And why they do not measure up to the Modest Proposal
The good news is that the debate we had to have about a year ago is, at long last, beginning. The bad news is that it is proceeding slowly and in often hopeless directions. The recent EU summit, for instance, decidedly refused even to touch upon the current crisis, being devoted instead to discussing the resolution of the… next crisis; the crisis, that is, which will never come about since, unless the current one is addressed, there will be no eurozone left after 2013 to defend!
As the penny is dropping ever so slowly (i.e. policy and opinion makers are beginning to realise that the current EU policy for tackling the eurozone’s current crisis is the equivalent of dousing an open fire with kerosene), a number of proposals have crawled out of the woodwork. The main alternatives to our own Modest Proposal (click here for the long version and here for a short one) seem to be:
- Big Bang approaches
- The Juncker-Tremonti Plan
- Walter Munchau’s suggestion that the EFSF be used to bail out Europe’s banking sector
- Thomas Mayer’s five point strategy
Let’s examine them one at a time.
1. Big Bang approaches
Massive Quantitative Easing: The simplest idea is that the ECB be empowered to ‘do a Bernanke’; to buy member-states’ bonds worth to up to €2 trillion from the secondary markets and then apply a haircut to the bonds it has already purchased; a haircut that it can tailor-make in order to return countries like Ireland and Greece to solvency. That would stop the domino effect immediately, reduce spreads and kill the sovereign debt crisis on its tracks. Why not go down that road and get it over and done with? Answer: Because Germany, France and most other member states would never authorise Mr Trichet to do such a thing. Their reasons are twofold. First, they (much like the Republicans on the Atlantic’s other side) labour under the intense fear of inflation, convinced (wrongly I believe) that such a massive exercise in quantitative easing will spark off a vicious circle of self fulfilling inflationary expectations. Secondly, Germany, Holland et al strongly (and very mistakenly) believe that the crisis was caused by the fiscal profligacy of the peripheral member states. To kill the debt crisis by industrial scale quantitative easing would be to excuse such behaviour and perpetuate profligacy in the future, at the expense of widespread inflation and a weak euro.
Comment: I too am less than keen on this type of Big Bang solution, albeit for very different reasons. The fear of inflation is vastly exaggerated. As the US experience has shown, in recessionary times quantitative easing does not even boost the money supply (let alone boost inflationary expectations beyond a level that would trigger a serious rise in actual inflation). Also, the fear that the large scale purchase of bonds by the ECB will let Greece and other spendthrift nations off the hook is ludicrous. The imposition of brutal austerity drives in our peripheral nations is proof that the EU can get its way when it wants to. There is, for instance, no reason why the Big Bang described above cannot be combined with a memorandum with each member state regarding its spending and borrowing limits. If the current IMF-EU loans come with such steely strings attached, the Big Bang could also be so conditioned. Having said all this, I too reject this Big Bang idea, only for a different reason: Convinced that the Crisis is the result of our currency union’s faulty architecture, I see nothing in this Big Bang that would re-design it. It may well extinguish the flames of this bushfire but would do nothing to address the deeper structural faults permeating the eurozone.
Bank expropriation: In another version of the Big Bang, the ECB uses a variety of means to buy out most of Europe’s banks. Given that the vast majority depend on the ECB for liquidity, and get it in return for worthless collateral, the ECB could get tough on them and demand in return not collateral (which they really do not possess any more) but equity. In this manner, before long, the banks will be owned by the ECB. Then the ECB can do as it likes with the bonds owned by the banks it owns. A quick haircut, a restructure and consolidation of those banks, and a re-privatisation (Sweden-style) after existing shareholders are wiped out. In one swift move, the ECB will have cleaned up the banking sector and it will have dealt a serious blow upon the debt crisis.
Comment: This would be the logical, ethical and most effective way of dealing with the current twin (sovereign debt – banking) crisis. Alas, our leaders are not up to the task of confronting the bankers. In this era of bankocracy that has dawned after the Crash of 2008 (in which nothing pays like grand failure), the EU’s politicians would not dare even contemplate such a move. The reason, therefore, why our Modest Proposal does not mention this policy is that, in attempting to remain… modest, it seeks to stay within the boundary of political feasibility. In short, not to ask of our politicians deeds that are beyond their feeble capacities, even if such policies are sensible and highly desirable.
