Here‘s the official statement of the heads of state of the Euro area governments from today’s meeting.
Colm McCarthy writing on these, em, pages, a few days ago explained that Europe’s Plan A–no banks will go under, no states will default on their debts, fiscal consolidation plus recapitalisation will see us through–is being quietly dropped in favour of Plan B. Today at the EU Debt Summit we got a glimpse of what Plan B will look like. (updated to official version).
Briefly, Greece is being allowed to selectively default, but this won’t harm Greek banks (nor their French owners) because the greek bonds will be guaranteed by an enhanced European Financial Stability Facility (EFSF) that can intervene in secondary markets amongst other new powers. Other debt-laden member states, including Ireland, will have access to cheaper funds from the uber-EFSF at longer maturities.
The markets liked it too, with bank shares enjoying a nice bounce. There’s some evidence the bounce we saw on the markets was just short equity positions being cleared out, so I wouldn’t take that too seriously as an indicator of how well this new plan will go down. I don’t think many people were surprised at Greece’s default. As macroeconomic events go, the default was pretty well expected, hence the lack of jitters when it was announced.
It is to be welcomed that the Greek default is somewhat orderly and buttressed by other member states’ guarantees to reduce (or avoid completely) balance sheet contagion. What’s not so welcome are some of the phrases used in the draft document. They are vague enough to allow lots of leeway should policy makers require it, but precise enough to guarantee action of some shape or form. All this does is move debate away from ‘what will they do’ to ‘how are they going to do it’, which is unhelpful given the seriousness of the situation. This is, after all, the tenth time EU leaders have met to sort the problems in Europe out ‘once and for all’.
Paragraph 7 of the draft contains the following rather ominous sentence:
To improve the effectiveness of the EFSF and address contagion, we agree to increase the flexibility of the EFSF, allowing it to:
– intervene on the basis of a precautionary programme, with adequate conditionality
That is really worrying language. Does it mean, for example, that the EFSF can require states to implement austerity measures without negotiation with the sovereign? The language is vague enough to be quite scary.
The composition of the new beefed up EFSF isn’t reported. The only place Italy is mentioned in the draft is to get a pat on the back for its recent fiscal consolidation. Is Italy, in its current fragile state, expected to keep its share of the EFSF up? Look at the table on page 1 of this document from the EFSF showing the contributions of member states. Italy is expected to pony up up to 78 billion euros if required. More information on just where this money is coming from would be most welcome.
Another slight worry is that Ireland has agreed to talk about the common consolidated corporate tax base (ccctb), meaning that perhaps there has been a movement in the government’s position on this issue, though agreeing to talk does not mean that Ireland’s corporation tax rate (a different beast) is under threat just yet.
All in all, a lot to discuss in today’s announcements, but I don’t personally feel the EU has solved its problems to the satisfaction of all, though commenters may of course disagree.
I know some of our blog commenters are big fans of the idea of ending the EU-IMF deal and immediately running a zero deficit. I spoke with Kathy Sheridan from the Irish Times a while back about how this would be chaotic.
It’s interesting then to see US politicians apparently eager to try out this experiment on their own economy, pretty much for the hell of it. Here‘s an interesting analysis of the decisions that could be facing the US Treasury on August 2. A corresponding analysis for Ireland would be really interesting.
European politicians are engaged in frantic negotiations to deal with both the Greek debt problem and the wider question of the EU’s approach to the problems of peripheral countries.
On the approach to the Greece, I’m not encouraged by the reporting from the financial press which has focused on a bank tax and debt buybacks.
First, we’re being told that the idea of a tax on European banks to raise about €30 billion is emerging as a “popular consensus” approach to getting private creditors to “help pay for the estimated €115bn bail-out”. As reported, it’s pretty unclear what happens with the €30 billion. Is it loaned to Greece and then later paid back to the banks that paid the tax? If so, it’s not really a tax in the usual sense of the word. Anyone who understands this is welcome to explain it in comments.
