option

Princeton’s Ashoka Mody (former mission chief for Ireland at IMF) has an op-ed in the Irish Times – it is here.

28 replies on “Time for euro zone to revisit debt default option”


However, such an eventuality is not going to arise in the short-term.

There would have to be a grand bargain made between all the EMU members with serious compromises on both sides.

It’s pointless expecting German voters to bailout Italy without some expectation that another Berlusconi would not dissipate the gains. Telling them how much they gain from the euro would not likely have much of an audience if average earners would see their taxes rise.

People resist central diktats and in time the Germans are likely to also have enough of being the ring masters.

We can see in Ireland that outside influence can only have a limited impact.

The carry-on about pensions and ministers admitting that they have no control over over bailed banks, is one example of how a culture is hard to change.

On Monday, the Irish Government announced an audacious or delusional new target: “in which Ireland in 2020 is the best country in the world for scientific research excellence and impact.”


The previous target was effectively declared inoperative and all failures were wiped clean.

As regards Spain, I have previously highlighted that pre-property boom, Spain had a 21% jobless rate in 1997 and 24% in 1994.

Now according to the European Commission its structural rate of unemployment (NAWRU: non-accelerating wage rate of unemployment) is  21.5% while Greece’s rate is 14.8% compared with official rates of 25% and 24%.

Ireland’s NAWRU is 13.8%.

In effect in Spain and Ireland, there are lots of former construction workers who lack the skills for many other jobs.

The evidence is accumulating that a policy of ‘austerity’ plus dumping the costs of the financial system failures on EZ citizenries dooms the EZ to depression and at least a lost decade, savage social and psychological costs, and perhaps permanent damage to the European Project.

Mutualise or default are other options but article 123 of Lisbon Treaty remains a huge barrier. I have been arguign for a declaration of state of emergency locally since early 2009 but how does one declare a state of emergency in the EZ so that debt mutualisation or QE on a massive scale becomes possible?

It is not encouraging when the German CDU election prospects takes priority over granting ‘official haircut’ to Greece which its debt sustainability demands according to the IMF. What hope for mutualisation? UDI and Default is a local scenario which must be explored. A reasonable starting point would be a declaraton of intent to ‘postpone indefinitely’ payment on the PNs to take pressure of the deficit reduction process. Kiel Institute for the World Economy calculated that Ireland needs a haircut of €50 billion so that its debt becomes sustainable and reporting of GDP rather than ‘real’ GNP plus some creative national accounting presents a false picture. Time to get bolshy – but first real action must begin at home and thus far this admin has wimped out on the hard yards and in mauling the vested interests and the gouging upper_echelons off the park. Yet, it is possible.

As Mody puts it: ‘Default option: It is time to revisit the default option.

… The default option is economically efficient, it is fair, and it is politically sensible. It may be the only way to hold together an unsustainable structure that threatens to drive deeper divisions and set back the magnificent integration project on which Europe has embarked.’

Ashoka Mody is Charles and Marie Robertson visiting professor of international economic policy at the Woodrow Wilson school, Princeton University. He was a deputy director in the IMF’s research department.

@The IMF

Stay the course.


On Sov Default John McHale linked to this paper on the EU’s multiplier thread Box 1.5 and … ignored. It is worth a read – key point is that there is life after a sov default – but at EZ mutualization or ECB QE contra Article 123 of Lisbon surely preferred.

The Economics and Law of Sovereign Debt and Default by Panizza and colleagues


@all again – some more from the IMF gene pool to complement Mody

Susan Schadler, former deputy director of the IMF’s European department, is currently a senior fellow at the Centre for International Governance Innovation and the Atlantic Council.

Europe’s crisis continues to fester. In large part this is due to a fundamental strategic error at the outset – the failure to restructure the debt of banks and governments. Ten years ago the IMF revised its rules for handling crises precisely to prevent such errors. But, under short-sighted political pressure, the rules of the game were changed and the IMF was set adrift in dealing with the crisis in Europe.