2. The Juncker-Tremonti Plan
As I (and Stuart Holland) have commented extensively on the JT in our recent posts (here and here), I shall not say much more on it, except to offer the following comment: The JT Plan has some excellent points (that it shares with the Modest Proposal) but also one major flaw: That it insists on eurobonds that are backed by each member state in proportion to its GDP. This is very, very silly. It suggests that Europe takes one step forward and at least another one backward. As Stuart Holland said recently, can you imagine Franklin Roosevelt ever suggesting that the US Treasury Bills be backed separately by California, Ohio and Wisconsin in proportion to their GDP? Or for their debts to be purchased by the Fed? The situation is terribly simple: The ECB should immediately be authorised to issue its own bonds (ECB-bonds or EU-bonds) for which only the ECB is liable. Then use the proceeds to finance the transfer of Maastricht-compliant tranches of existing debt from the member states to its own books (that is, member state bonds equal in value to 60% of the state’s GDP; the size of debt, that is, which Maastricht permits).
3. Walter Munchau’s suggestion that the EFSF be used to bail out Europe’s banking sector
Walter Munchau has been making the point we (Stuart Holland and I) have been hammering away at for many months now: It is a sign of Europe’s deep misunderstanding of its own crisis that all eyes are on the sovereign debt crisis when the crisis is unfolding at once in two realms – sovereign debt and a banking sector on the verge of collapse (and kept alive only by the kindness of the ECB). Munchau, as do we, laments the ‘bail outs’ which throw new, expensive loans onto insolvent states in return for austerity policies that only make the banking crisis worse. His suggestion (see here) is simple: Use the EU ‘bail out’ fund, the EFSF, to recapitalise banks rather than to lend to insolvent states.
Comment: There is no doubt that Munchau’s suggestion is better than the current policy. I would much rather the EU found a way of cleaning up the Irish banks than to lend huge amounts to the Irish state so that the latter can keep pouring money endlessly into its zombie banks. However, my objection to Munchau’s proposal has two aspects. First, it deals with only one of the Crisis’ two manifestations. (The current EFSF-based policy pours money raised by the EFSF into insolvent states whereas his preferred policy would have it that the EFSF-raised funds go into the banks.) What we need is a two-prong, simultaneous attack against both problems: the debt of states and the losses of banks. The second aspect of my objection concerns the very structure of the EFSF. To me, the EFSF is a throwback to the bad (not so) old days of the CDOs: By issuing its own bonds which include guarantees from different member states (with different creditworthiness), the EFSF’s own bonds have the structure of a CDO. (Click here for an essay in which I explain this.) In short, the EFSF is a problematic child of the current crisis that takes the form of the toxic derivatives which occasioned it. For this reason, it is part of the problem, not of its solution.
4. Thomas Mayer’s five point strategy
In a recent article in the Frankfurter Allgemeine, Deutsche Bank’s Thomas Mayer toed the Merkel line, rejecting eurobonds on the grounds that they would “turn the eurozone into a transfer union with unlimited liability” and thus “risk its survival in the absence of a genuine political union”. This monotonous response against eurobonds is, of course, based on turning a blind eye to the fact that the debate has moved on; that both the JT Plan and our Modest Proposal escape the accusation of unlimited liability by limiting the issue of eurobonds to a specific Maastricht-compliant percentage of GDP. In this sense, Mayer’s article would not merit a second look had it not contained an interesting alternative proposal. The latter comes in the form of a five point plan for addressing the euro Crisis:
- Step 1 – All member-states that may develop problems refinancing their debts in the future (by this I take it he means: Portugal, Spain, Italy and Belgium) must enter the EFSF immediately
- Step 2 – Extreme austerity measures to be adopted in all these countries
- Step 3 – Sovereign bonds to be exchanged for guaranteed bonds
- Step 4 – The member states that remain outside the EFSF (i.e. the surplus countries like Germany, Austria etc.) guarantee each other’s debt for up to 60% of their GDP, therefore shoring up their capacity to finance the EFSF
- Step 5 – The whole of the EU agree to a permanent disciplinary mechanism that involves punitive action against profligate member states, default mechanisms etc.)
Before commenting on this plan, it is useful to note the good news: It seems that the silly season (when German opinion makers repeated ad nauseum that tight fiscal discipline plus the existing bail outs would do the trick of stopping the euro crisis from spinning out of control) is well and truly over. Now, even Thomas Mayer feels the need to put forward a comprehensive plan – as many of us had done months and months ago. So, let’s look at his plan. What’s new in it?
Steps 1,3 and 4 is the answer. Step 1 seems to suggest that, to arrest the domino effect, and put an end to speculation about which of the heavily indebted countries will run to the EFSF next, all of them should enter its bosom instantly. Steps 3 and 4 try to address the question: Who will then manage to put up the mountains of capital that will be necessary if all these countries are to be propped up by the EFSF? The swap of sovereign for guaranteed bonds and the mutual guarantees (see Steps 3&4) are meant to reinforce the capacity of the surplus, low-debt countries to back the EFSF up. Finally, Steps 2 and 5 are mere re-statements of the usual invocation of discipline and austerity.