However it’s structured, this seems to be the wrong approach to the wrong problem. The goal seems to be to keep Greece’s debt burden exactly where it is (thus not solving the key problem) but to reduce the headline number for the size of a second EU-IMF loan (which solves a political problem in some countries). In relation to private sector “burden sharing”, the approach still seems to view a Greek default as unthinkable (despite almost everyone viewing it as inevitable) while adopting a very strange approach to the demand for “private sector involvement”: Why should banks that don’t own any Greek debt have to pay a tax to contribute to a second bailout?
Maybe there’s a good idea hiding under this reporting: If so, I’m happy to have it explained to me.
Then there’s the increased focus on debt buybacks. The idea of debt buybacks is popular with both politicians and holders of debt. The politicians get to claim that there was no coercive default on the outstanding debt, thus saving face. The creditors usually manage to get the debt bought back at a nice premium to the current market value, so many of them make a tidy profit.
Academics that have looked at this issue generally don’t like debt buybacks. Here‘s a short article from VoxEU by some IMF staff. And here and here are two classic older articles written in the context of the 1980s Latin American debt crisis.
To briefly explain why buybacks are not as great an idea as they appear, consider the case of a country with debt and GDP of €100 billion, so the debt ratio is 100%. The market doubts this debt burden is sustainable and so prices the debt at 60 percent of its face value.
Now a programme is announced whereby funds are provided to allow the country to buy back all its debt. Those behind the plan imagine they can go into the market and start purchasing debt at 60c and get the debt ratio down to 60%. However, because the debt ratio would be sustainable at 60% and at that point the government would be able to pay back all of its debts, there would be no need in such a situation for there to be a market discount on the price of the debt.
So, as the programme is announced and the government intervenes to start repurchasing its debt, the price of the debt would jump above 60c. The final price of the debt would depend upon a number of factors including the terms on the money being provided externally to fund the programme. But the end result would probably be significantly less debt relief than obtained, for example, by a straight swap of new for old bonds involving a forty percent reduction in net present value.
In relation to the wider Euro area problems, I’m somewhat optimistic that Thursday will see a harmonisation and reduction of EU programme interest rates, extension of maturities, as well approval of EFSF loans for debt buybacks. Personally, I would like to see the remit of EFSF extended to allow it to lend directly to banks, replacing excessive ECB funding as well as Emergency Liquidity Assistance. Of course, I doubt if this is even being considered.
We’ll see what happens but my prediction is that political face saving will take precedence over economically efficient solutions.
Update: The FT has an answer to my question about the bank tax which mixes it together with the buyback plan: “According to officials, it would amount to a 0.0025 per cent levy on all assets held by eurozone banks and would raise €10bn per year for five years. The cash would go to the bail-out fund, which would then use the money to conduct a Greek bond buy-back.”
The Barrington Medal is awarded under the auspices of the Barrington Trust (founded in 1836 by the bequest of John Barrington). The award is intended to recognise promising younger researchers in social sciences in Ireland. This will be the 163rd anniversary of the lecture series and the recipient will be the one hundred and twenty-fifth Barrington Lecturer. The award is a silver medal and €1,000.
The lecture should be based on a paper of not more than 7,500 words addressing a topic of relevance to economic or social policy and of current interest in Ireland. Candidates, who are within 10 years of completing a primary degree (or not more than 33 years of age), should submit a detailed abstract of approximately 1,000 words on the proposed lecture. They should also submit a short curriculum vitae and the name of a proposer who is familiar with their work. Entries should be sent by the 29 July 2011 to
Dr Seán Lyons
Honorary Secretary, The Statistical & Social Inquiry Society of Ireland
c/o Economic and Social Research Institute
Whitaker Square, Sir John Rogerson’s Quay
Dublin 2.
Email: sean.lyons@esri.ie
Winners since the mid-1980s:
Clinch, J. Peter; Delaney, Liam; Harmon, Colm; Horgan, John J.;Johnston, Joseph J.;Kane, Aidan;Kearns, Alan; Keeney, Mary J.;Lane, Philip R.; Lawless, Martina; Lee, George; Lucey Brian M.; Lucey, Siobhan; Muckley, Cal; McCoy, Daniel A.; McNicholas, P. D.; Meenan, James; O’Rourke, Kevin; O’Toole, Ronnie; Oldham, C.H.; O’Neill, Donal; Thornhill, Donal J. and Whelan, Ciara.