It seems that the authentic voice of the IMF is finally coming to the fore, after long being smothered by the politics of deference to the amateurs who are also its paymasters. It is hardly coincidental that this coincides with the institutional IMF digging it its heels on the need for official sector default by Greece.

A wave of debt defaults would be the end of the 30 year long bond rally. The end of bonds= risk free. The end of low interest rates.

One might suspect that the timing of the shift in IMF behaviour bears some relation to the US electoral cycle. The IMF could hardly have bucked both US and EU influence at the same time, and the Obama re-election campaign could have been derailed by crisis. Now, the priority must be to stop Europe from continuing to smother the global economy. This is unlikely to happen within Obama’s second presidency if the EU and its appendages continue their current death march into maximising the number of Member States whose public debt burden is in or beyond Schrödinger’s cat territory.

@ David O’Donnell

Finley Peter Dunne’s (1867-1936) Irish comic character Mr Dooley’s comment: “No matther whether th’ constitution follows h’ flag or not, th’ Supreme Coort follows th’ election returns,” could also be applied to the IMF.

It’s not too long ago that George Osborne was a poster boy of the folk at the Fund.


Nick Robinson of the BBC in May 2012: 

It was the soundbite of the chancellor’s dreams. The head of the IMF said that when she looked back at the UK’s deficit in May 2010 and imagined there being no plan to reduce it “I shiver”.

This came after Christine Lagarde had backed “the policy mix” ie the combination of government tax and spending policies and the Bank of England’s interest rate and quantitative easing policies.

No big gaisce here but what is a bit striking is how fast François Hollande dropped his soundbites on growth that had won many admirers – – there is still an urgent need for leaders to honestly address the issue of economic growth and how sustainable jobs can be created.


“there is still an urgent need for leaders to honestly address the issue of economic growth and how sustainable jobs can be created.”

The issue is bigger than “how sustainable jobs can be created”. Do the people running the system want sustainable jobs to be created ? Is it not more profitable to keep things the way they are ? Profit margins in the US for example have never been as bountiful.

It seems that the other elephant in the room is plutocracy.

I just wonder where the IMF would stand in the list of those willing to take a hit with regards to their loans extended to the programme EZ countries. This article sounds a bit like hurler on ditch blurb to me but when push comes to shove I’m not so sure the IMF will actually be willing to take a loss.

I noted here before that the most important comment in recent times which emanated from the ECB was a statement made by Mr Draghi in a recent press conference in which it was noted that rolling over debt (restructuring) would be seen as monetary financing and monetary financing is not within the scope of the ECB so the notion that public financing agencies such as the IMF and the ECB can willy nilly suggest that debt write offs are the way to go and then expect that they sit outside the arrangement is the absolute definition of wishful thinking.

The article mentions Leo Buchheit and within his most recent paper outlining the options available the following was noted:

On October 4, 2012, ECB President Draghi was asked why the ECB would not roll over (that is, restructure) its holdings of Greek government bonds. His answer (as reported by Reuters):
[Rolling over] would qualify as monetary financing. We have said several times that any voluntary restructuring of our holdings would be equivalent — would be monetary financing.”
Monetary financing of a Member State is impermissible under ECB’s charter. How this statement can be squared with the September 6 promise to accept equal treatment with private creditors in the event of a restructuring of OMT-acquired bonds remains to be seen. See link: http://www.reuters.com/article/2012/10/04/ecb-rates-idUSECBNEWS20121004

Things that make you go hmmm..

@Michael Hennigan

‘leaders’ [small ‘l’ intentional] are still thinking in the old world, with the old world neoliberal ideology – and claiming to be trying to return to the old world …

but it isn’t coming back – from the gurus at the Monthly Review through Olivier Blanchard to a few sane right wing pragmatists this is now self-evident ….

New thinking on how ‘labour work’ is to be distributed and recompensed – sane approaches to welfare and pensions – ideas of a living wage – and most centrally and yet to be addressed – serious reform of the rogue nature of much of the financial system which demands agreement at the supra-nationa level.

That said, I’m planting more spuds and cutting an extra bank of turf!