Comment: This is the least credible plan in the existing menu. First, Step 1 requires that the EFSF is expanded to almost €3 trilliion; a gigantic sum that must be raised in the open markets by the EU states not under the EFSF. Not only is the sum gargantuan, and will cause much consternation in the world’s markets, but it is to be backed by very few eurozone member-states (Germany, Holland, Austria, the Scandinavian countries and tiny Luxemburg). The proposal will, in fact, be laughed out of court by the likes of the UK, Poland, Slovakia etc., i.e. the non-eurozone EU members, who will be most reluctant to participate in the creation of this monster. Additionally, my caveat regarding the very nature of the EFSF continues to hold, only in this case with added power. Notice also that this proposal will do nothing to address the banking sector crisis while, by extending exceedingly harsh austerity macro policies to almost half of Europe, it is more likely than not to bolster the recessionary dynamic in the whole of the European continent. In the name of responsibility and discipline, Mr Mayer is putting forward a highly irresponsible idea.
Comparisons with the Modest Proposal
To remind readers who have seen our Modest Proposal of its main suggestions, and to relate it to those who have not, here are the three main steps we propose:
- Step 1 – Stabilisation: The ECB and the EU Commission convene a meeting between (a) the heads of the fiscally-challenged member-states, and (b) representatives of the European banks holding the former’s bonds. In a few hours a deal is brokered according to which the banks swap the existing bonds issued by debt stricken states for new ones with a much lower face value and longer maturity. In exchange, the ECB offers the banks guarantees of continued liquidity for at least five years.
- Step 2 – Reversing the crisis: The ECB takes on its books forthwith a tranche of the sovereign debt of all member states equal in face value to (the Maastricht-compliant) 60% of GDP. To finance this, it issues EU bonds that are its own liability (rather than backed by eurozone members in proportion to their GDP).
- Step 3 – Spearheading investment-led recovery: Empower the European Investment Bank to fund (drawing upon a mix of its own bonds and the new eurobonds) a pan-European large-scale eco-social investment-led program by which to put in place a permanent counter-force to the forces of recession in peripheries that keep dragging the rest of the currency union toward stagnation.
I conclude with the comparison of the above with the alternatives examined previously along four criteria: (a) Political feasibility, (b) Cost to European taxpayers, (c) Fairness, (d) Effectiveness in Dealing with the Crisis, and (e) Contribution to a Better Designed Eurozone.
In terms of political feasibility, all five proposals (the Modest Proposal and the four alternatives above) can be implemented without any changes in the Lisbon Treaty. This is important. However, the Big Bang approaches would prove impossible to pass the obstacles of the surplus countries’ objections. Mayer’s five point strategy would be music to many ears in the surplus countries (due to its emphasis on pan-European austerity) but would cost too much to implement and would split the EU up (between, on the one hand, the surplus eurozone countries and, on the other, eurozone member states like Italy who do not want to enter the EFSF as well as non eurozone countries like the UK who do not want to contribute massively to the EFSF). So, from the perspective of political feasibility, only the JT Plan, Walter Munchau’s suggestion and our Modest Proposal stand a chance.
Turning to the cost to the taxpayer, the Modest Proposal is by far the cheapest. Indeed, it would dismantle the EFSF and would put an end to the idiocy of asking German, Dutch, Slovakian etc. taxpayers to borrow money on behalf of the Greek and Irish states so that the banks can get monies which, given their sorry state, they will never lend to business. Instead, the ECB orchestrates a sensible haircut by these effectively insolvent banks and issues its own bonds on the open market. No one loses! (Even German bonds will experience no appreciable increase in their interest rates.) And given that these ECB-backed eurobonds are used to take on only the Maastricht-compliant part of the member states’ debt, there is no sense in which moral hazard is enhanced (that is, no defensible argument can be made that the peripheral states are given an incentive to spend and borrow without constraint).
Regarding fairness, the Modest Proposal comes on top once again. The negotiated haircut agreed to by the banks will appeal to all fair-minded people who recognise the simple truth that banks must bear part of the responsibility for the current mess. (And this includes Mrs Merkel, who is very keen to see private investors take a hit – only she postpones this ‘contribution’ to the next crisis!) Of all the proposals discussed here, only the Modest Proposal passes this simple fairness test (except of course the Bank Expropriation version of the Big Bang which, tragically, is too politically demanding and has been ruled out on the grounds of infeasibility).
Lastly, when it comes to effectiveness in dealing with the current crisis and their capacity to prevent a future one, the Modest Proposal is more appealing for two simple reasons: First, because its eurobond proposal does not included the highly suspect EFSF structure (or the idea that member states ought to back them up with new national loans) and, secondly, because it is the only plan that includes the provision of a new Marshall Plan for Europe, based on the active engagement of the European Investment Bank.
Until we see a plan that is better suited than the Modest Proposal to reverse the current crisis and set Europe on the path to recovery, we shall continue to canvass for it.