It is interesting to note that attention has not been drawn to the following element in the article.

“In just 18 months (from the April 2011 IMF economic outlook to now), the projected debt ratios of the heavily indebted economies, other than Ireland, have risen. These ratios will rise further as the full extent of the austerity-induced growth damage is revealed.”

If Ireland is the exception in this context, and continues to be, is it also the exception generally?

The writer also, it seems to me, overstates the weight of the economies in question and theirs, and Europe’s role, in “dragging down” world trade.

The debate – with valid arguments on both sides – seems to go around in circles. An example would be the list of things advanced that make a single currency work in the US. But the EU is not the US. Rather a collection of nation states, 17 members of which clearly miscalculated in introducing a common currency without doing their homework and simply putting blind political hope in its success.

Ireland has to look after her own interests. The main objective must surely be to continue to decouple from the four Mediterranean states in difficulty whose situation, as MH points out repeatedly, has returned largely to what it was, for example, in relation to employment prior to the creation of the euro.

There is absolutely nothing in this piece that ordinary, well informed folk have not already figured out. Unpayable debt is … … well, unpayable! “Well golly gee! How about that!” “Who’da thunk!”

Debt grows geometrically … … economic growth is arithmetic. What part of these two mathematical terms do non-ordinary folk not understand? The geometric plot-line of debt growth has intersected the arithmetic economic plot line and is ‘off-to-the-races’ above the latter. Its Jubillee time – again!

ie: The way this quandry will be (maybe not!) settled is pure politics – as in Realism! Bye-the-bye, the US is a sovereign federal state of somewhat independent states. Europe is a geographically contiguous (well, almost) set of fully soverign, independent states. Its a political no brainer! They just have to locate that mislaid brain.

“However, such an eventuality is not going to arise in the short-term.” Michael, I nearly cracked up at this. Yogi Berra stuff!

Not forgetting The Corporates … View from Berlin


Tango with the Tax Man
Multinationals Find Loopholes Galore in Europe

Large multinationals, many of them based in the United States, are masters at avoiding taxes on profits made abroad. Apple, for example, paid just $100 million in taxes in 2010 on overseas profits of $13 billion. But Germany would like to put a stop to the practice, and is finding some influential support. By SPIEGEL Staff more… [ Forum ]


Mody says:

“The collective judgment of Europe was that the debts owed by Irish banks should become the obligation of the Irish taxpayer.”

This might play well here but it is pretty useless as a negotiating position because it is not true.

Ireland introduced a two-year guarantee of virtually all the liabilities of what became known as the covered banks on the 30th of September 2008. This was introduced without seeking the advice of, or even consulting with, any other country, the EU, the ECB or the IMF.

On the night of the guarantee Anglo Irish Bank owed:

€52 billion of retail/non-retail deposits,
€20 billion of interbank deposits,
€11 billion of senior unsecured bonds,
€7 billion of covered bonds, and
€7 billion of subordinated and other liabilities

The depositors were all repaid in full and by the time the guarantee expired on midnight of the 30th of September 2010, only around €4 billion of the senior unsecured bonds remained. Earlier that same day Brian Lenihan had announced that making good the losses in Anglo Irish Bank would cost between €29 billion and €34 billion.

Burden sharing was sought, and refused by the ECB, with the remaining €4 billion or so of senior unsecured bonds in Anglo but by then the dye was set.

@Seamus Coffey

Ireland introduced a two-year guarantee of virtually all the liabilities of what became known as the covered banks on the 30th of September 2008. This was introduced without seeking the advice of, or even consulting with, any other country, the EU, the ECB or the IMF.

The guarantee of virtually all liabilities of the financial sector was and is and the policy of the EU, the ECB and Germany. Had we consulted them the “advice” we would have been given is the instruction that we subsequently received.

No bondholder is to be left behind.

Do you dispute this?

@ Shay,

We didn’t ask, so they didn’t say it.

Have a read of the ECB Opinion on the guarantee published on the 3rd of October 2008. And the European Council summit statement of the 14th of October 2008. The key paragraphs are extracted here.

As for no bondholder left behind. Try:

“The amendment of the Treaties will be restricted to the following issues:

– The establishment of a permanent and robust framework to ensure orderly crisis management in the future, providing the necessary arrangements for an adequate participation of private creditors and allowing Member States to take appropriate coordinated measures to safeguard financial stability of the Euro area as a whole.”

Copyright Nicolas Sarkoy & Angela Merkel, Deauville, October 2010

That one really helped us! And as for banks there were plenty of reports like this from the July 9th Council of Finance Ministers.

There are no absolutes in this. The “instruction we subsequently received” to pay the remaining Anglo senior unsecured bonds was in October/November 2010 and again in the summer of 2011 . Jorg Asmussen, though not a member of the ECB Governing Council at the time has told us why this decision was made:

“Protecting the hard-won gains and credibility from the early successes in 2011 was also a key consideration, to ensure no negative effects spilled-over to other Irish banks or to banks in other European countries.”

The decision to repay €4 billion of Anglo senior bonds in October 2010 is far removed from the decision to guarantee €97 billion of Anglo liabilities in September 2008. That was a solo run and trying to pass the responsibility for it is unlikely to deliver much.

Mody’s piece is generally fair but there was no “collective judgement of Europe” in government buildings on the night of the 29th of September 2008.

Portugese unemployment rate hits record high. There’ll be trouble at t’mill if this keeps up.

Nice picture of a policeman kicking the shit out of a woman in the Telegraph. Those boys saw what happened in Libya. If the system collapses, nobody pays them. Keep sticking that boot in son. Your mother would be proud of you.

Seamus Coffey:

There was indeed ‘no collective judgement of Europe’ on September 29th. 2008. But the penny dropped in Dublin long before October 2010. Mody knows what happened subsequently – he was there.

@ colm mccarthy,

If the (correct) recommendations of the IMF in relation to the Anglo senior unsecured bonds had been followed in October 2010 would our position now be materially different? I don’t think it would.

If the institutions of the EU had not held a stick over Ireland to enforce no bondholder left behind, would our Government have been able to resist the imperative to renege on the part of the guarantee that related to pre-guarantee bank bonds? I don’t think it would.


If Ireland walked blindly into the bear trap in September 2008, the door was firmly closed on Ireland in Oct 2008 by the ECB. [Ref below].

Even if you believe that the only amounts at issue of were bonds in issue at Oct 2010, what was the total of bank bonds outstanding at that date. Why would all bank bonds not have been bailed in.
The whole Ireland / ECB bond saga should be tested at ECJ level. If Ireland has to pay all without any ECB culpability, after such a hearing, would we be any worse off than we are now?

Speech by José Manuel González-Páramo, Member of the Executive Board of the ECB
Closing remarks at XVI Meeting of Public Economics
Granada, 6 February 2009.

“While the aforementioned measures significantly improved the information available to markets, investors and competent authorities, the failure of Lehman Brothers last September generated an unprecedented deterioration in the degree of confidence in the banking sector triggering the coordinated action of governments. In this context, the European Heads of State adopted a set of common principles aimed at addressing the financial turmoil and ensuring that the design of national stabilisation measures did not lead to negative spill-over effects across countries. The “EU common principles” endorsed at the European Council of 15-16 October laid down the common features for granting guarantees on new issuance of bank debt and recapitalisation measures adopted by the Member States.
The Governing Council of the ECB contributed to this work by proposing recommendations encompassing the provision of government guarantees for bank debt and recapitalisation measures. First, the Governing Council of the ECB proposed a set of recommendations on the framework for granting government guarantees, which identified the following main objectives for this measure: (1) addressing the funding problems of solvent banks; (2) safeguarding the level-playing field among financial institutions in order to avoid market distortions; and (3) ensuring consistency with the operational framework of the Eurosystem, to avoid impairing the implementation of the single monetary policy. Furthermore, these recommendations included a pricing system for the government guarantees on bank debt.”

fyi CDU VS greeks

Bad Haircut
IMF Greek Debt Default Demand Could Haunt Merkel

The International Monetary Fund wants Greece’s creditors to forgive a portion of the country’s debt, a move which could cost Germany up to 17.5 billion euros. With general elections approaching next year, Chancellor Angela Merkel is adamantly opposed to such a move.


fyi must read

Beyond Regulators’ Grasp
How Shadow Banks Rule the World
By Martin Hesse and Anne Seith

Beyond the banking world, a parallel universe of shadow banks has grown in the form of hedge funds and money market funds. They’re outside the reach of conventional financial regulation, prompting authorities to plan introducing new rules to prevent the obscure sector from triggering a new financial crisis. But in doing so they risk drying up an important source of funding to banks and firms.

[…] It’s because of concerns like this that the realm of the shadow banks will likely continue to grow. The stricter the regulations for normal banks, the more money migrates to the unregulated parts of the financial world. FSB Secretary General Andresen fears that investors will soon forget the potential consequences of risky deals with shadow banks. “And if regulations aren’t in place by then, we could easily experience something similar to what happened in 2008.”


Pardon the plug but I learn a lot from NakedCapitalism … and a bit here 2!

Wednesday, November 14, 2012

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@ Joseph,

This was the position in the middle of February 2011. There was €16.4 billion of senior unsecured bonds “in play”. Of these €5.2 billion were in BOI. You couldn’t impose haircuts on them because of losses made by other banks.

Excluding BOI there was €11 billion of bonds. The €1 billion that were in PTSB are probably also subject to some doubt as the recapitalisation/nationalisation there was based on a stress test projection of future losses rather than current losses. The keys ones are the €6 billion that was in AIB and the €4 billion in Anglo/INBS.

Some bonds will have matured from the 30th September 2010 to the time this table was produced in February. Up to mid-January the amount was <a href=”http://debates.oireachtas.ie/dail/2011/01/12/00083.asp”less than €200 million for Anglo. There was a €750 million senior unsecured bond that matured on the 31st of January. All told across all the covered banks around €2.4 billion of senior unsecured bonds matured outside the guarantee in the final quarter of 2010. I have not seen a breakdown by institution of this total.

At the end of the guarantee there was probably around €13-to-14 billion of senior unsecured bonds in the covered banks outside of BOI. A 60% haircut to all of these would have generated around €8.5 billion of savings, a very significant sum. If limited to Anglo/INBS the figure would be about one-third of this.

@Seamus Coffey

Have a read of the ECB Opinion on the guarantee published on the 3rd of October 2008.

I would not describe the opinion of the ECB on the initial bank guarantee as “interesting” but I suppose it does contain points of interest.

Firstly, the ECB appeared to be far, far more concerned with the implications for competition law of the bailout than any other feature even as the European component of the global financial crisis got into full swing – strong echoes of Jean Claude Trichet’s strongly determined focus on inflation when it was utterly irrelevant.

Secondly we can say with some certainty that though the ECB claimed to be worried about the Irish governments budgetary position (section 2.5) when it came down to it, and it was in a position to make a choice, the ECB chose preserving investment in the banking sector over national budgetary problems. End of discussion – settled by history.

In fact there is no need to read the thoughts of the ECB, or the thankfully brief Deauville emission from Merkozy (“an adequate participation of private creditors” – adequate for what?), because we know what they did. They insisted on the full repayment by the Irish state of bond holders in an insolvent bank. They still do.

It is stretching credulity to suggest that had we waited for the ECB to suggest a course of action it would have been somehow different from the one they helped force us to take. Likewise for the German bloc or the European Commission.

No one could honestly disagree with that, could they?

History is repeating itself, what is required now is what was required then – that we do something that our European “partners” are not on board with rather than accommodating (or trying to second guess, as with the initial bank guarantee) a delusional and damaging European economic consensus.


Many thanks for that detailed information.

Whatever about the Irish bonds, watching protests in Portugal, Spain and Italy last night one gets the impression that, to use a football analogy,
‘Austerity is losing the dressing room’.

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